Official forecasts from the nonpartisan Congressional Budget Office (CBO) suggest the national debt is growing unsustainably. Over the coming decades, public safety net programs like Social Security and Medicare are projected to consume an ever-larger share of the budget, crowding out spending on vital public needs like infrastructure and defense. The CBO forecasts that the nation’s debt burden—which is already historically high at 78 percent of GDP—will nearly double within a decade and a half. At that point, the federal government would need to borrow significantly from bond markets to finance mandated expenditures.
This scenario could push interest rates up sharply. The growing national debt could leave little capital to fund private sector investments, such as capital expenditures for construction or research and development projects. As businesses struggle to secure financing, the nation’s growth potential could be further diminished.
Despite the looming credit crunch, bond markets remain tranquil. The yield on the 10-year Treasury bill sits just 1 percentage point ahead of inflation. Bond investors appear skeptical of some of the assumptions underlying the CBO’s dire forecast.
Very few investors question the CBO’s analytic rigor, but its baseline assumptions are open to debate. The office’s forecasts are based on current law—its projections cannot assume that Congress will make any future legislative changes to improve the nation’s balance sheet.
While legislators are best served by economic forecasts based on current law, investors realize that the economy is dynamic. The bond market seems optimistic that a political solution will emerge to mitigate the country’s fiscal troubles before the crisis arrives.
If the economy’s growth rate were to exceed expectations by a single percentage point, the nation’s long-term fiscal outlook would brighten significantly. Boosting growth by 1 percentage point is far from impossible—the CBO’s forecasts assume that the economy will expand by just 1.9 percent annually in the coming decades, far below the 20th century’s 3.5 percent annual average.
The CBO’s projections align with the current business cycle; although the labor market has recovered over the last decade, GDP has expanded slowly at an average 2.2 percent annual growth rate.
This slowdown likely reflects a new demographic reality in the United States as the overall population ages. Longer lifespans among baby boomers mean that America’s working-age population will grow more slowly than the number of retirees in the coming years. With relatively fewer workers contributing, revenues from payroll taxes alone will be insufficient to support healthcare and pension programs for the elderly. The government would be forced to go to the bond market to make up the difference.
For some Midwestern and Northeastern states, demographic trends are exacerbated by older residents migrating to warmer southern climates. The total population of Illinois, for example, is growing about half a percentage point more slowly annually than the national average, leaving a smaller workforce to support state pension programs and maintain existing infrastructure.
If the workforce were to grow more rapidly, the nation’s fiscal outlook would improve. The economy could certainly accommodate more workers. Full employment has arrived, yet 7 million jobs remain unstaffed. If businesses’ demand for labor were fully met, GDP growth would accelerate by approximately half a percentage point.
A larger workforce would contribute more to payroll taxes, placing public safety net programs on firmer footing. It would also boost the economy’s growth potential, and faster growth would reduce the deficit’s share of GDP and create less strain on capital markets from future borrowing.
Finding more workers shouldn’t be difficult. The next generation of workers has already been born, but not all of them have moved to the United States yet. If immigration reform boosted the workforce’s growth by half a percentage point annually, the deficit would become far more manageable.
Immigration reform alone can’t entirely fix the nation’s budgetary issues. Controlling the growth of healthcare costs and investing in worker productivity will also be necessary. But increasing the size of the workforce can give the nation more flexibility—and more time—to address its fiscal challenges.
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