The national debt has entered the chat

There’s been heightened focus on the U.S. national debt since August 2026, when total federal debt outstanding surpassed $40 trillion. Clearly the trend is concerning, having grown more than 70% since the onset of the COVID-19 pandemic, along with persistent fiscal budget deficits and rising borrowing costs – both of which push the debt load higher.

In recent months, long-term U.S. Treasury yields touched their highest levels since 2007, reflecting the risk of ongoing imbalances between U.S. government spending and revenue collections (i.e., budget deficits) and the country’s heavy reliance on debt to backfill these shortfalls.

The short-term impact on the economy is mostly a “crowding out” effect, meaning funneling capital away from more productive spending and competing with funding private investment. It also leaves less flexibility for other government spending, especially if there’s a crisis. Additionally, it means higher-for-longer interest rates to finance everything for consumers and businesses. Over the long term, those cumulative effects hold down economic growth.

The U.S. is not facing a debt crisis nor at risk of default. However, failure to bring federal spending and revenue into better balance and lowering the country’s debt dependency over time likely risk negative outcomes, such as lower private investment that slows economic activity, structurally higher interest rates, further sovereign credit ratings downgrades, and damaged federal fiscal flexibility.

Background

Since its inception, the United States has relied on government-issued debt to finance its needs – for both liquidity and, more recently, budget shortfalls. At the end of the American Revolutionary War, the U.S. carried the equivalent of $2.5 billion in debt adjusted for inflation, owed primarily to France and some wealthy American citizens. The total sharply increased with the U.S.’s involvement in World Wars I and II to roughly $4 trillion before leveling off for decades. In the 1980s, significant tax cuts and increased military spending kicked off a new era of U.S. debt issuance. In the early 2000s, the U.S. Department of the Treasury issued federal debt to finance wars in Afghanistan and Iraq. In the late 2000’s, debt was used to provide economic stimulus in response to the Great Financial Crisis. 

Since the onset of the COVID-19 pandemic in 2020, the total U.S. debt load has grown by roughly $16 trillion to just over $40 trillion today, which equates to 123% of U.S. gross domestic product (GDP).

However, a better measure of U.S. debt is the federal debt “held by the public,” which removes approximately $8 trillion that the U.S. government effectively owes itself. The U.S.’s debt held by the public as a percent of GDP— known as debt-to-GDP ratio—currently sits at $32 trillion, or about 100% of U.S. GDP, up dramatically from 79% at the end of 2019.

Ballooning government debt is far from a U.S.-centric phenomenon. Since the COVID-19 pandemic, most developed market countries increased their debt load to support their economies, likely dampening the global market reaction to the U.S.’s 17% increase in debt-to-GDP.

Zooming out beyond simply the change since the pandemic, Japan and Italy are carrying higher debt-to-GDP ratios than the U.S. That said, while others have increased, most developed market countries’ debt-to-GDP ratios remain lower than the U.S.

Another important way to gauge the current debt situation is by looking at how much the U.S. spends each year on its interest payments to U.S. government bondholders. U.S. borrowing costs benefited tremendously from the steady decline in interest rates between the early 1980’s and 2020, particularly since 2008. That dynamic has changed.

Currently, annual interest paid is equivalent to roughly 3.3% of GDP and roughly 15% of total federal government spending. As a result of growing debt and higher interest rates over the past few years, the federal outlay for interest payments is the government’s fastest growing expense and the third largest behind Social Security and Medicare. The U.S. government now spends more on servicing its debt than national defense.

Persistent, large federal deficits have demanded robust government debt issuance to backfill the shortfall as interest rates climbed to multi-decade highs. Therefore, interest payments have grown significantly more burdensome. The U.S. is expected to issue roughly $2 trillion in additional debt in 2026 at still-elevated rates relative to recent history. Thus, while still manageable, the U.S. is likely to see its annual interest payments become a growing share of the budget for the foreseeable future.

It should be clearly stated that, despite the country’s rising debt burden and budgetary imbalances, U.S. government debt remains the safest and most secure marketable security in the world with virtually zero risk of default. The U.S. remains in a strong position to meet its debt obligations on outstanding U.S. Treasury bills, notes, bonds, inflation-protected securities, and floating rate notes. The U.S. Treasury market’s enormous size and investor demand also provide exceptional liquidity, which is unapparelled in global markets.

Still, the current fiscal backdrop has negative consequences. The amount of additional compensation investors demand in the face of uncertainty—known as term premia—recently touched their highest levels since 2011 which, in turn, contributed to the rise in long-term interest rates. In effect, global bond markets are penalizing the U.S. for its spending and debt burden. Absent sustainable solutions that address the fiscal imbalance and reduce the pace of U.S. debt issuance, these concerns are likely to persist.

This could fuel structurally higher yields, higher rate volatility, and keep government interest outlays on an upward trend. These threats were the impetus behind Treasury Secretary Scott Bessent’s decision to increase buybacks of U.S. government debt between 10- and 30-year maturities. It allows the Treasury to create a source of demand for outstanding debt with long maturities, retire those securities, and concentrate future issuance in the front end of the yield curve.

The short-term impact on the economy is mostly a “crowding out” effect. As interest payments grow and demand a larger share of the federal budget, less funds are available for more productive spending such as infrastructure, transportation, or education. The additional debt issuance by the federal government also competes against private investments.

It also leaves less flexibility for other government spending, especially if there’s a crisis. Additionally, it means higher-for-longer interest rates to finance everything for consumers and businesses. Over the long term, those cumulative effects hold down economic growth.

The U.S. debt and spending dynamics – mixed with heightened political polarization – have provoked the ire of major credit rating agencies. In 2011, S&P lowered its U.S. credit rating from AAA to AA+ for the first time in history in the wake of a particularly heated debt ceiling debate. S&P has maintained its AA+ rating ever since. In 2023, a similar debt ceiling standoff led to Fitch downgrading the U.S. from AAA to AA+. Last year, Moody’s lowered the U.S.’s Aaa rating to Aa1, specifically citing unsustainable budget deficits, debt servicing costs, and political discord in its decision. In our view, these credit ratings actions were (and are) a reflection of weak fiscal policies, deteriorating fiscal stability, and governance fissures that hinder productive debates. In reality, the U.S. still owns the most dynamic economy in the world and has every ability to pay its debts.

Thus far, credit ratings actions have been far more about the long-term trajectory of fiscal imbalances and leadership’s failure to address them than an immediate threat of default. While a U.S. default would have far-reaching adverse consequences for the U.S. and global economies, we believe the risk of non-payment to U.S. bondholders is virtually zero. Still, further rating or outlook downgrades could create increased market angst and even higher borrowing costs for the U.S. government going forward. It could also threaten the United States’s envied status among global government debt issuers. Higher U.S. Treasury yields would also increase financing costs for businesses and consumers on things like home mortgages, auto loans, and credit cards.

The situation demands the creation of a sustainable fiscal path forward – but there is no perfect solution. Over the coming years, a mixture of the following solutions is likely needed to reverse the current fiscal trajectory.

The primary source of revenue for the U.S. government is individual income taxes, which account for more than half of all receipts. Payroll taxes comprise another third of federal revenue, although those mostly fund Social Security and Medicare spending. It is likely that higher taxes – particularly on the country’s highest earners and corporations – may be implemented to address the persistent budget shortfalls. The remaining other sources – such as sales and excised taxes (on goods like gasoline and alcohol) along with custom duties (aka tariffs) – are much smaller but could be increased to generate revenue for the federal government.

While federal government spending is roughly 6% of GDP, so it isn’t a significant portion of GDP, it’s still about $7 trillion annually. Thus, government spending levels can have direct ramifications of the health of the economy. Areas that are likely to be placed under the microscope are the largest line items and are often political lightning rods – Social Security, Medicare, and defense spending. These debates will remain contentious; however, credit ratings agencies are likely to require the U.S. to review its spending levels across the entire budget and put forth a more sustainable playbook for the decade ahead. Additionally, it’s unlikely any agreement to raise taxes would come without spending concessions.

One way to improve U.S. debt-to-GDP ratios is by boosting the denominator in the ratio – GDP – via higher consumption. The U.S. government can support consumption by lowering taxes; however, current deficits make further tax cuts more complicated. Legislators can also pull several other levers to increase growth and productivity such as a greater emphasis on infrastructure investment and support the U.S. manufacturing renaissance. In this arena, artificial intelligence (AI) may offer a key investment opportunity that can increase domestic productivity, so long as AI doesn’t result in permanent displacement of workers.

One of the most reliable ways to achieve lower interest rates is through the Federal Reserve (Fed) conquering inflation. Using history as precedent, returning inflation to the Fed’s long-term target of 2% should encourage two outcomes. First, Fed officials could lower the Fed funds rate. Secondly, U.S. Treasury yields should trend lower across the yield curve. In turn, lower U.S. Treasury yields would mean more palatable borrowing costs. We expect inflation to approach the Fed’s 2% target over the next few years, but it may settle slightly above that threshold. Additionally, we do not expect the Fed to lower policy rates back to the historic lows seen after the Great Financial Crisis or COVID-19. Therefore, U.S. borrowing costs should improve in this scenario, but remain higher relative to recent history.

The U.S. is not facing a debt crisis and is well-positioned to meet all its debt obligations for years to come. U.S. government default risk remains the lowest in the world. There are clear-but-difficult solutions to address the country’s long-term fiscal sustainability. However, if the latest trajectory for debt and deficit growth continues over the next decade, the outlook turns more worrisome. The U.S. could face negative consequences such as credit rating downgrades or higher borrowing rates imposed by market participants – but not default.