By James McBride, Council on Foreign Relations

With the U.S. national debt expanding rapidly over the past decade, the state of the federal budget has come under intense scrutiny. The annual deficit spiked following the 2008 financial crisis, and budget analysts say that without reform government spending will continue to outpace revenue.

As President Donald J. Trump prepares his administration’s first budget proposal, his ambitious plans for new spending and tax cuts have unnerved some fiscal conservatives who would like to see deficit reduction. Meanwhile, the dependence of the United States on foreign investors to finance its debt has raised renewed questions over the U.S. economy’s vulnerability to foreign governments or shifts in investor sentiment.
What is the U.S. government’s fiscal position?

In the wake of the 2008 financial crisis, both the U.S. deficit and debt spiked for several years as the federal government collected less tax revenue and increased spending to counteract the downturn.

The 2016 budget deficit was roughly $600 billion, with the federal government spending $3.9 trillion while taking in $3.3 trillion in revenue. This amounts to about 3 percent of gross domestic product (GDP), down from nearly 10 percent in 2009. The average over the past five decades has been 3 percent.

Publicly-held debt has nearly doubled since 2007, rising from about 40 percent to nearly 80 percent of GDP.

Since the start of the crisis in 2007, total U.S. government debt has roughly doubled. Debt held by the public—the measure of how much the government owes to outside investors—stands at $14.4 trillion. It has nearly doubled since 2007, rising from about 40 percent to nearly 80 percent of GDP. (Counting intragovernmental debt, or debts owed by one U.S. government agency to another, brings the total to nearly $20 trillion, more than 120 percent of GDP.)

Without any further spending, the Congressional Budget Office estimates that the debt will grow by $9.4 trillion over the next decade.

How would Trump’s budget plans affect it?

Trump has yet to fill out many of the details of his administration’s budget plans, which are expected by mid-March, roughly in line with most new administrations. Funding for the current fiscal year expires on April 28.

But based on his campaign pledges, many analysts say Trump’s policies would be likely to significantly widen the budget deficit.

  • Trump has promised to not make any cuts to entitlements, welfare spending that includes Social Security, Medicare, and Medicaid. Entitlements make up both the largest and fastest-growing chunk of the federal budget—nearly half of all spending—and economists project that failing to reduce their rate of growth will be the biggest contributor to the deficit in the coming decades.
  • Defense spending totaled $584 billion in 2016, and Trump has promised to “rebuild our military” by adding fifty thousand soldiers, expanding the Navy’s fleet, and adding planes to the Air Force. He has not released cost estimates.
  • Infrastructure is another area in which Trump has promised major spending, floating the idea of a $1 trillion plan. He has said that the vast majority of that would come from private investors, incentivized by tax breaks that could total $137 billion. Another administration priority is building a wall along the U.S.-Mexico border, which estimates put between $12 and $25 billion.
  • The tax reform plan Trump released during the campaign includes cuts to both corporate and individual taxes, and experts say it is likely to significantly increase the deficit. Trump, like some other Republicans, says that cutting taxes will boost growth and thus increase government revenue. Analysts including the nonpartisan Tax Foundation, however, estimate that even accounting for accelerated growth, Trump’s tax plan would increase the deficit by $2.6 trillion to $3.9 trillion over the next decade.
What about the debt ceiling?

Congress has long tried to exert control over federal spending by placing a limit on U.S. debt. This “debt ceiling” has been raised fourteen times since 2001. During the administration of President Barack Obama, Republicans in Congress used it as a bargaining chip in 2011 budget negotiations. While the ceiling was ultimately raised in that instance, the standoff led investors to question the U.S. government’s ability to pay its debts and drew the first-ever downgrade of U.S. debt, from the ratings agency Standard & Poor’s. In 2013, and then again in 2015, Congress voted to temporarily suspend the limit.

The current suspension expires in March, and Trump administration appointees have signaled differing philosophies. Treasury Secretary Steven Mnuchin has warned of the dangers of defaulting, while the director of the Office of Management and Budget, Mick Mulvaney, has previously favored  using the debt limit to push for spending cuts.

How does U.S. debt compare to other countries?

The United States’ debt-to-GDP ratio is among the highest in the developed world. Among other industrialized countries, the United States is behind only Belgium, Portugal, Italy, Greece, and Japan.

The United States, however, benefits from the U.S. dollar being considered the most stable and desirable currency in the world. High demand for the dollar as the global reserve currency means that the United States can finance its debt more cheaply and easily than most other countries.

Who holds the U.S. debt?

The bulk of U.S. debt is held by investors, who buy U.S. Treasury bonds at varying interest rates. This includes both domestic and foreign investors, and foreign governments as well as private funds.

Foreign holders of U.S. debt have received particular scrutiny. Foreign investors hold roughly 43 percent of the total, amounting to about $6 trillion. As the Congressional Research Service explains

[PDF], about two-thirds of foreign-held U.S. debt is held by governments.

By far the two largest holders of U.S. Treasuries are Japan ($1.09 trillion) and China ($1.05 trillion).

By far the two largest holders of U.S. Treasuries are Japan ($1.09 trillion) and China ($1.05 trillion). China had been the United States’ largest creditor for nearly a decade, but it was surpassed by Japan in 2016, according to U.S. Treasury data. No other country holds more than $300 billion.

Does foreign financing of the debt matter?

Steady demand from foreign creditors has allowed the United States to borrow money at relatively low interest rates. But some policymakers have raised concerns over the potential dangers of a single country, China in particular, using its holdings to to put pressure on the United States. Some economists have warned that a sudden sell-off of U.S. debt could spike interest rates, sharply increasing U.S. borrowing costs and potentially causing an economic crisis.

In 2015, for the first time in more than a decade, foreign investors purchased fewer U.S. Treasuries than they sold. That trend accelerated in 2016, with foreign holdings dropping by $201 billion. While China and Japan still hold the lion’s share of U.S. foreign debt, both countries reduced their holdings in 2015 and 2016.

Some investment analysts have raised fears that uncertainty over the new administration’s intentions are leading investors to drop their holdings as a “warning to Trump.” However, CFR’s Brad Setser points out that the drop pre-dates Trump. Instead, he says, it primarily reflects foreign governments’ own economic policies. For instance, he says, Japan’s government decided that it wanted to hold fewer long-term bonds and more cash, while China has been selling its reserves to support its currency. And while some central banks may be reducing their holdings of U.S. bonds, foreign private investors have been increasing their purchases. Ultimately, Setser says, there is little sign yet that foreign investors are losing their appetite for U.S. debt, particularly when many large countries continue to run large trade surpluses.

Additional Resources

The U.S. Treasury provides daily tallies of the total U.S. publicly held as well as intragovernmental debt.

This 2016 Congressional Research Service report [PDF] explains the dyamics of foreign ownership of U.S. debt and discusses some of the leading concerns.

The Congressional Budget Office highlights the primary sources of U.S. government spending, as well as the historical trends of debt and the deficit.

Donald Trump’s tax plan would boost the economy, but likely not enough to make up for the plan’s lost revenue, explains the nonpartisan Tax Foundation.