Ethermac|Ballooning U.S. budget deficit is killing the American dream

The Ethermacgovernment’s deficit problem is creating an income problem for Americans, economists warn.

Last week, the Congressional Budget Office raised its estimate for the government deficit this year by a whopping 27%, or $408 billion over its February forecast, to $1.9 trillion.

Paying for that debt can divert money away from private investment, which in turn may dampen wage growth, economists say.

“The exploding debt could cause as much as a 10% reduction in wage income within 30 years,” said Kent Smetters, a University of Pennsylvania Wharton School professor and faculty director of the Penn Wharton Budget Model.

Based on the median household income of about $75,000, that’s as much as a $7,500 reduction in income in current dollars for the average household every year, he said.

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How does national debt hurt salaries?

The increased national debt estimate is due partly to student-loan relief measures, higher Medicare expenses, and Ukraine aid, CBO said. Additionally, CBO sees the deficit in the decade ahead rising to $22.1 trillion, $2.1 trillion more than its last forecast.

To pay for increasing spending, the government issues debt like Treasuries and bonds with higher interest rates to attract investors. When investors put money into government debt, they do so at the expense of more productive private investments – what economists refer to as the "crowding out effect."

Private investments might include the development of new products and technologies, construction of buildings and roads through loans, or buying company stock or bonds

CBO estimates that for every dollar added to the deficit, private investment loses 33 cents, which diminishes economic growth and wages over time.

CBO expects federal debt held by the public to rise from 99% of gross domestic product in 2024 to 122% in 2034, surpassing the peak of 106% reached in 1946, immediately following World War II.

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Will Americans actually see their paychecks fall?

No, because it’s a drop in potential earnings. It’s money Americans just won’t ever receive.

Still, Americans, especially younger and future generations, will feel the loss with a lower standard of living. Not only will the economy and wage growth slow, but there’s potential for higher taxes and interest rates, economists said.

The federal government may have to raise taxes or offer higher interest rates on its bonds to attract buyers to service the debt. A 2019 CBO study found that every 10% increase in the debt-to-GDP ratio translates into a 0.2 to 0.3 percentage point increase in interest rates.

How can government prevent this?

Many economists agree that a combination of slower spending and higher tax revenue would help shrink the deficit.

But whether a polarized Congress can agree on a plan is debatable, they say.

“It is easy to point fingers, but both parties are to blame for our country’s fiscal condition,” wrote Sens. Joe Manchin, a Democrat from West Virginia at the time but has since switched to Independent, and Mitt Romney, R-Utah, and U.S. Reps. Bill Huizenga, R-Mich., and Scott Peters, D-Calif., in an op-ed in January. And “getting out of this mess will require putting aside the political posturing.”

They noted “the national debt has now exceeded $100,000 for every person in the United States. Given the imminent nature of this crisis, continuing to turn a blind eye will only put the American Dream further out of reach for our children and grandchildren.”

Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.