A new Penn Wharton Budget Model analysis suggests that the United States may be approaching the limits of how much federal debt the economy can sustainably support, raising concerns about the long-term consequences for future generations.
Earlier this month, Business Economics and Public Policy professor Kent Smetters and graduate research fellow Hangjun He published a report estimating that U.S. federal debt cannot realistically exceed around 210% of gross domestic product “before financial markets cease to lend at any feasible tax rate.” Under current projections, the report found that the federal government could reach that threshold within the next two decades.
“Above this level, there is no feasible future additional tax on broad-based labor income that can finance the interest payments at the returns demanded by financial markets,” the report stated.
The researchers emphasized that the estimate is not a prediction of when a fiscal crisis will occur. In an interview with The Daily Pennsylvanian, Smetters — the faculty director of the Penn Wharton Budget Model — said that “the real way to think about it is that it is a strict outer bound,” adding that “capital markets could unravel long before we hit that limit.”
“It’s basically computed under the assumption that Congress and the president will eventually get their act together and figure out some kind of sustainable plan,” Smetters said. “So capital markets keep believing that to be true up to the point where it’s not mathematically possible for that to be true anymore.”
The analysis examined how federal debt, health care spending growth, and future tax burdens interact over time. The researchers estimated that under higher health care cost growth scenarios, policymakers could be forced to make significant fiscal adjustments by 2045. The report also estimated a 25% chance of the debt limit being reached within 14 years.
According to the report, stabilizing debt at the projected outer limit would require “a permanent additional tax of about 15 percentage points on all (uncapped) labor income.”
“This would be larger than the tax that’s currently collected for Social Security and Medicare Part A with both employees and employer pay,” Smetters said.
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The report also warned that financial markets could react before debt reaches its theoretical limit if investors lose confidence in the federal government’s ability to restore fiscal sustainability. Smetters pointed to the market turmoil that followed former British Prime Minister Liz Truss’ fiscal policies in 2022 as an example of how investors can rapidly reassess a government’s fiscal outlook.
“Bond markets often, if they think it’s going to lead to fiscal irresponsibility, respond by demanding much higher interest rates to compensate for taking on that debt,” Smetters said.
Health care spending growth is one of the largest factors affecting how quickly the United States could approach unsustainable debt levels, according to the report. As more people retire and health care costs rise, those expenditures are expected to consume a growing share of federal spending.
“Without fundamentally reforming health care, we’re not going to have much of a shot of really dealing with the problems underneath,” Smetters said. “It’s a very big driver of future spending.”
Smetters explained that rising debt results in higher taxes, less capital formation, lower wages, and higher interest rates. He noted that those effects would impact younger Americans, who he believes will be generally “better off” compared to prior generations yet still live with the long-term consequences of today’s fiscal decisions.
“Typically, we pass along a better world to younger people than we inherited ourselves,” Smetters said. “This is the first time where that may not be true.”
