ABSTRACT
This chapter examines some potential problems that could be caused by large persistent deficits. It identifies conditions that could lead to runaway debt. Debt service has a momentum of its own, a momentum determined by interest rates, and by the rate of increase in individual's income. Federal income taxes reduce the effective rate that government pays on its debt, but by a reverse process. Whereas the individual benefits by reducing his tax liability, the federal government benefits by increasing its revenues because the public pays taxes on some of the interest payments. The nominal interest rate overstates the real cost of debt in an economy with inflation. Even if debt is not explosive, a persistent structural deficit in the neighborhood of 5% of gross national product (GNP)—as projected by the Congressional Budget Office (CBO)—poses a serious threat to long-term economic growth. The danger stems from the current imbalance between domestic savings and credit demands—an imbalance that is likely to continue.
