Why does America owe so much Debt?

Why does America owe so much Debt

America is the most powerful economy yet the most indebted country. How? Let’s explore.

The United States of America’s economy is considered the most powerful and strongest economy in the world. An economy that perhaps most countries look up to as a role model. Surprisingly, this superpower economy is the world’s largest debt-taking economy. According to May 2022 data, the US owes $30.49 trillion in debt. In addition to it, America is the largest indebted nation. The US has been continuously hitting its debt ceiling for many years.

Why America needs so much debt?

Taking debts is not a strange thing. Governments worldwide have been using it for several centuries to finance their spending. After WWII, the US debt was 100% of its GDP and it has reached its maximum.

  • The main reason for this high debt is Federal Budget Deficit. The US Treasury Department collects tax and gives it to the federal government and most of the time its revenue collection is lower than its spending. It is called a budget deficit.
  • The second reason is that America is a consumer-based country. Their living standards are so high. In fact, 23 trillion dollars of GDP is not enough to sustain their living standards. That’s why it takes debt to give its citizen a standard lifestyle.

To understand its spending, one needs to understand its budget structure:

Mandatory spending in America includes

  • Social security
  • Federal pensions
  • Medical care
  • Disability funds
  • Military salaries

The US population is an aging population. Its young and productive people are being replaced by retired and old age people. That’s why its mandatory spending is constantly being increased.

Discretionary spending

  • Military
  • Education

More than half of this portion is spent on military expenditures. After all, America is the world’s superpower. In 2019, the defense budget was 700 billion dollars which is equal to the combined budget of the seven largest militaries after the US.

Debt interest payments

Apart from this spending, the huge tax cut is also a reason for low government revenue. The US government thinks that tax cuts can contribute to GDP. In 2017, it was expected that tax cuts will boost the GDP by 1% each year, but it is not the case in reality. On the other hand, these tax cuts decrease the government revenue consequently reducing the budget size.

Who owes this Debt to America?

Ironically, 40% of the debt is held by the American government. The US government secures its money for mandatory spending in bonds. Moreover, 1/3rd of the debt is owed to American companies, investors, banks and insurance companies, local government, and pension funds. Overall, 70% of the debt is owned domestically in the US. The rest of the 25% is held by foreign investors. Among countries, Japan holds 4.4% of the total debt of the US. India also has a debt of 216 billion dollars over the US as per the data of 2021.

Why do developing countries give so much debt to the US?

The US is the largest importer and it pays in the dollar for the import.  The world uses this currency as a reserve. Countries purchase treasury bills from the US to maintain their forex reserves. These bills can easily be cashed during any crisis. Such bonds of the US government are considered the safest investment. Though the interest rate is low on these bonds, this is the best way to increase foreign reserves. The US government never defaulted on payments of such bonds. That’s why countries prefer to put their capital in these bonds instead of their markets.

What could be the possible way forwards?

The government should try to redefine its spending smartly. It needs to prioritize its expenditure better. Real issues need to be given preference during spending. Government should reformulate welfare programs and policies. It should also change the tax structure in a sustainable way.

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