U.S. debt: how is it going to end?

I've not written on this blog for several months, but reading another article on the debt got me started again.

According to a recent article in the USA Today, the U.S. government has $61,600,000,000,000.00 of unfunded liabilities as of the end of 2010 (using GAAP). How do we get out from under this mountain of debt?

Can we just raise taxes for those making more than $250,000 per year?
Let's think about the numbers a bit more. $61.6 trillion works out to each household in the country owing $527,000 -- more than 10 times the average annual gross household income! Even if we decided to take 100% of EVERYONE's personal income in taxes, it would take more than 10 years to pay off that debt. Obviously this is impossible. Raising taxes on everyone won't do it, much less raising them only on the "rich".

Can we reduce the debt directly?
We could eliminate roughly half of it with some fairly straightforward reductions in the two largest sources of this debt: Medicare and Social Security. Since both program were introduced to help care for people living beyond their expected lifespan, the current qualifying age is artificially low. Gradually increasing the qualifying age for both medicare and social security would dramatically reduce future obligations. It could be done so that people within 10 years of the current qualifying ages are unaffected, perhaps increasing it 1 year for those 10-20 years away, 2 years for those 20-30 years away, and 3 years for those 30-40 years away (and so on until the qualifying age is older than the expected lifespan, as it was when Social Security was established).

Even though this seems reasonable intellectually, it is politically untenable. Look back at the reaction to the President's bipartisan National Commission on Fiscal Responsibility and Reform's proposal to raise the Social Security qualifying age by 2 years starting in 2075 (for those currently 64 years away from retirement!) Dozens of Senators and Representatives quickly made announcements they would not support such "radical" reform and instead "protect" Social Security (by letting it go broke :(

As I've written before, a huge reduction in the Social Security liability could be made by retaining the current maximum benefit limits (still adjusting for inflation). Simply eliminate the regressive maximum annual contribution limit (in 2011, only the first $106,800 of income is subject to Social Security taxes). However, this doesn't fully solve the problem for Social Security and it does nothing to reduce the even larger Medicare obligations. Raising qualifying ages seems the most rational approach.

Can we inflate our way out of it?
By printing more dollars, the U.S. government makes the value of each individual dollar less: production costs increase, goods and services become more expensive, employees demand higher salaries, etc. You can already see the beginning of this, with the U.S. Dollar losing roughly 20% of its value against other currencies in the past year. Things we import from elsewhere (such as oil) cost more. Oil price inflation is particularly insidious, as it dramatically impacts transportation costs for everything. Although inflation greatly hurts savers (such as retirees living off their savings), it's beneficial to debtors (since they pay back their debts with currency that is worth less).

Unfortunately, nearly all of our obligations are adjusted for inflation, with automatic "cost of living" adjustments. So, while we end up paying back the debt with lower-value dollars, we end up owing more, so inflation doesn't help. Overall, because of the effect of inflation on the rest of the economy, it's more detrimental than beneficial, unless perhaps we could break the automatic inflation increases to benefits. However, we know that is politically infeasible and harmful to recipients.

Can we grow our way out of it?
Theoretically, this would be a great solution. A strong economy would generate more business income, jobs, personal income, and thus increase the taxes available to pay these debts. However, this appears extremely unlikely. We seem to have little control over our economic growth, and as the well respected research of economists Carmen Reinhart and Ken Rogoff show, once debt reaches a certain level near 100% of GDP, economic growth declines dramatically. By the way, if you don't mind a lot of data and charts, check out their book: This Time Is Different: Eight Centuries of Financial Folly. Our national debt (not the $61.6 trillion in future obligations, but "only" the $14.4 trillion we explicitly owe now) is now over 95% of our current $15.1 trillion GDP. So, no, we almost certainly can't grow our way out of this debt.

Will we end up defaulting?
Defaulting means that we would not pay our obligations. We'd probably continue to pay our external debt as long as possible, so we could continue to borrow money. However, without another solution, we'll be forced to stop paying for something. What would go first? Would we start by cutting Medicare coverage, perhaps actually creating the "death panels" that were fictionalized in the 2009 national health care discussions, and then continue reducing medical benefits? Perhaps repeated cuts in pay for all government employees? Fire lots of them? Eliminate most of the military? Gradually reduce Social Security payments until we have to eventually get rid of the program altogether? The choices would not be easy and they would hurt lots of people. And then what happens? Increased suffering, poverty, illness, homelessness, and even starvation?

Yet, if we can't make the difficult decisions to be financially responsible now, it will be worse when we are finally forced to do so later. Every year we delay reducing our obligations, the cuts have to be bigger and the likelihood of passing them in Congress decreases. Sadly, default seems the most likely scenario to me, and I am frightened by the prospect.

What do you think?
Please leave a comment with your thoughts on the subject.