Public Debt: The End of the Welfare State?

The Pivot Between Political Choice and Market Compulsion

July 2025

Complacency, Crisis and the Promise of Infinite Refinancing

The question lenders to both advanced and developing countries use to ask was whether the borrower could repay its debts. Over time, those questions morphed into whether, and on what terms, the borrowing country could refinance thosedebts. In more recent times, during the zero/negative interest rate era, it often seemed as though no questions were asked at all.

That complacency fueled an explosion of public debt. In 2024, global public debt surpassed 100% of world GDP. The U.S., the borrower most able and willing to satisfy market appetite for liquid debt securities, took advantage, and increased its borrowing as if funds were free, because, at zero rates, it was. The IMF projects that by 2030 U.S. debt-to-GDP ratio will exceed 127%, with federal interest payments set to consume 14% of all government revenue, more than what is projected to be spent on education, infrastructure, and research combined

The origins of today’s debt surge include once-in-a-generation shocks such as the 2008–09 financial crisis and the COVID-19 pandemic that forced governments worldwide to deploy massive fiscal firepower. Central banks understandably supported this surge with exceptionally low interest rates and balance-sheet expansions, making large-scale borrowing sustainable. Now, a reckoning is in sight. But neither political leaders nor populations appear willing to tolerate comprehensive repayment plans that require trade-offs, but instead rely on the assumption that refinancing at benign rates can continue indefinitely and/or that AI will magically stimulate growth sufficient to grow out of increasingly unsustainable government balance sheets.

Washington’s Magical Budget, Denial and the Erosion of Fiscal Credibility

Nowhere is the tension between fiscal rhetoric and market reality more acute than in the United States. The latest chapter in Washington’s budgetary theater involves a clever legislative maneuver by the Senate: applying the so-called “current policy baseline” to budget reconciliation legislation that will chart the course for the world’s largest and most important economy for the next decade. This tactic effectively reclassifies the 2017 tax cuts as permanent, even though they were explicitly drafted to be temporary. If the “current law baseline” was applied, the Congressional Budget Office estimates the current plan will increase the deficit by $2.8t over the decade. But, if the current policy baseline is used instead, those earlier tax cuts are assumed to add nothing incremental to the deficit. That $2.8t deficit thus becomes a $1.4t surplus. This accounting sleight-of-hand allows policymakers to make over $4t in projected deficits disappear – on paper – while doing nothing to actually address the actual trajectory of federal obligations or interest costs.

Meanwhile, tariff and trade policy has followed a similarly dangerous trajectory, threatening negative impacts on global trade and economic activity that would damage virtually everyone, but with the promise of tariff revenues that would be paid by someone, but not the American public, and where the costs are seemingly disregarded. This month (June), the trustees of U.S. Social Security and Medicare funds estimated those funds are projected to be exhausted by 2033, one year earlier than last year’s estimates. But reforming those programs is politically unpopular, and today’s politicians from both parties seem unwilling to acknowledge the obvious. When credit rating agencies, or central bankers, highlight these dynamics, they are scorned by policymakers. But private markets are increasingly taking note, with U.S. borrowing costs and the value of the dollar both showing signs of strain.  

Rising Rates and the Return of Market Discipline

To proceed down this path, requires those providing the capital to pay for the social spending to go along. Which they seem willing to do, for now, though the era of zero interest rates is over, and so the most direct effect of current policies is mounting debt service costs. Even marginal uplifts in longer-term interest rates can rapidly balloon annual interest payments. If financial markets exercise their “bond vigilante” role, political actors, eternally complacent in the deferral of tough decisions, are likely to find fewer options available. Either they confront rising debt explicitly, or the markets will impose a reckoning for them, either through steadily rising long term interest rates that choke off growth or something more abrupt that leads to a loss of fiscal flexibility in the event of a crisis.

This brings us to the paradox of private market discipline. In theory, private investors rationally price risk. When they demand higher yields, or worse, stop funding entirely, they force governments to restrain deficits or enact structural reforms. But in practice, this response is neither predictable nor equitable. Sovereign borrowers face volatility in whichcapital may flee on the whiff of political uncertainty or external shock. Fiscal austerity then arrives involuntarily, potentially forcing cuts to socially vital programs, including education, healthcare, social safety nets, to appease financial markets, whose discipline is real, but who lack the tools to target specific areas of fiscal and political irresponsibility. When governments dodge tough budgetary reckonings, the risk is that eventually private investors, central banks and other quasi-official sector providers of capital, deflate illusions, and inflict discipline politically, socially, and economically.

This dynamic underlines the core question: Who disciplines the state, and how? Ultimately, the sustainability of the welfare state rests on a willingness to reconcile social promises with market realities. Responsible government balance sheet management and adoption of sound, even if sometimes politically unpopular, policies, evidence that fiscal credibility and social equity are not mutually exclusive. But neither is assured in the absence of investor confidence. 

For all the well-founded criticisms of the Maastricht rules and its uneven implementation, the Euro area at least maintains an active dialogue that accepts fiscal discipline as a goal, in contrast to the untethered discussions in Washington. For a welfare state to survive, governments must actively choose to self-limit, through deference to some discipling mechanism that presses for necessary and credible entitlement reform, or adjustments in tax and spending grounded in public deliberation. When political leaders instead opt for budgetary sleight-of-hand, they effectively risk ceding control to markets- or foreign creditors. Neither is designed to care for welfare objectives. Markets care about yields; foreign states care about leverage.

The Crossroads: Political Choice vs. Market Compulsion

It circles back to the baseline debate in Washington. If Congress were compelled to rely on the current law, not policy, baseline, the present drift toward debt escalation would become more transparent. It would highlight necessary trade-offs. Faced with stark numbers, political discourse might even become real referenda on debt and clear choices on spending and taxation.

What does this all mean as we convene in France to debate “Public Debt: The End of the Welfare State?” We are not witnessing an end so much as a crossroads. Public debt is today the pivot point between political choice and market compulsion, between fiscal citizenship and creditor edict. The path to a more stable welfare model is not hidden. It is familiar. It lies in openness, credible institutions, and political courage. It lies in telling voters the truth about intergenerational liabilities, in aligning budgets with societal values, and in reshaping how creditors engage in distress. It will demand the very essence of democratic leadership.  I am not naive.  Jean Claude Juncker’s observation that: “we all know what to do, but we don’t know how to get re-elected once we have done it,” remains true today, perhaps more so in an era of social media amplification of populist memes and unrealistic popular expectations derived from zero interest rates and COVID entitlements. 

But, to allow markets to provide the discipline that politics cannot, is to put at risk the state’s social mission. That, at the end of the day, might be the greatest danger we face.

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Written specifically for the Rencontres.

Douglas Rediker is non-resident Senior Fellow at the Brookings Institution in Washington, D.C., USA.