Keating: Coming Together on Government Debt
by Maryann O. Keating, Ph.D.
Personal advice like, “Don’t buy a house costing more than three times your annual salary” or “Mortgage payments should be no larger than a quarter of your take home monthly income,” are useful. In these contentious times, wouldn’t it be great if Americans, regardless of political persuasion, could adopt a rule of thumb regarding Federal budget deficits?
The federal government in 2020 spent about $26.3 out of every $100 produced. Approximately half of all Americans would prefer the government to spend more and the other half, less. That’s politics, but government debt hygiene is a separate issue.
In 2020, U.S. Federal government spending resulted a record budget deficit equal to 14.9 percent of GDP, the dollar value of everything produced. The 2020 deficit as a share of GDP hasn’t been this high since WWII. Total federal debt outstanding, the accumulation of previous deficits, now exceeds 100 percent of GDP.
About 23 percent of total U.S. government debt is held by agencies like the Social Security Trust Fund. Foreign governments hold about a third of the remaining public debt.
Can a nation run deficits and increase its national debt indefinitely? In a worst-case scenario, high interest payments on national debt captures such a large percentage of tax revenue that a government is forced to default. Then, residents and foreign lenders will refuse to hold or purchase additional government bonds. Finally, revenue from the sale of government securities will be swapped for ownership of public and domestically owned assets. At this point, international organizations, in return for providing needed financial relief, will dictate domestic economic policy. No wonder economics is called the dismal science.
Some economists express little concern over government spending and minimize the warnings of others from both political parties. They argue that government debt is essentially different from private debt.
Governments are theoretically able to borrow from the future indefinitely by rolling over bonds as they come due. However, this implies that people continue to buy and hold government treasuries. Fortunately, for the United States, the public at home and abroad have been willing to hold dollar denominated bonds issued by the Treasury to finance its annual deficits. Holders trust that the U.S. government remains in a position to increase taxes to meet future interest payments and, furthermore, is committed to maintaining the purchasing power of the U.S. dollar.
Can a government inflate its way out of debt, essentially paying back dollars worth less than when the bonds were originally issued? Perhaps, but this assumes some naiveté on the part of bondholders who will eventually catch on to the scheme and require bonds with higher interest rates and shorter terms to maturity. Attempts to inflate away the debt burden would also require some monetary policy gymnastics on the part of the Federal Reserve to repress interest rates as well as guarding against moderate inflation morphing into hyperinflation.
Ultimately, tax revenue relative to government spending is the key. The U.S. has experienced a Federal budget deficit each year since 2001.
Deficits and increasing debt occur whenever government spending exceeds taxes collected. Surprisingly, given the 2020 decline in GDP, Federal tax revenues have not fallen as precipitously. How can this be? Tax reform and deregulation put the pre-2020 national economy on a sturdy foundation. Similarly, Indiana tax revenue appears to have declined less than 1 percent between 2019 and 2020. This is good news, indeed. However, going forward, it is essential that new taxes, regulations and other programs not suppress the economy and inadvertently result in reduced tax revenue.
Congress, the national and state administrations and we the people have used the pandemic to justify an unprecedented spending binge. But ultimately debt has to be paid with a transfer of real resources to debtors. Presently, the U.S. debt burden is not critical, but to avoid future austerity it is essential to get a handle on annual deficits.
To maintain Social Security, Medicare, defense and public works in the long run, Americans could target surpluses-deficits as a percentage of GDP to the average percentage growth in GDP. Congress inevitably will try to circumvent such a ceiling, but the people would have the sense to realize that, barring major events, deficits exceeding the potential GDP annual growth rate of 3 percent are out of line.
Reality will mug us sooner or later and we will realize that spending that continually exceeds normal ranges cannot be ignored.
Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.