Public Debt – It’s Not So Bad

Both Democrats and Republicans find convenient rhetorical uses for complaining about current budget deficits and total public debt. Democrats cite the deficit and debt to argue for increasing taxes, while Republicans point to  them as reasons to reduce government expenditures. One verbal tactic is to compare either the current tax receipts, total expenditures, the deficit, or total debt in terms of absolute values as in: This is “the largest tax increase in history” or the “deepest budget deficit in history.” But as the country continues to grow at a rate of about 3% per year and as even low inflation devalues the currency, over the long run modest tax increases or deficits can be made to appear much larger than they really are.

To appropriately understand our fiscal situation is it necessary scale national fiscal values the same way we scale our own finances, by our income. The house one purchases today may be substantially more expensive in nominal dollars that a house bought twenty years ago. However, during the intervening time one’s ability to afford that house increases with income growth, while inflation has increased the house’s nominal, but not real value. This is evidenced by the historic expansion in the rate of home ownership. Even though house prices have increased with time, more and more people over the last century have been able to own their own home. Despite price increases, growth in incomes have made homes are more affordable

Similarly, government expenditures, revenues, and debt must be scaled by the gross national product GDP. Here, we focus particularly on the national debt as measured against the national GDP. The graph below is instructive. It is a plot of total US debt divided by GDP as a function of time from the beginning of the country to 2006.

The national debt has taken on a greater importance as the size of government expanded so tremendously since the 1930’s so it is important to focus on the graph after that time. Even during the Civil War in the 1860s, government spending as a fraction of our total wealth was lower than it in the period after the early 1930s.

Government spending has a stimulative effect, taxation has depressing effect, and some level of public debt seems salutatory. The radical decrease in the debt-to-GDP ratio after the end of World War II in 1945 was not the result of budget surpluses, but very strong growth in GDP.  However, at the end of the 1960’s the debt ratio dropped below 40% and in the 1970s the US experienced decade-long economic stagnation. The period from 1980 to the present has experienced much higher levels of total debt-to-GDP and simultaneously much greater rates of economic growth and general well  being. While individual year surpluses may be beneficial, if they drive the debt too low, the government suppresses economic growth.

We are perpetually warned that we are leaving too much debt to our grandchildren. However, the erstwhile “Greatest Generation” that survived the Depression and won World War II left a debt-to-GDP ratio of over 120%, twice that of the current period. Their more generous and important legacy was the subsequent decades of rapid economic growth that dramatically reduced the debt-to-GDP ratio.  In the current period, we should perhaps be a little less concerned about the debt we leave our children and more concerned about whether we bequeath to them a vibrant and rapidly expanding economy.

The current debt-to-GDP ratio is not only reasonable but hovers around a level consistent with a period of nearly three decades of continuous and robust economic expansion. The long-term concern should not be the current debt, but the unfunded Social Security and Medicare liabilities we have incurred. The only way we can hope to meet these obligations is to maintain high economic growth, and a proper level of debt is necessary for such growth.

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