In my last column, “Examining our national debt,” I discussed the history of our national debt and how inflation and economic growth help the government deal with its debts without actually paying them off.
In this column, I will discuss the troubling levels of national debt in relation to the size of our economy.
I previously discussed how the private sector can take on debt in excess of its current earning capacity because borrowers reasonably anticipate future earnings growth. For example, once a college student gets a job and several promotions, it is easier to pay off those college loans.
The federal government does the same thing, but it has an extra advantage inasmuch as it can perpetually refinance its debts. The government counts on the economy to grow faster than its debt levels, making a hypothetical repayment more feasible.
That’s why economists compare the national debt to the size of the economy rather than merely focusing on the amount of debt.
In 1945 our national debt was approximately 147% of our GDP. (GDP stands for Gross Domestic Product which is the value of all goods and services produced by our economy.) Twenty-nine years later, the national debt was only 33% of GDP. The US Treasury did not pay down any of its debt, rather our economy grew so much that it was considerably easier to service the debt burden. Since 1974 our national debt has steadily increased to about 100% of GDP where it is today. In the last forty-three years, the growth in our debt has outpaced our economic growth.
When I took some post graduate business classes twenty years ago, the professors taught us that federal deficits that are no more than 1% to 3% of GDP are not harmful because they stimulate growth, and as long as the economy grows at least 3% annually, the incremental national debt will not place an undue burden on the US Treasury.
It was around that time when former Vice President Dick Cheney proclaimed that deficits don’t matter. At the time Mr. Cheney apparently did not comprehend the government’s eventual borrowing needs.
In the past ten years, governments around the world have poured money into their economies and have funded that infusion with increased debt. In the United States, we have been able to absorb much of the incremental general fund debt by borrowing from the surplus in the Social Security fund.
Our general fund debt is currently about $20 trillion. About 20%-25% of that amount has been financed by Social Security and other government employee retirement funds.
Unfortunately, as Baby Boomers retire in increasing numbers, the Social Security surplus used to finance much of the deficit will evaporate. Therefore, the federal government will have to find other sources to both refinance existing debt and to finance future spending deficits.
In 2017, (the last Obama Budget) the budget deficit was nearly $670 million. In 2018 the deficit is planned to be $833 billion and the fiscal 2019 budget deficit is expected to be nearly $1 trillion.
Our national debt continues to grow by 4% to 5% annually, while our GDP grows at a slower rate. Based on the last quarter century, it is unusual to achieve 5% annual GDP growth. The Republicans are trying to accelerate the rate of GDP growth, but they cannot seem do so without increasing the deficit.
The federal government currently incurs interest costs of about $363 billion annually. Its cost of funds is presently about 2%. During the 20th century, US Treasury interest rates averaged about 7%. If interest rates return to historical averages, spending will increase by over $1 trillion annually.
Our tax system taxes labor at higher rates than investment income or corporate earnings. Taxes on labor are the largest single component of our tax revenue. Yet, over the ensuing decade, labor is going to be replaced with robotics and artificial intelligence resulting in an erosion of our tax base.
Unless we have meaningful reforms to our health care system, the federal funding of healthcare is going to result in higher debt.
The largest historical contributor to our national debt is war. We are currently fighting a war on terror and a future entanglement in another military confrontation is certainly possible.
Some economists expect our federal debt to approach $30 trillion by 2025. It will be difficult to grow the economy fast enough to keep pace with that magnitude of debt increase.
Additional debt in relation to GDP ultimately constrains the government’s ability to spend money on discretionary items, seriously impairing the government’s ability to function effectively.
That is why the government is likely to quietly pursue inflationary policies. That is the remedy frequently pursued by other countries whose debt levels have outpaced economic growth.
The 2020’s might look a lot like the 1970’s. (No bell bottoms please!)
Jim de Bree is a retired CPA who resides in Valencia.