The Corner

The Size of Our Debt and Why It Matters

In his speech last night, the president seemed quite oblivious to what this debt-ceiling debate should really be about: Washington’s willingness to address the country’s long-term debt problem. Basically, while it is true that raising the debt ceiling soon will allow Treasury to continue to pay all of its bills (most of them stemming from past spending and commitments), it won’t address our inability to pay our future bills and avoid future default.

This is what the S&P and Moody warnings are about: Unless Congress manages to adopt a credible $4 trillion plan soon, putting this country on a sustainable path, they will downgrade us. These warnings aren’t just about raising the debt ceiling to pay our bills today. They are about the fact that our projected debt-to-GDP ratio is on its way to becoming unsustainable. This year, the debt held by the public is $9.7 trillion, which is roughly 69 percent of GDP. According to CBO, it will reach 200 percent in 2037, if the economy doesn’t collapse before then. These projections aren’t surprising considering that the president’s budget doubles the debt held by the public from $9 trillion today to $18 trillion in 2021.

While avoiding default today is important, it shouldn’t obscure the important thing, which is to  put an end to this reliance on borrowing to pay for government spending. This is even more important considering that the debt/GDP metric actually underestimates the scale of our debt problem. Here is why:

1. Intragovernmental debt (roughly $4.6 trillion). That debt is money that the federal government owes to its various trust funds. In other words, it’s a liability to the government but an asset to the trust funds, so in accounting term it’s zeroed out. However, over time and gradually, the programs will redeem the IOUs in their respective trust funds as they need the money to fund benefits. As they redeem their IOUs, the intragovernmental debt decreases but the debt held by the public increases. Eventually, this $4.6 trillion will be converted into public debt.

2. Unaccounted liabilities. There exists a broad range of liabilities that are debt, yet are not captured in the debt/GDP ratio. To take one example, the Financial Statement of the United States values the government’s civil-service pension liabilities (that is, the contractual claims on government accumulated to date by civil servants) at $5.7 trillion. That amount is not captured by the debt/GDP ratio. A share of this $5.7 trillion will be paid for by IOUs included in the intragovernmental debt, which we know will be converted into public debt.  In addition, the unfunded share of this liability will have to be paid for with more debt, which isn’t accounted for in the debt/GDP metric. The Financial Statement of the United States shows another $1.5 trillion of such liabilities, such as payments due to GSE.

3. Unfunded liabilities. As you know, there is a (rosy) balance of $39 trillion in unfunded liabilities over 75 years for programs such as Social Security and Medicare.

While we can’t add all these numbers up because it would be the equivalent of comparing oranges to apples (some of these numbers represent the net present value of beneficiaries’ future claims on the government), it helps illustrate why the debt-to-GDP ratio underestimates how much present and future debt has been accumulated over the years. Hopefully, this also helps illustrate why the debt-ceiling debate going on right now shouldn’t just focus on Treasury’s ability to pay our bills today, like the president did last night, but must focus on our overall debt problem.

Looking at the debt ceiling this way tends to lend some support to a two-step approach to raising the debt ceiling: a large down payment along with a credible process to achieve the rest of the savings before the next election. However, the down payment needs to be large and not made up of savings that won’t actually happen, and it can only be a first step toward bigger and harder steps to reform the cause of our long-term problems: Social Security, Medicare, and Medicaid.

While the task may seem overwhelming because the size of the fiscal adjustment needed is very large (a roughly eight-point reduction in the debt-to-GDP ratio), the good news is that it can be done and it’s been done before. Here is the IMF on the issue:

However, fiscal adjustment on the requisite scale is historically not unprecedented. During the past three decades, there were 14 episodes in advanced economies and 26 in emerging economies when individual countries adjusted their structural primary balance by more than 7 percentage points of GDP. […]

The bottom line: judging from past experience, such a major adjustment will no doubt be difficult, but is possible.

The IMF report includes an interesting discussion about why there is no reason for a government to default and makes an important distinction between between primary-deficit problems and interest-rate problems.

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