Forbes recently had a very good article which explores the US Federal Debt and how it affects economic growth. It also reviews government debt for the future, and its affect on the private sector and the debt-to-GDP ratio. Unfortunately, it doesn’t cover the entirety of US debt, which includes substantial entitlement obligations, but that’s probably fodder for another article entirely. If you want a decent primer on our federal debt — which translates into $154,161 each taxpayer owes towards it — read the article below.
The availability of credit in the U.S. was a major catalyst in the economic boom of the twentieth century. However, too much of a good thing can also be a problem. Is the U.S. too reliant on debt? Is the federal government mortgaging the future earnings of an entire generation? In this article, we’ll explore these and other issues as we take a look at the debt cycle in America.
The Impact of Debt on Economic Growth
In the early part of the twentieth century, if people didn’t have the money to purchase an item, they would save for it. With the introduction of credit terms, high-dollar items became much more affordable. It also changed the way we view debt. For example, rather than think of a new car in terms of its total price, we began to focus on the amount of the monthly payment. And, as the use of debt increased, the American standard of living rose with it. Excessive debt was also one of the primary catalysts for the economic boom of the 1980s, 1990s, and part of the 2000s. However, when debt is used in excess, it steals from the future since it must be repaid. This is because a dollar borrowed today necessitates that a dollar plus interest be repaid in the future. This reduces the amount of money available for future spending. If the amount of debt accumulated is significant and the period of accumulation is long, the required debt payments will negatively impact economic growth. What about government debt? How does it impact the future and the economy?
Government Debt and the Future
As I write this article, the federal government has accumulated $18.2 trillion of debt. In 2004, the federal debt was $7.3 trillion. This rose to $10 trillion when the housing bubble burst four years later. Today it exceeds $18 trillion and is projected to approach $21 trillion by 2019. When you break this down to an amount per taxpayer, the numbers are substantial. It has more than doubled over the past 11 years, rising from $72,051 per taxpayer in 2004 to $154,161 today. As the debt continues higher, the liability of every taxpayer is also rising. The change in the amount of the federal debt per taxpayer from 2004 to 2015 represents an average annual increase of 7.16%. This is much more than the average annual wage increase during the same period.
The Great Private Sector Extortion?
What problems might result from our fiscal failure? With the debt per taxpayer as high as it is, if the government continues to raise taxes on middle income earners and above, it will become increasingly difficult for many of these individuals to preserve their standard of living. This will result in a reduction of wealth that spans the entire income spectrum, excluding perhaps the super-rich. The difficulty will begin in the middle class and eventually creep toward the higher income earners if the debt problem persists. Why will this create difficulty? Because these individuals will be asked to pay higher taxes so the federal debt can be retired. It may be framed under a pretense of patriotism but will really be just another excuse to extract money from the private sector. As the private sector shrinks, economic activity will slow which will result in smaller wage increases. Therefore, these individuals will be squeezed from both ends (taxes and wages). This is one of the key reasons why the middle class is shrinking. It’s as if we’re all on the Titanic and people are continuing to sing and dance while the ship slowly sinks. Does the federal government have the ability to repay its debt? And, if it does today, what about in five or ten years? How difficult will it be then? Let’s address this question now.
The U.S. Debt-to-GDP Ratio
The debt-to GDP ratio compares the amount of the public debt to the size of the economy. For example, if GDP – which is the total of all goods and services produced in the U.S. – is $17.0 trillion and the debt is the same amount, the ratio would be 100%. As the debt rises beyond GDP, the ratio will exceed 100%. This indicates that the debt is greater than the total of what we produce. You might equate it to an individual’s debt-to-income ratio which helps lenders assess an individual’s ability to repay a loan. America’s debt-to-GDP ratio in 1980 was only 35.4%. Ten years later it was 57.7%. As you can see from the chart below, America’s debt-to-GDP ratio has continued to rise and today stands at 102.6%. Although this is not a staggering percentage, as an absolute number, $18.2 trillion in debt is very formidable.
Is the federal government getting in over its head? Will the mounting debt cause a financial hardship on Americans? As the debt continues to expand, the economy will continue to be sluggish, the tax burden will continue to grow, and the middle class will continue to shrink. If Washington doesn’t act soon, will the debt become an unmanageable burden? I believe the answer to this questions lies somewhere between “absolutely” and “very likely.” How bad could it get? It’s difficult to say. To change direction, however, we will need elected officials who are willing to put the needs of the country ahead of their own agenda. In other words, politics will have to take a back seat. You can be sure of this: You cannot circumvent the laws of economics. If we continue to accumulate debt, if we ignore the warning signs, if our officials maintain the status quo, there will be consequences. I only hope America realizes it before it’s too late.