President Trump recently cut a deal with Democrats to raise the debt ceiling and fund the government for three months. Republican leadership had wanted a deal to fund the government for eighteen months so they would not have to revisit the issue before the 2018 mid-term elections. When the components of this deal reached the House for a vote, 90 Republicans voted against raising the debt ceiling, including Rep. Alex Mooney (WV 2d). Mooney issued a statement, saying “I voted against raising the debt limit because our national debt is already too high. West Virginian families have to balance their budgets each month and the federal government should do the same.” Really? Balance the federal budget each month? This statement shows that Mooney misunderstands the issues of public debt and deficit spending, or assumes that his constituents do. It is probably both.
The differences between the federal budget and a household budget are quite substantial. Generally, the spending side of a household budget is limited by the income of the wage earners in the family. If a household routinely spends more than this income, there will be trouble. But governments cannot be limited like this. Instead, they must respond to spending requirements that are unrelated to projected tax revenues for the year. Take, for example, the extraordinary spending needed to finance WW II. And, while a household buys consumables like clothing and restaurant dinners, government buys capital assets like roads, bridges and hospitals that benefit us for decades. When you consider the income side of budgets, governments have the power to raise new revenues through higher taxes and can actually print new money. Households have no such power. This wealth-creation power is what enables governments to borrow at much lower rates than households can.
When a government spends more than it brings in during a particular year, it has a deficit. In 2016, 44 of the top 50 world governments by budget size ran a deficit. The sum of all past deficits is the national debt. The national debt of a particular country can be compared with that of other countries, not by comparing the absolute amounts, but by comparing the ratio of debt to gross domestic product — the value of all goods and services produced during the year. Measured this way, by far the largest debtor nation is Japan. Its debt is over 2.5 times its GDP. The United States is 7th among developed nations. Our “national debt” is slightly higher than our GDP. But this is somewhat misleading because this “national debt” includes the debts of all states and localities as well as the federal debt. Considering only the federal debt, which is what Mooney was talking about, our debt to GDP ratio would be much lower.
Our national debt spikes during historical crises and then subsides as the economy is able to absorb the effects of the debt. According to the analysis of the St. Louis Federal Reserve Bank, our national debt to GDP ratio is now high because of the Great Recession that began in 2008. The federal debt increased largely because falling incomes led to lower tax receipts. Also, unemployment and poverty rose, which increased the cost of social insurance programs such as Medicaid and unemployment insurance. Following the recession, a number of factors, including the implementation of the $840 billion American Recovery and Reinvestment Act, caused the debt-to-GDP ratio to increase at a rapid pace.
An excessively high national debt is not a good thing. High public debt reduces the flexibility the government has during a recession to prop up the economy through increases in spending and tax cuts. And many economists believe that high public debt reduces the long-term growth potential of an economy. This is for two reasons. First, higher debt requires higher debt service, preempting a more productive governmental use of that money. Second, the increased sale of government bonds will absorb more of the available private investment funds, making them unavailable for corporate borrowing. Corporations borrow to invest in capital equipment, and other things that grow the economy.
But Mooney claims that our national debt is too high. Too high by what standard? The primary concern for holders of government debt is that the government will default. Excessive debt makes the risk of default higher. Measured by the reaction of U.S. debt holders, our debt is not “too high.” For that matter, neither is the debt of Japan, over twice as high as ours as measured against GDP. The debt paper of these two countries continues to be viewed as a safe haven in times of market turmoil.
Most Republican discourse about excessive debt ignores one other important fact about the U.S. national debt. Seventeen percent of the federal debt is held by the Federal Reserve Banks and other intergovernmental authorities. The interest paid on those debt instruments is ultimately returned to the Treasury.
Conservative politicians like Congressman Mooney are fond of attacking spending on social programs by arguing that this only increases our debt and that we are leaving a financial mess for our children to clean up. This argument is bogus. For the most part, we owe our national debt to ourselves. In his recent book What We Owe, IMF official Carlo Cottarelli points out that approximately 70% of the U.S. national debt is held by residents of the United States. These U.S. residents have lent money to the government. In the future, everyone will be taxed for the purpose of repaying the children of today’s Americans who have lent the money. All this money — the money spent by the government that was lent and the money that will repay these debts — has or will circulate in the U.S. economy.
While we should keep an eye on the level of our national debt, it is not now “too high” by any objective measure. The key to reducing debt is increasing the rate of economic growth in this country. If our rate of growth could once again reach 3% per year, nobody would be talking about the national debt. That is why the upcoming debate on tax reform is where the focus of Congress should be. Tax reform — not big tax cuts for the rich — has more potential for generating economic growth than anything else on the table.