Why the national debt doesn’t matter – or how I learned to stop worrying and love Treasuries

A friendly reminder. IOU from www.shutterstock.com

The rate of growth of the US federal government’s debt load has slowed of late, but its level remains high.

As of the end of 2014, total US Treasury obligations stood at US$18 trillion, more than 100% of current US output, or $56,500 for every one of us. This hefty sum is a reflection of the large annual budget deficits that the federal government has run, pretty much continuously, since 1931. (Prior to that, surpluses were much more common, apart from the years following the Civil War.)

But as another round of anxiety-causing debt-ceiling debates is likely to return, it is worth asking whether we should even care about the government’s debt. Is it a good measure of the federal government’s role in the economy or even a good indicator of the fiscal burden on US taxpayers? Does the size of our nation’s debt matter?

Why it’s irrelevant

To be sure, $18 trillion is a large number. But that number is essentially irrelevant to proper thinking about the economic role of the US government, or about responsible fiscal policy.

Government debt simply reflects the timing of taxes. The face value of debt will be large if, for given past and future levels of government spending, taxes are collected later rather than sooner.

But regardless of when taxes are collected, what ultimately matters is the quantity of the economy’s scarce resources the federal government commands and controls, which mostly depends on the level and path of government spending.

Government debt is not necessarily a good indicator of such control – the government can be wildly intrusive in the economy even if it never borrows, or it can be fiscally effective and efficient with high levels of debt.

Default isn’t imminent

Current debt levels in the US also do not indicate imminent default. As long as the federal government remains an “ongoing concern” – fiscal institutions remain strong and effective, taxing authority is maintained, and the long-run productive capacity of the nation’s economy is secure – there is no economic reason to fear default on the nation’s debt (only political reasons, such as debt-ceiling mischief).

To remain solvent and ultimately pay what it owes, the Treasury needs only to balance its budget over the long run, not over an arbitrary unit of time like a year. Near-record low interest rates on government debt suggest that bond market participants agree with this view, and are not afraid of sovereign debt default in the US.

If excessive government debt-burdens on future generations keep you up at night, buy Treasury securities with the money saved from low current taxes and bequeath those securities to your kids. They can use the principal and interest to pay off high future taxes, with no ultimate effect on their net wealth or well-being.

In other words, taxpayers can use capital markets to offset transfers of their wealth (taxes) to bondholders by becoming bondholders themselves. It’s almost like a hedge. In aggregate, if private savings rise along with levels of government debt, then the latter need not crowd out borrowing for productive activity by the private sector. There would still be plenty of lending capacity to go around. This argument holds even if all US debt were to be held by the People’s Bank of China.

The real burden to worry about

Assuming that the US government will always pay its bills and never default, the fiscal burden on the private sector ultimately depends on the path – past and future – of government outlays and expenditures. And here is where the $18 trillion “on-balance-sheet” debt is likely to woefully underestimate the federal government’s true liabilities and their potential demand on the economy’s resources.

Treasury debt is the government’s formal commitment to repay its creditors, but Uncle Sam has many other commitments for future spending that are not on the books, so-called “off-balance-sheet” liabilities. Such liabilities do not show up in standard debt measures. While these commitments are different in nature from the promise to pay back previously borrowed funds, they are nonetheless a potentially large burden on taxpayers, and surely governmental imposition on the economy.

These commitments arise from implicit and explicit federal loan guarantees that support housing and education policy, from deposit insurance and Federal Reserve actions that attempt to promote a stable financial system, and from commitments to the elderly and poor through social security, pension guarantees, and Medicare/Medicaid.

Economist Jim Hamilton has recently estimated that such off-balance-sheet liabilities could exceed $70 trillion, more than three times the the current value of outstanding treasury securities. The biggest share of that, or about a third, is Medicare.

So OK, worry about the debt, but pick the right measure to worry about.

Forget about the debt, focus on future spending

We should think less about the timing of taxes (which determines debt) and more about how much the government spends now and in the future, what that spending is for and how to best collect taxes to pay for that spending (which are independent of debt).

Tops on my list of fiscal issues worthy of serious consideration are:

  1. corporate and income tax reform to eliminate complexity and reduce incomprehensible and costly economic distortions, regardless of the effect on debt

  2. elimination of regulatory and policy uncertainty (get rid of the unnecessary and economically illogical debt ceiling!), and

  3. establishment of systematic cost-benefit analyses of government spending programs to help properly define the role of the federal government in the economy.

These issues are more important than the irrelevant magnitude of the national debt.