Federal Debt will Bankrupt Our Country?
Deficits are due to out of control spending?
Is Debt a Problem?
In the US, government insured mortgage loan programs like FHA, VA and USDA require a debt to income ratio of around 40%. This means that mortgage debt of up to 2.5 times the borrower’s gross income is considered affordable.
In October of 2022 Elon Musk bought Twitter for $44B partially funded by $13B in loans from Bank of America, Morgan Stanley and others. Twitter’s revenue in 2022 was about $4.4B, so Musk’s bank financing alone was about three times potential revenue.1
In a 2016 CBS This Morning interview with Nora O’Donnell, Trump said “I’m the king of debt. I’m great with debt. Nobody knows debt better than me, I’ve made a fortune by using debt, and if things don’t work out I renegotiate the debt. I mean, that’s a smart thing, not a stupid thing.”
These examples suggest that debt is a valuable tool commonly used by individuals and corporations. So why is the federal debt, which currently is about 1.2 times GDP, considered unaffordable? Is government debt different? Does it present unique problems? Lets assume for now that the federal government behaves like a corporation and that our current level of debt is undesirable. As a start, it’s worth reviewing a bit of history.
How Did We Get Here?
At the end of 2023 the total US federal debt was about 119% of GDP. Compared to most homeowners and corporations this is a relatively small amount, but it is historically high and some believe that it’s a serious problem. So how did we get here?
During the second world war the national debt exploded to 120%, a level similar to today. But after the war it started a steady decline to pre-war levels, reaching a low point of just over 30% of GDP near the end of 1981. Then the trend reversed and over the next few years grew to over 60% of GDP. Since then it has continued to grow, with a brief decline during the Clinton administration, to the current level of 121%. (the blue line in the chart below). So what happened in 1981 that caused our debt to grow so quickly?
click on the chart for a larger version
Ronald Regan was elected President in 1980 after after running on a platform of government reform. Based on the theory of Supply Side Economics, his administration proposed that lower taxes, fewer government regulations, and decreased government spending would free the economic engine of capitalism and re-invigorate the economy. Dubbed Reganomics by both supporters and critics, the promise was that the resulting growth would erase federal deficits and debt and financial benefits would naturally ‘trickle’ down to everyone.
His signature accomplishment was an income tax cut which reduced the top marginal rate from 73% to 50%. (red line in the chart above). Although these cuts were intended to be offset by reductions in spending they were were never achieved.2 (green line in the chart above) In fact, spending as a percentage of GDP has remained relatively stable ever since at around 20%, The exceptions are short lived increases during recessions, (identified by the grey bars on the chart).
Of course lower taxes/revenue and steady spending resulted in increasing deficits and debt, resulting in tax increases later in his term. This trend has continued to this day except for a brief dip during the Clinton administration.
If we take a closer look at just income versus spending the problem becomes clearer. (chart below) As long as spending and income increase in tandem, like the period from 1965 to 1981, debt doesn’t increase. When income drops without a proportional decrease in spending, like the Regan/Bush years, the debt goes up.
Can We Fix It?
It would seem obvious that our debt is the result of an imbalance in spending and income, with the largest spikes caused by external forces which no one controls. But most economists agree that the current amount of debt is not an existential threat.
It should also be obvious that lowering taxes is not the solution. But conservative administrations continue to promote the elusive benefits of supply side economics and spending cuts that never materialize.
What may not be as obvious to the average voter is that the US Congress, not the president, is responsible for both income and spending. And decreasing spending or raising taxes are equally unpopular. In fact, even collecting taxes is unpopular with conservatives, as demonstrated by the incessant attacks on additional funding for the IRS.3
So what is the solution to our debt problem? The answer may be here… (click on the image for a larger version)
The chart above shows the total wealth held by US households from the end of the Clinton presidency in 1990 to the present. Each line represents a segment of the population by percentile of wealth held. The black line is the total for the least wealthy 50% of all households. The other lines show totals for other segments. Green for 50% to 90%, orange for 90% to 99%, and blue for the top 1%.
A quick look at the chart shows that half of the population hasn’t experienced the same level of gains as the rest. For instance, the top 1% of households wealth has grown by over 400% compared to less than 300% for the lower half of the population. And the upper 0.1% (not shown) gained almost 500%.4
So if our economy is generating tremendous wealth could the answer be as simple as raising taxes?
Tax Policy
The wide and increasing discrepancy in wealth suggests that higher income Americans are contributing a smaller portion of their income to funding the government than those at the lower end of the scale.
The problem and solution seem obvious. It’s time to abandon the conservative dogma of prosperity for all via tax cuts for the wealthy and create a tax policy that would result in a more equitable outcome.
For example, imagine a tax policy starting in 2001 designed to balance the budget and keep the deficit at a constant 55%. If taxes were collected proportional to the total increase in wealth at the same rate from all households the result would be a gain of 318% for everyone. Those at the bottom would gain slightly more and those at the top slightly less.
Of course a workable solution is not likely to be so simple or easy to implement. But this example demonstrates that the US economy generates enough wealth to deliver prosperity to all with current spending levels and a balanced budget.
Questions:
Is a tax on income the only way to pay for government?
What level of federal debt is acceptable?
Are government policies responsible for increasing wealth inequality?
By October of 2023 Twitter, rebranded X, was worth about $19B, the loans were underwater, and 2023 revenue was estimated at $2.5B.
In 1982 congress passed Public Law 97-258 which gave the congress the power to set a maximum amount of debt owed by the federal government. But since congress also determines both how much the government can spend and tax rates the provision was nonsensical. The primary result has been a never ending series of threats to shut down the government if we insist on paying the bills that congress already authorized.
In 2001 $5.8T or about 55% of GDP. At the same time the total net worth of US households was $42T. By 2024 total net worth had grown to $152T, an increase of 363%. But the gains weren’t evenly shared. Households with a net worth in the lowest 50% of families gained 292% while those in the top 0.1% gained 495%. Other income groups gains were distributed between these extremes with the gains increasing with increasing wealth. During the same period the national debt grew by 597% to $34.6T.
Hey Joel. Thanks for the comment!
Good explanation. Thank you.