The Federal Deficit and the Tax Burden: We can afford the debt not the spending.

Over the past year, the amount of publically held Treasuries, the current debt of the U.S. government, has ballooned. Debt held by the public has risen from 56 percent of GDP (already a near record) to over 63 percent of GDP in 2009. Importantly, this increase has occurred before most of the stimulus money from the American Recovery and Reinvestment Act has been spent; indeed, of that money, a meager $151 billion had been drawn as of the end of August. With this large debt come concerns over fiscal sustainability.
I have always taken it for granted that the debt was sustainable. After all, why would the markets lend to the government if the debt were not sustainable. Recent events (and Krugman’s excellent ariticle in the NY Times on the state of macroeconomics—Summers’ ketchup economics is brilliant.) have shaken my outright confidence in markets. So, I thought I should do my own sustainability calculations. I came to the surprising conclusion that the stock of government debt is not only sustainable but it is downright affordable.

To be conservative in my estimates, I use the entire amount of Treasuries outstanding. Publically held debt is a better measure of government debt but either will do for my purposes—funds held by the Fed and other public agencies don’t really count. In my mind, counting them is the same as counting the total sum of Treasuries that could be issued.

To check for sustainability, I take the Federal Government in hand and put it on a debt payment plan. If the Feds were a household and we were financial managers we might choose a 10 to 30 year plan depending on their age and circumstance. But, governments are special. I chose to put the gov’t on a 100-year payment plan at the end of which time debt must be zero. Of course with the payment plan the government is forbidden to acquire new debt—this feature will be the lemon in the pudding.

If real interest rates stay at their current low levels of around 1 percent (unfathomable), the payment plan costs each of the 137 million workers in the United States $1,361 per year, a paltry 1.7 percent of personal income. Even if real interest rates rise as high as 10 percent (equally unfathomable (or maybe I can picture this one)), the debt burden per year remains an affordable $8,248 per year per worker or about 10 percent of personal income. The latter number is large but feasible.

The real problem is that the government must also raise sufficient funds to keep from borrowing more. The Bush administration ran the largest deficits of any government to that time. If we add the Bush deficits to the total, yearly payments need to rise. Under the low interest rate case, this raises the payments to a little more than $3,000 per year per worker. At 10 percent, we are quickly approaching $10,000 per worker per year.

The Obama deficits are projected to be much, much larger. If we have to raise revenue to offset the average Obama deficit over his first term as calculated by the CBO, even at 1 percent interest, the debt payment is $6,326 per worker. At 10 percent interest, payments per worker increases to almost 17 percent of personal income.

This exercise reveals the national debt to be affordable in the ordinary sense of the word. The United States could pay off its debt in a mere 100 years with only a modest strain on workers. However, if government spending continues to rise (or stays at the current levels), the strain on workers is likely to extreme. Additional taxes in excess of 10 percent of total personal income are likely to have a large negative impact on the workforce.

I might be in favor of higher government spending or I might be against it. As always, the decision is one of public policy and not of economics. But, good economics should inform the decisions and we should make an informed choice on how much to spend based on an honest national dialogue.