Reality Check – Debt and Deficits

Monday’s Reality Check – a weekly presentation of facts and figures to help us all discuss important issues with some degree of understanding. Because, despite living in this post-modern, post-truth world, the fact remains that facts still remain.

Continuing our discussion of the US Federal Budget, today we are going to be looking at two important elements that, too often, get confused – the deficit and the debt. The deficit is the annual amount that spending by the government exceeds revenue collected.  As we mentioned in the prior post, the deficit for FY 2015 is $438 billion. On the other hand, the debt is simply the total amount of outstanding debt at any given time.  As of March, 2015, the total federal government debt came to around $18.100 trillion. Now one of the problems in talking about these government figures is that the numbers themselves are so staggeringly large that they are virtually incomprehensible to most of us ordinary humans. So let’s try to put these numbers into some kind of perspective that we can understand.

First, let’s just point out that the $438 billion in deficit for FY 2015 only adds around 2.4% more to the total debt.  So think about someone who has $100,000 in mortgage and credit card debt and they added $2,400 to that debt this year.  I don’t think that we would necessarily consider that person irresponsible, especially since they were keeping up-to-date with the interest payments on their debt.  And we certainly wouldn’t say that their debts were “spiraling out of control”, as we often hear from some pundits.

Now let’s look at these numbers in comparison to the US economy as a whole.  Gross Domestic Product (GDP) is defined as the total output of goods and services in a specific time.  For 2015, US GDP was measured at nearly $18 trillion. Accordingly, the annual deficit of $438 billion is again just above 2.4% of the US annual GDP and this would be the equivalent of $2,400 for a person making an annual income of $100,000.  Again, I don’t think we would call this person profligate or a reckless borrower. And, as it happens, economists have a rule of thumb that, barring unusual economic conditions, deficits should be around 2 or 3 percent of GDP.  So, the current US deficit is right in that recommended range.

But, you’re thinking, the deficit may be fine at 2.4% of GDP, but what about that $18 trillion in total debt we owe.  Well, that debt is a little more that 100% of our nearly $18 trillion GDP. Again, thinking about our example of someone with $100,000 in annual income, this would be the equivalent of a $100,000 mortgage – an amount we would hardly consider an outrageous debt.  Now, economists recommend a debt-to-GDP ratio of around 60 or 70 percent and, therefore, they have some concern about our level of debt.  But we have to remember that we are recovering from the worst financial collapse since the Great Depression in the 1930s, certainly an unusual economic environment. And it should also be pointed out that Japan has maintained debt-to-GDP ratios of around 200% for a number of years, seemingly without the adverse consequences some economists have predicted.

Speaking from my own fiscal history, when I graduated from college, my debt to income ratio was about 175%. And, similarly, when I bought my first house, the ratio was about 130%.  And when I used my home equity to renovate what would become my current house, my debt-to-income ratio was close to 200%.  So it would be pretty ludicrous for me to say that the current US deficit and debt is unsustainable when, by standard measures, my own finances were in much worse shape than the government’s. And I can’t imagine what the ratios are for younger people today with the cost of a college education. Now you may say – wait, the US Government only collects a portion of total US GDP in taxes – and that would be true.  But, by the same token, an individual with $100,000 in income also has expenses not related to just paying the mortgage.  The bank holding your mortgage will not be asking for that whole debt to be repaid all at once and, similarly, the US Government does not have to pay off the debt in one fell swoop.

To sum up, when you actually start comparing the US debt situation with our own personal finances, you realize the situation is not nearly as dire as some would like to make it out to be. Now, in further Reality Checks, we will discuss some potentially worrying trend lines, the differences between the government and the family budget, and the reasons why balancing the budget and eliminating the debt is a political fantasy.  But that is for another day.