Senior Advisor for Federal Fiscal Policy
President Obama’s budget commission which is supposed to craft a plan by year-end to significantly reduce budget deficits and debt in the coming years, showed signs of veering off course this morning on the question of what kind of “debt” needs controlling. That may sound technical but it could prove important, focusing attention on a measure of our fiscal situation that makes little economic sense.
Just to be clear, the federal government faces a serious long-term budget challenge, with deficits and debt projected to rise under current policies to dangerous and unsustainable levels. But we need to understand the nature of the challenge at hand and how to appropriately measure basic concepts like deficits and debt.
In her presentation to the commission this morning, University of Maryland professor Carmen M. Reinhart asserted that what matters when it comes to debt is what’s called the “gross debt” of the federal government. A number of commission members enthusiastically agreed.
Most economists and budget experts agree, however, that the right measure is “debt held by the public” – what the federal government borrows in private markets to finance its deficits. “Gross debt” includes “debt held by the public” plus the money that federal programs loan to one another (e.g., what Social Security and other trust funds lend to the government when their earmarked revenues exceed their immediate spending needs). That makes the debt level seem much higher.
But, as the Congressional Budget Office explains on pp. 14-15 of its June 2009 report on the long-term budget outlook, intra-governmental debt is “not useful for assessing” the impact of federal borrowing on the economy.
Debt held by the public is important because it reflects the extent to which the government borrows in the private credit markets. Such borrowing draws on private national savings and international savings, so more borrowing reduces the savings available for investment in the private sector (for factories and equipment, research and development, housing, etc.). Large increases in such borrowing also can also push up interest rates and increase future interest payments that the federal government must make to individuals and institutions outside of the United States, which reduces the income of Americans. By contrast, intra-governmental debt (the other part of the gross debt) has no such effects because it is simply money the federal government owes (and pays interest on) to itself.
Two examples show that gross debt is not a reliable indicator of our fiscal situation and could confuse people about what needs to be done and when.
For instance, eliminating the Social Security trust fund and every other trust fund would dramatically reduce our gross public debt – from its current 89 percent of Gross Domestic Product (GDP) to 58 percent. But, without reducing our obligations to pay Social Security benefits or raising taxes to finance them in the coming years, that by itself would do nothing to reduce the projected deficits that we will face in the coming decades.
By contrast, reducing future Social Security benefits or raising Social Security payroll taxes would, in fact, lower our projected deficits. But, because those steps would increase the amount that Social Security would lend to the rest of the government (as explained above), they would do nothing to reduce the gross debt.
What we need is a serious discussion about how to reduce future deficits. What we don’t need is to use a misguided standard of federal debt that will confuse rather than enlighten our efforts to address those deficits.