About the Author
The self-imposed US debt ceiling is laughable once you view it in the context of an individual who has no ability to pay back the amount borrowed and yet sets the interest rate payable. It would be one thing if there was a balance sheet with uncorrelated income producing assets on the other side (like trees, road, oil or water) or perhaps an uncorrelated store of value (gold or land).
It is clear by now that politicians the world over have no concept of the sustainability of public finances and yet we, the voters, keep letting them win elections based on ridiculous spending promises that simply serve to create the poverty that results from allowing ourselves to live beyond our means.
I am going to use some very big round numbers in this article. I will assume that the US collects around US$2 trillion in taxes. Out of interest, GDP could be US$15 trillion this year (see US income taxes out of total taxes; GDP forecasts).
Make no mistake; this is not the fault of the politicians. It is the fault of the voters and the democratic systems we hold so dear that allows us to actually vote for things we simply can’t afford. The more we allow the political system to borrow from the future, the more welfare beneficiaries we create. Living beyond our means in terms of economic activity and consumption without paying back the debt it took to gain our living standard means we consume resources that rightly belong to our children (think natural resources like food, water and oil).
There is a lot of talk around that we should use GDP for deficit and debt yardsticks. There is also talk that as long as the growth in nominal GDP exceeds the fiscal deficit and approximately equals the ten year government bond yield, then things are fine. I say that in this age of regulated interest rates (yes, you heard that right, we are embracing a communist monetary policy regime) none of these indicators (nominal GDP growth to fiscal deficit and ten year) actually matters!
Allow me to illustrate by way of an analogy to the current level of debt, now well on its way to US$16 trillion.
Let’s start with a clean sheet and ask a few questions to set the scene. Oh and forget the Fed, it has way out done its role of smoothing the operation of the banking system which, in turn, has shown that it is a source of economic friction rather than a facilitator of economic activity.
What is a fair tax rate? You can play around with this, but I am going to say 20%, (you can check out this site for corporate and personal tax rates around the planet).
How much of our taxes should be spent on servicing debt? This does rather assume we have this luxury, but again I am going to say a maximum of 20% before we start suffering a loss in living standards.
How much should we pay for debt? Well this is usually set as a function of long run inflation and a required real rate of return for investors to tie their money up by taking our future income. I am going to say 2% inflation and 2% required real rate of return which gives a ten year bond yield of 4%. When the economy stops being run by communists then maybe we revert to a “normal” proxy of the ten year bond yield with this handle.
There you have it. A clean sheet of paper and we have the basic financing pieces. No BS, no promises, just affordable and sensible metrics. A sensible starting finance position is we can afford 20% of our income as tax and we can afford 20% of these taxes to pay interest at 4% in perpetuity.
How much income do we currently produce? Well there are a number of ways to do calculate this. We could fall back on using GDP as measured on an Income, Expenditure or Production basis. Here is how Wikipedia sets it out.
Knock yourself out with the technicalities, none of which matter in the financing case too much. The US takes US$2 trillion in taxes with around 10% of the labour force unemployed (14 million). Leave aside the U6 stuff and assume that if we get this number down to 6 million we are doing pretty well.
If these 7 million people could be employed, then corporate profits would increase, those employed would pay taxes and would cease drawing benefits. I am not going to get into the fiscal spending side of the equation just now. We have to assume the worst and these people would contribute little in the way of net tax and the companies that employ them would have the rather nasty habit of not paying a high rate of taxes either. We could assume that employers make $2,500 for each of the 8 million low paid employees per year and pay 10% in taxes on that. This would improve the tax take by (a whopping) US$2 billion on US$20 billion in new profits or just 0.1% of our current US$2 trillion tax take.
So here are the “clean sheet of paper” numbers for the level of debt we can afford. US$2 trillion in taxes times 20% we can afford divided by 4%. The answer is US$10 trillion. This is a true debt ceiling.
Any more than this and the US is simply living beyond its means. If you play around with the affordable tax of 20% and make it say 15% or heaven forbid 10%, you can get to some more realistic numbers. The next time you hear any political plan that does not centre on running a fiscal surplus for the length of time taken to run US$6 trillion in surpluses over ten years (not cutting $2 or $4 trillion from some “baseline” of debt growth), you know it is BS.
The next leg of course is the affordable amount of spending implied by this “blank sheet of paper” approach. I said 20% of taxes on interest and that this is US$400 billion (based on US$2 trillion tax take). Spending has to be cut on the same basis from the current US$3.5 trillion to, firstly, US$2 trillion (that is, all expenditures must be initially cut by 40% to stop the rot and balance the books) and surpluses run that total US$6 trillion over whatever time scale, say ten years or US$600 billion a year.
In other words, spending should be cut from US$3.5 trillion a year to US$1.4 trillion for ten years (60%) to set the books right for the next generation. That is every vote for every government department.