Ways to look at the debt

People seemed to like my previous post about budgetary pie charts, so I thought I would follow up with some basic charts on U.S. debt. (A deficit is a shortfall in a single budget year; the debt is the total accumulated shortfall over time.) 

First, here is a graph of the U.S. debt in nominal dollars.(Source here.) Pretty scary, isn’t it?

Scary indeed ... but also virtually meaningless. In fact, it’s hard to overstate what a wrongheaded way of looking at the debt this is. 

For one thing, a dollar in 1940 is not the same as a dollar in 2010 – there are 60 years of inflation separating them. According to the Bureau of Economic Analysis, $1 in 2010 had the purchasing power of 6.4 cents in 1940. So doing this in nominal dollars makes no sense. 

Also, we’ve had a lot of GDP growth since 1940. That’s important. If your income is $100, a $50 debt is a burden; if your income is $10,000, it’s trivial. So even if you track debt in inflation-adjusted dollars, you’re missing the “compared to what?” part.

Here’s a much better way of looking at debt since 1940, courtesy of the Congressional Budget Office.

Here, we’re measuring accumulated debt as a percentage of GDP. Notice the long gentle decline from 1946 to about 1970, the run-up in the 1980s (Reagan's tax cuts), the decline in the mid-1990s (Clinton's tax hikes, plus the dot-com boom) and the sharp recent increase (the Great Recession and the stimulus). Our debt burden hasn't constantly increased, it has ebbed and flowed. 

And though it has flowed quite a lot since 2008, it's still well short of the heights it attained the mid-1940s, when it exceeded 100 percent of GDP, thanks to that mother of all stimulus programs, World War II. For four years, we engaged a large fraction of our population in the most economically pointless of all activities – a total war* – and we ran up a huge bill doing so. 

I have no idea if deficit scolds were shrieking about a bankrupt government in the 1940s. If they were, they were wrong. Our massive war debt did not cause an economic collapse or a crisis in investor confidence. Instead, as everyone knows, we shifted successfully to a peacetime footing, and from 1945 to 1975 we enjoyed the greatest period of sustained economic growth in our history. We built the suburbs and the middle class, held off the Russians, explored space – all while steadily reducing our debt burden.

That history should give us some perspective on today's debt and deficit scare-mongering. Our recent debt explosion is temporary, not structural. We spent the money, not on Social Security or Medicare increases, but in an effort to offset the effects of the worst economic collapse since the Great Depression.** Because it's temporary, it's analogous to our WWII debt; if we paid that down gradually, we can pay down this. 

Now, we do face structural challenges in the medium term: The Baby Boomers will be retiring over the next few decades, and their entitlements will strain Social Security a little and Medicare a lot. We'll need to "bend the health care cost curve" (we pay outrageously more for health care than other countries) and make adjustments to ensure revenues stay in line with expenses. 

To give some perspective on that, here's a third and final chart: 

The Tea Party crowd insists the U.S. is Taxed Enough Already; as a result of their influence, the GOP refuses to consider any additional tax revenue as part of a plan to stabilize entitlement programs. Yet, as you can see above, the U.S. is fairly lightly taxed by developed-country standards.† 

But isn't that good for our economy? It depends. While it appears to be true that, all else being equal, higher taxes are associated with lower growth, in the real world many other factors come into play. As a result, the correlation between tax rates and strong or weak economic growth is far from straightforward. (Interestingly, higher top marginal tax rates are associated with more growth, not less.) Likewise, though there may be a modest negative relationship between government size and growth, "the size of government does not seem to matter much [for rich countries]." The quality of governance matters much more.  

I'm not insisting that we should raise taxes to help the Baby Boomers through retirement. That's an ethical and political question as well as an economic one. Nevertheless, Chart No. 3 is pretty good evidence against the notion that doing so would bring our economy to a screeching halt. 

Addendum: Here's much more on whether the GOP fixation on tax rates makes economic sense. 

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*Say what you will about the stimulus, it didn't involve sending thousands of able-bodied men off to die in Europe and the Pacific, or building thousands of expensive tanks, ships and planes only to have them blown up by the enemy. 

**For what it's worth, every one of the half-dozen economists whose presentations I covered during that period concluded the stimulus was effective. So did the majority of the studies analyzed here.

†The 24.1 percent includes federal, state and local taxes. Considered alone, federal tax receipts account for about 18 percent of GDP.