Monday, December 17, 2012
How Should We Think About a $1 Trillion Deficit?
A Trillion is a very big number. It is being used to scare people about our need to cut government spending on social security programs that have been important for a large segment of our population. We are told that deficits of that magnitude are unsustainable. One way to think about the problem is look at our personal debt in relation to our income. For most people their mortgage debt is related to their income. The size of their debt is only relevant in terms of their ability to service their debt. Lets suppose that someone with a good credit history has suffered a loss of income. Their ability to service their debt, in the face of lost income, may become a problem as their debt to income ratio increases. They may be able to restructure their debt, however, because their creditors expect their income to return to previous levels. The US has a similar problem. Its debt to GDP ratio has increased for two reasons. Governments lose tax revenues, as GDP falls during a recession, so its debt to GDP ratio increases. Government spending on social insurance programs also increase. That explains around half of the trillion dollar deficit in 2012. Since the government is considered creditworthy, however, the government has been able borrow money from investors to service its debt at low interest rates. As long as the economy improves, and tax revenues increase, the debt to GDP ratio will return to sustainable levels. In the long run, however, government spending, primarily on healthcare, is growing faster than GDP grows even in a good economy. We must bring healthcare spending in line with GDP, and growth in tax revenues, in order to have a sustainable ratio of debt to GDP. Since we have a very inefficient healthcare system, there is a lot of room for improvement. Political gridlock is the only impediment to containing unsustainable growth in the cost of healthcare. It is also standing in the way of the actions that we need to hasten our recovery of the the recession.