Politicians and journalists talk frequently about “fiscal responsibility”—lamenting that we don’t have it now, but that we need to acquire it to avoid financial disaster. And they always seem to have at least a subliminal message, if not overt, about whom we should elect—or throw out of office—in order to achieve that blissful state of “fiscal responsibility.”
Curiously, though, few of them ever define what they mean by that term; either they think it goes without saying, or they think equivocating better serves their agenda. Even think tanks, with people who should know better, commit the error. For example, even though “fiscal responsibility” is the subject matter of the following two documents, neither one contains an explicit definition of the subject term. (Does it mean "eliminating" the deficit? If so, should we sometimes run surpluses? Or does it mean getting the deficit "under control"? If so, what the heck does that mean? See if you can figure it out.)
• Why is Fiscal Responsibility Important?
• The Concord Coalition's Report on Fiscal Responsibility
Many people, I suspect, are simply trusting that somebody else has defined “fiscal responsibility” properly. In my experience, that’s a dangerous presumption—very dangerous. Not only is it mental laziness for me to let someone else do that critical thinking for me, but also, when everyone in the debate has a different mental picture of the key issue, I've found that it becomes impossible for objectivity to prevail. Here's an example...
Here are several possible, mutually-exclusive meanings for “fiscal responsibility”:
• reducing the debt (dollars)
• completely eliminating the debt (dollars)
• balancing the budget (i.e., keeping the dollars of debt constant)
• reducing the debt burden (growing GDP faster than debt)
• maintaining a constant debt burden (GDP growth=debt growth)
• keeping unemployment low and inflation under control (...forget debt, it doesn’t matter as long as those two stats are in good shape)
Six different ways of defining “fiscal responsibility.” A foggy atmosphere like that is definitely not conducive to a rational debate.
In an article last year titled Rate Your Neighbor’s Economic Attitude, I took a stab at classifying four different lines of thought. But that article apparently wasn’t enough, because the most common emails I get these days say something like this:
Okay Steve, I get it: Debt-to-GDP is the thing to watch, not the dollar level of debt. But that begs the question, How much is too much? Specifically, what do you think is a too-high ratio of debt as a percentage of the economy?
Fair enough. My definition is summarized in the image at the top of this article —and instead of just a simple answer to the question How much is too much, you may have noticed that it also contains a bonus: my answer to the unasked question, How much is too little?
Two things should be apparent right away. In one respect, I am with the vast majority: Veering off the road to the left—into “Too High” territory—would be bad for our country. However, in another respect, I am in a tiny minority: Veering off the road to the right—into “Too Low” territory—would also be bad for our country. My rationale follows.
When is the debt burden “Too High”?
The debt burden becomes “Too High” when the economy has been growing at an anemic pace, or has been stagnant, or (worst) has been shrinking. For evidence of that, check out where Japan is on the Thermometer; then take a look at these charts indexing Japan to the USA. Anemic growth has plagued Japan for quite a while. (Recently, it looks as if growth may be improving there, and if so, that will eventually turn into good news for Japan’s debt burden.)
As the graphic at the top of this article shows, I’ve chosen 80% (debt-to-GDP) as the point at which the alarm bells in my head would reach maximum volume. Why? Because we'd only have forty points to go before it hit our historical peak of 120% (post-WW2). We successfully grew our way out of that situation, and I'm optimistic that we could do it again if our priorities were in the right place. If 80% were our tipping point, we'd have plenty of runway to get things turned around before we set a new historical peak. [Your "too-high" tipping point may differ from mine, but picking one and being prepared to defend it is a big step towards rational debate.]
When is the debt burden “Too Low”?
Nobody ever asks this question, but I’m answering it anyway: the alarm bells in my head would reach maximum volume if our debt-to-GDP ratio dropped to 40%. Why? Because I strongly believe that growth is enhanced when a portion of our federal spending is financed with debt instead of tax receipts. If our debt ratio were too low, I think we'd be stifling growth, and thereby missing opportunities for making our children and grandchildren even wealthier.
In my judgment, a strong parallel to the growth-friendly federal policy I advocate can be found in the way corporations fund their own growth. They almost never use 100% equity financing; similarly, they almost never use 100% debt financing. You can bet there’s a point somewhere in between those two extremes that minimizes the cost of capital for funding growth projects. (To test that assertion, pick a few NYSE companies at random, and see how many of them have zero long-term debt. And if you lucked out and got Microsoft in your random sample, you found the needle in the haystack—the exception, not the rule—and I want you to buy my next lottery ticket.)
For the federal budget, think of tax receipts as “equity financing” and deficits as “debt financing.” When a prudent measure of borrowing is used to supplement tax receipts, tax rates can be lower than they would have to be to “balance the budget.” That's a growth-friendly policy.
Because borrowing permits tax rates to be lower, private sector business-builders have more after-tax resources to fund their ideas for better hot dog stands, day-care centers, plasma televisions, bullet-proof vests, video games, alternative-fuel auto engines, and anti-gravity machines. (Did I leave anything out?) In other words, they have more financial resources to create new products, new services, new jobs—and new tax receipts from all those for our government. That, by the way, is how we can “increase taxes” without increasing tax rates. It is happening as we speak, and the short way to say it is “economic growth.”
There’s a common denominator for my high and low boundary choices: economic growth. As the debt burden approaches 80%, it will signal me that economic growth is too low. As the debt burden approaches 40%, that will also signal me that growth is too low. In the former case, the likely culprit will be an overwhelming proportion of nonproductive government spending; in the latter case, the likely culprit will be needlessly-high tax rates. But in either case, stifled growth will be the fundamental problem I'll look for first.
So, to make it clear, here’s the definition:
Fiscal Responsibililty - The body of growth-oriented federal laws and policies that sustain the nation’s debt-to-GDP ratio at 60% plus-or-minus 20%.
If you know of anyone who thinks that one is no good, tell them they're invited to propose their alternative definition—especially in articles or political speeches using the term "fiscal responsibility." (Blue Dog Democrats, are you listening? How about you, Concord Coalition?) I'd be happy to toss around any new ideas that could improve the definition.
Lastly, if you know anyone who disagrees, but would rather not offer an alternative: tell them to consider Karl Popper’s admonition:
Those among us who are unwilling to expose their ideas to the hazard of refutation do not take part in the scientific game.