The debt ceiling: a long-term remedy

Treasury Secretary Henry Paulson has asked Congress for an increase in the federal debt ceiling as soon as possible, from $8.965 trillion to $9.82 trillion.  That proposal leaves room for improvement; I'll explain why below. 

First, here's part of what he said yesterday:

"The full faith and credit of the United States, to which we all remain committed, is a national asset and a cornerstone of the global financial system," Paulson said in his letter. "In light of current developments in financial markets, which would be exacerbated by uncertainty in the Treasuries market, I urge the Senate to pass the legislation reported by the Finance Committee to increase the debt limit as soon as possible." 

He's absolutely right about US creditworthiness being a national asset.  Unfortunately, it's impossible to place a value on that asset, so we can't know how much it helps to offset the government's widely-publicized "unfunded liabilities."  That's too bad, because creditworthiness (not quantifiable) is one of several intangible assets helping to keep interest rates down in spite of the (quantifiable) unfunded liabilities. 

A better idea
Anyway, I think the recommended change to the debt ceiling could be much better.  Instead of changing the debt ceiling from $8.965 trillion to $9.82 trillion, I recommend changing it from $8.965 trillion to 75% of GDP. 

Making the debt ceiling dependent on the size of our economy—which is a good proxy for our ability to sustain a given level of borrowing—would immediately yield at least two major benefits.  First, it would put a stop to the meaningless, time-wasting debates and grandstanding about dollar limits.  Second, it would force Congress to introduce a new element into the fiscal debate: how to enhance the growth of our economy. 

I can think of several experts whose testimony would help Congress understand how the government might be able to enhance the economy's growth, starting with Paul Romer.  Robust growth will be especially important in light of the unanimously-recognized upward pressure on government obligations, coming within the next decade or two.  It deserves more time in the national debate. 

New debt ceiling: 75% of GDP.  How about it? 

=============
I explained this rationale in more detail a while back, in an article titled "Fiscal Responsibility Defined at Last."
If I sound like a broken record, it's for a reason.

Comments

[A Tanatar]

How about a better idea: new debt ceiling: 150% of a budget. Or: new debt ceiling: 100% of sustainable budget proficit over the next 20 years. Or: new debt interest ceiling: 20% of US budget. Or: new debt increase limits: 40% of increase in taxes over the last year. Or: new foreign debt increase limits: net positive foreign investment income.

The goal of 75% of GDP is simply arbitrary. Since we are talking about federal debt, it has to be able to withstand a possible increase in interest rates due to inflation.

[Bob]

Whatever SIMPLE metric we can use to shift the emphasis to economic growth instead of being content with this pablum porridge (as in Goldilocks) economy is fine with me.

This "hunker down" mentality I'm beginning to see will bring about some of the gloom the gloomsters desire...just that it won't happen the way the think.

I thought of using the tired "think outside the box" cliche' because if there is an example of being myopically focussed in a box, it has to be the idiots in Congress and the sad line-up of Presidential candidates.

[Jim Bradley]

I like the concept, but the implementation is a problem. Government can't function properly (no profit or loss), so government spending is almost always counterproductive. (Can you imagine how much better off we'd be selling exports rather than government debt?). If the debate about raising the debt ceiling tends to limit additional spending it will likely prove better than a "% of GDP".

[john]

Why don't we print dollars till we drop. exchange them in euros until the euro dollar ratio is 1 : 8965000000000, and pay of the public debt. after that delete 13 zero's from the notes and start all over.

[Tim Shell]

The main asset of the US government is the legal authority to tax the US economy. To value that asset we can do the following:

1. Take total government receipts.

2. Estimate how much of the government's spending is necessary to preserve its ability to tax the economy.

3. Take the difference between #1 and #2, which is equivalent to the government's "earnings".

4. Estimate a sensible P/E ratio for such a large entity.

5. Multiply "earnings" by this P/E ratio to get the value of the asset.

So, for #1, the US government collects about $4.1 trillion a year.

For #2, we need to specify what is necessary to preserve the tax collecting ability of the state, and what is "discretionary". If they stopped funding PBS, would the government's ability to tax the economy be impaired? No, so PBS is "discretionary". If they stopped funding the Air Force, would the government's ability to tax the economy be impaired? Eventually, yes, so that is "necessary". "Necessary" spending is probably limited to courts, law enforcement, and defense. So off the cuff, we can estimate that $1 trillion of spending is necessary to preserve the government as government, everything else is stuff we might want but could survive without.

For #3, the difference between total receipts and estimated "necessary" spending is $3.1 trillion.

For #4, P/E ratios for large caps are about 15.

So to get #5, the value of the government's main asset, multiply 15 by $3.1 trillion, for a total of $46.5 trillion.

Put that on the asset side of the ledger. On the other side put the $9 trillion in debt. Balance this out and the "market cap" of the US government is about $37.5 trillion.

Just another way of putting the total debt in perspective.

[PseudoNoise]

Gov't needs to spend in downturns to speed recovery, and since tax receipts corrolate w/ GDP, that'd mean the ceiling would automatically lower when we need deficit-spending the most.

I'd think we'd want to encourage spending down debt when times are good (GDP up) and be able to borrow when times are rough (GDP down).

[Luis]

This reminds me of the European Stability pact:
Public debt/GDP <=60%

[Luis]

And the convergence criteria for the adoption of the EURO

[mark]

I would suggest reading the article "we need a bigger budget deficit" by William Vickrey (1997 Nobel prize in economics). You can find it in an article at William Hummel's site (which Steve has linked to in the past)titled "the need for a budget deficit".

[DrToast]

So how come someone like Paulson who understands this doesn't make the suggestion?

[matt]

At the very least, it is nice to have a sensible forum with which to discuss these matters. I agree that interest rates have to be a component of any quantitative definition for a debt limit. The ability of government debt to assist growth must be a function of the interest that must be paid.

In any event, our government would seem to have a whopping get out of jail free card in the SS trust fund and intragovernmental debt. If this debt was just taken off the books since it is not owed to anybody external, our debt/GDP ratio would be in the 30-40 range. Of course, this is not politically possible, even though the retirees would still obtain their same benefits.

[Pelkabo]

Steve, not to hijack the thread, but I'd like to see what you have to say about the falling value of the dollar with respect to the euro. I recently spent a week in Paris and yes, things were somewhat expensive, but the Parisians themselves are also complaining that things are expensive -- and they get paid in euros. This suggests that in terms of purchasing power parity, the euro may be overvalued.

Incidentally, Paris "felt" about as expensive to me as Manhattan. In other words, I wouldn't want to live there on my current salary, but I certainly don't feel like a pauper in either city.

[Steve]

Pelkalbo:
Excellent point. I'd like to see the dollar stabilize right where it is. Some don't mind a falling dollar, because it tends to decrease the trade deficit. But it can also be a strong signal for future inflation -- and, as I've said a few times before, it's cheating to *inflate* our way into a smaller debt to GDP ratio, instead of *growing* our way into it. Deserves a more detailed post; maybe I'll work on that this weekend (...that will give me another day's look at the dollar).

[Luis]

What is better? A weak or a strong currecny? In Spain it has always been considered that it was good to have a weak currency: you have the possibility to make your economy more competitive by devaluating it. Nevertheless, this is in the short term. In the long term, I doubt it. On the other hand, you become more competitive as you actually pay less for your workers (speaking in a global basis) but your economy as a whole becomes less important for the world.

[Tom Hanna]

75% of GDP is an awfully big increase from the current figure (under 65%) especially considering that the debt as percent of GDP is dropping. But whatever figure is chosen under such a regime (65%,70%,75%), the percentage ought to drop on a regular basis. If total debt at 50% of GDP is desirable and achievable in 20 years, then start at 75% and drop the figure 1% a year. Want to keep some borrowing ability in place? Stop at 25% in 2057. It would still be a huge improvement.

[muirgeo]

I don't understand the need to raise the debt ceiling. I've been reading this blog for some time now and as I understand it the tax cuts will pay for themselves and the budget will be balanced by June of 2008. What gives?

[Louis C]

One reason why the Euro may become the global currency of choice over the dollar is precisely because they do limit their debt as a percentage of "GNP".

I like your idea, but 75% is way too high. Our Government is far too socialistic. If we are to maintain our position as global leader and bastion of Capitalism, we should follow Tom Hanna's idea, but start at 65% and decrease 5% every four years until it reaches 40%. This approach ties it to the election cycle. We need to make this a political issue for voters, and a measure of Congress' success or failure.

[Steve]

muirgeo:
Maybe this old article will help:
http://tinyurl.com/2dljs9

[muirgeo]

75% of GDP seems kind of arbitrary almost like micro-managing the economy.

I suggest we just look at
historical debt to gdp and think long and hard about who to vote for in 2008 if we want a more favorable ratio.

http://zfacts.com/p/318.html

[gunthestops]

A simple question, what stops our government from overspending? This year our budget deficit will be about 150 billion dollars, but the total amount that will be added to the national debt will be a little over 500 billion dollars and will top 9 trillion in total national debt. It basically comes down in simple terms of “on and off” budget spending. A curious thing has happed in the budget process that has turned debt and deficit spending on its head. The majority of overspending in the past was in the yearly budget deficit and watched carefully, àbut now the majority of overspending goes straight to the national debt bypassing the budget process. So if the national debt can be used as an ever-growing slush fund that apparently some feel that there is no obligation to bring down or pay back why should our government control its spending when there no obligation to constrain it? In fact if you can keep adding to the national debt without consequences then you can have your cake and eat it too. In essence you can have greater and greater spending and lower and lower taxes with no down side!!!---------But what about the currency---the world may judge us harshly for our financial recklessness.

And lastly, one of the most useless statistics used when speaking of the nation debt is its comparison to national income (GDP). It is the debt to income ratio (tax income) that is important. Also the debt service (interest on the debt) which over the next 3 years will be close to a trillion dollars.

[Steve]

gun:
The ratio of debt to gdp is imperfect, but it's a widely-used benchmark. I personally think net interest as a percent of tax receipts is more to the point as an indicator of creditworthiness, but debt to gdp is a good proxy.