January 26, 2005
By Brian M. Riedl
Over the next few weeks, the unveiling of new budget forecasts,
as well as President Bush's budget proposal, will be followed by
predictable, sky-is-falling coverage of the "record budget
deficits" that threaten to force up interest rates and devastate
the economy. Many people will say that only tax increases can avert
Don't believe them.
America's debt burden is actually below the post-World War II
average. In fact, it's lower than at any time during the
The misunderstanding flows from the obsessive focus on the budget
deficit, which is not the proper measure of the debt burden.
Here's why: Suppose a family borrows $5,000 this year. Are they
carrying too much debt? Answering that question requires knowing
how much debt the family is already carrying. If they owe $95,000
from previous borrowing, then the additional $5,000 is less
affordable than if the family had no prior debt.
It also requires knowing the family's income. A debt of $100,000 is
easily manageable for Bill Gates, but not for many lower-income
The proper way to measure the impact of borrowing is to consider
the total debt as a percentage of income. Banks use this "debt
ratio" to determine how large of a loan families and business can
The same common sense applies to measuring the federal government's
finances. Last year's $413 billion budget deficit says no more
about Washington's debt burden than the $5,000 loan says about a
family's debt burden.
A better measure is the federal government's debt ratio, calculated
as the total federal publicly held debt as a percentage of
America's annual income (the gross domestic product).
The current debt ratio -- 38 percent -- is actually below the
post-World War II average of 43 percent. America's debt burden is
low by historical standards.
Heavy borrowing during World War II pushed the debt ratio up from
40 percent to 109 percent. Since then, it has typically ranged
between 25 percent and 50 percent.
The plummeting post-war debt ratio is no mystery: Economic growth
has dwarfed the amount of new debt. Since 1946, inflation-adjusted
federal debt has grown by 84 percent, while the economy has surged
429 percent. Just like a family with rising income can afford to
buy a more expensive home and take on more mortgage debt, the
growing American economy has been able to easily absorb its modest
This is especially true since 1994, a period in which the economy
has grown six times as fast as the federal debt. This kept the 2004
debt ratio lower than it was at any point in the 1990s. So it's not
surprising that recent budget deficits haven't raised interest
rates or devastated the economy.
Even an increasing debt ratio may not significantly raise interest
rates. Theoretically, government borrowing raises interest rates
because it leaves less money for individuals and businesses to
borrow, which in turn forces up the price of money (the interest
rate). However, Americans are no longer limited to borrowing from
America's savings pool. They can access a global financial system
that is so large and integrated -- trillions of dollars move around
the globe each day -- that it can easily absorb the federal
government's borrowing without triggering a substantial increase in
Harvard economist Robert Barro studied 12 industrialized economies
and found that for interest rates to rise by 1 percent, the debt
ratio would need to increase by 10 percentage points in each of the
12 countries. And even those small movements are usually
overwhelmed by larger trends affecting real interest rates, such as
economic growth and expectations of future inflation.
This isn't to say federal debt is harmless. Interest costs
taxpayers approximately $160 billion annually. Like anyone else,
government should borrow only when the benefits outweigh the
To the extent that federal debt is burdensome, it is a spending
problem. Federal revenues have grown substantially over the years,
yet lawmakers haven't shown the fiscal responsibility necessary to
The best way to reduce the debt burden over time, though, is to
streamline wasteful federal spending. Specifically, reforming
Social Security and Medicare can save trillions of dollars that
would otherwise drive the debt ratio to painful levels.
By contrast, raising taxes wouldn't reduce the debt burden at all.
Although the debt may shrink, tax increases would likely reduce
long-term economic growth even more, leaving the debt ratio no
Rather than obsess over annual budget deficits, lawmakers should
focus on reducing the debt ratio by streamlining spending and
enacting pro-growth tax policies that can keep America's debt
is Grover M. Hermann Fellow in Federal Budgetary Affairs in the
Thomas A. Roe Institute for Economic Policy Studies at The Heritage
Distibuted Nationally on the Knight-Ridder Tribune wire
Over the next few weeks, the unveiling of new budget forecasts, as well as President Bush's budget proposal, will be followed by predictable, sky-is-falling coverage of the "record budget deficits" that threaten to force up interest rates and devastate the economy.
Brian M. Riedl
Grover Hermann Fellow in Federal Budgetary Affairs
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