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US Government Debt: How much should we worry?

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RotaryPresentation_09082021 (1)Presentation at Rotary Club of Fort Collins September 8, 2021
US Government Debt: How much should we worry?
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US federal debt since the 1970s
The gross federal debt has been steadily rising since 1970, independent of the party of the sitting president.
Federal debt as a % of GDP since the 1930s
Similarly, the gross debt/GDP ratio has been on the rise since the 1980s.
Total public debt is ~ 126% of GDP as of 2021, following Covid- related stimulus measures
1950 1960 1970 1980 1990 2000 2010 20201940
P e rc e n t o f G D P
Federal Debt: Total Public Debt as Percent of Gross Domestic ProductFederal Debt: Total Public Debt as Percent of Gross Domestic Product
Gross Federal Debt as Percent of Gross Domestic ProductGross Federal Debt as Percent of Gross Domestic Product
Shaded areas indicate U.S. recessions. Sources: OMB; St. Louis Fed fred.stlouisfed.org
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Is the federal government spending too much?
Federal gov’t consumption + gross investment as a % of GDP is lower today than in 1970.
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What about tax revenues?
Federal tax receipts are volatile, but on a downward trend since the late 1990s

The top marginal tax rate has been on a downward trend since the 1960s.
Source: Tax Policy Center
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Corporate tax rates
The steady decline in the effective corporate tax rate (from over 50% In the 1950s to less than 10% today resulted in lower revenues as a share of GDP.
Source: Tax Policy Center
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Summary • Federal Debt as a share of US GDP has been gradually rising since
the 1980s.
• Debt grows when the government operates a deficit — it earns less than it spends (we’ll return to this later).
• But federal consumption and investment spending as a share of GDP has been falling.
• The rise in the federal Debt/GDP is at least as much about lower revenues as it is about government spending.
• Decline in tax receipts also partly coincide with falling top marginal tax rates and falling corporate tax rates.
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How much should we worry? • Federal Debt/GDP ratio is currently just below 110%, up from ~
40% in 1980.
• The increase would be a problem if rising debt obligations make it harder to find sufficient demand for government debt, which in turn would require offering higher interest rates on government bonds.
• Luckily, US treasury bonds are in high demand not only domestically but also worldwide, because:
• The US dollar is still the prime international reserve currency (more than 60% of global FX reserves);
• The solvency of the United States is not questioned by financial markets: US debt is basically a risk-free asset.
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The mathematics of debt stabilization • The “least controversial equation in macroeconomics” (Nobel Prize
winner Thomas Sargent)
(interest rate – growth rate) x Debt/GDP + Deficit/GDP
• If the US economy grows faster than the interest rate on US debt, and the deficit stays under control, the debt/GDP ratio will stabilize or even fall.
• (one can solve the above equation for the deficit/GDP ratio that stabilizes the debt/GDP ratio)
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Short vs. long run • Both the Great Recession of 2008-09 and the Covid-19 shock prompted
increases in deficit spending and therefore the Debt/GDP ratio.
• This is what should be done during recessions, when the private sector cuts its spending, which reduces aggregate demand and growth.
• Interest rates have been low thus “accommodating” the fiscal expansion:
• Low interest rates increase the fiscal space for the federal government: • Debt can be rolled over for a while without necessarily seeing the
debt/GDP ratio increase. • When the economy returns on a normal growth (and tax
revenues) trajectory, part of the increase in debt/GDP will pay for itself.
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Spending and revenues
• As the US economy eventually recovers from the Covid-19 shock, it is best to worry about the deficit/GDP ratio than the debt/GDP ratio.
• Long-run fiscal positions implying deficits above the debt-stabilizing rate will increase the debt/GDP ratio.
• Tax revenues are also important: in 2019, total tax receipts as a share of GDP were 24.5%, compared to the OECD average of 33.7% (UK was 33% for example).
• A more progressive tax code can be used to reverse some worrying trends in income inequality affecting the US economy since the 1980s.
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Inequality: Top income shares
The share of top 1% and top .01% in US income has increased since the late 1970s, at the expenses of everyone else.
Source: Tax Policy Center
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The middle class has been losing ground to higher incomes.
Source: Pew Economics Institute
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Progressivity of US tax code
The US tax code is progressive, but not so much at the very top of the income distribution.
Source: Tax Policy Center
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Conclusions. Looking ahead • Even though the federal debt/GDP ratio has been rising, I am not too worried
about it:
• Demand for US Treasury bonds (safe assets) is high, even at low interest rates;
• Low interest rates make it easier for debt to partially pay for itself through economic growth.
• As the US economy recovers (eventually!) from the Covid shock, fiscal stimulus through high deficits will no longer be necessary.
• The deficit/GDP ratio is the key indicator of fiscal sustainability to look at.
• Government spending as a share of GDP is already declining: being serious about debt reduction requires to look at the revenue side (i.e. taxes).
• A more progressive tax code can increase revenues while at the same time reversing worrying trends in income inequality.
Thank you!
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