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The Debt Ceiling Distortion

Friday, April 27, 2012

Maybe it’s time to redefine the ‘debt ceiling’—to give it some teeth.

It’s common knowledge that the federal debt has been increasing exponentially. Given Capitol Hill’s long track record of just-in-time increases in the statutory debt limit, one wonders just how much value there is in having a so-called limit (a.k.a. a “debt ceiling”) as it is currently defined—apparently, little besides the political grandstanding value for the party that doesn’t occupy the White House in any given year.

Maybe it’s time to redefine the “debt ceiling”—to give it some teeth.

The chart below is the conventional, “hockey-stick” view of our federal debt, as well as the ever-increasing debt limit Congress supposedly imposes on the fiscal process. Judging from contemporary headlines, op-eds, and letters to editors, this chart alone is sufficient reason to start panicking. Fortunately, however, it’s not the only way of gauging the effects of our federal debt.

This chart might make it seem as if a disaster is in progress. Although that just might be true, panicking is likely a gross overreaction—that is, if we can get the economy growing more rapidly. The second chart below will make that point.

Why might knee-jerk panic be an overreaction? Because it ignores key information. It’s like jumping to the conclusion that your favorite baseball team will lose the game merely because the cleanup hitter has struck out twice in a row. Sorry, but that’s not enough information. For example, what if the rest of the team is about to score plenty of runs while the pitching staff holds the opponents scoreless for the rest of the game? If that happens, who cares about the cleanup hitter’s bad day? A win is a win. As Casey Stengel said, “"The Yankees don't pay me to win every day, just two out of three." And there’s more than just one way to win a baseball game.

4.26.12 SConover Debt Limit 1

By the same token, watching the debt level alone does not give us enough information; the size of the economy, for example, is a key determinant of both tax revenue and creditworthiness. The bigger our economy, the more federal debt we can comfortably afford—and, conversely, the faster that debt is growing, the faster our economy needs to grow.

The following chart is an alternative view. It tracks our federal debt from 1940 to the present—but it also incorporates some important missing information: The size of the economy. A large and growing economy makes it easier to bear the burden of any given level of debt, which is why the ratio of debt to gross domestic product—GDP—is an internationally-recognized indicator of the burden of any nation’s sovereign debt. Compared with the historical record of federal debt in the chart above, the U.S. debt-to-GDP ratio tells a different story, as shown below. (The data for both charts is available at the White House web site, in Tables 7.1-7.3.)

4.26.12 SConover Debt Limit 2

This history of our debt-to-GDP ratio strongly suggests that the worst U.S. debt burden in the last seven decades is not happening today; instead, it happened in 1946, immediately after World War II. How did we work our way out of that historically high debt burden? We grew the economy, by putting more and more people to work at higher-paying jobs.

Shouldn’t that be a big hint to us? Shouldn’t that tell us that the debt level is not the only thing we should be watching? Growing the economy is at least as important as our debt level, and the ratio of debt to GDP indicates how well or poorly we have been doing in the aggregate. As the historical chart above implies, during the Eisenhower years we rapidly reduced the debt burden by growing the economy. Why can’t we repeat that solution 60 years after our grandparents set the example for us?

The ratio of debt to GDP is more informative than the debt level alone. A “debt ceiling” as we define it today—say, “$16 trillion”—is less meaningful than a “ceiling” of, say, “110 percent of GDP.” (There’s only one way to keep federal debt below $16 trillion: Stop increasing the debt. But there’s a second way to keep the debt ratio below 110 percent: Grow the economy faster than the debt. The debt ratio makes economic growth impossible to ignore in policy debates.)

Watching the debt level alone does not give us enough information; the size of the economy, for example, is a key determinant of both tax revenue and creditworthiness.

In the second chart above, note the World War II peak, for which we justifiably borrowed money from ourselves in order to win a war that the world had been unable to prevent. See also the subsequent Reagan-era defense buildup financed with the help of extra debt—a period during which it is arguable that we borrowed money to prevent a war. And note the subsequent Clinton-era decline in debt-to-GDP, financed partly by GDP growth and partly by “cashing in” a so-called peace dividend.

Perusing our history of debt-to-GDP illustrates why today’s so-called debt ceiling isn’t telling us everything we need to know. Much better would be a “debt-to-GDP” ceiling. When we grow our economy faster than we grow our debt, we are on the right track; we are improving future generations’ security and financial well-being.

Economic expansion deserves at least equal time in our fiscal policy debate; it’s not just about the federal debt. It’s about our private sector’s ability to grow more than enough to employ everyone who wants a good job, and to maintain or improve our nation’s creditworthiness. It’s time for all of us—Republicans, Independents, and Democrats—to start thinking in those terms. Which candidate offers the better prospects—not just for reigning in wasteful spending, not just for promoting more-productive spending—but, most importantly, for growing the overall economy?

In short, which candidate would be the leader more likely to keep us below a federal “debt ceiling” of, say, 110 percent of GDP? If we’d start talking about the debt in those terms, the national discourse would be much more informative, and much less prone to demagoguery.

Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy.

FURTHER READING: Conover also writes “The Unfairness of the Buffett Tax,” “Peace—and Prosperity—through Strength,” and “Why Growth Matters More than Debt.” Mark J. Perry contributes “Are 'Green Energy' Policies Thwarting Job Growth? Yes: Strategy Sabotages Economic Recovery.” Michael Barone says “Voters Want Growth, not Income Redistribution.” R. Glenn Hubbard claims “Tax Reform Is the Swiftest Path to Growth.”

Image by Rob Green / Bergman Group