Tax Analysts Blog

Before Fiscal Collapse: The Slow Decline

Posted on Oct 19, 2010

Economists Carmen Reinhart and Kenneth Rogoff have written several papers and a book reporting on their research that gross public debt in excess of 90 percent of GDP severely hinders economic growth--perhaps by more than one percentage point per year. Separate research by Caner, Grennes, and Koehler-Geib put the "tipping point" for slower growth at gross debt in excess of 77 percent of GDP. For the United States the ratio of gross government debt to GDP at the end of fiscal year 2010 was 92 percent.

Economists go back and forth measuring government debt as either gross or net--that is, net of government debt held by federal agencies (mostly in the Social Security trust fund). So whenever comparing debt-to-GDP ratio you have to be careful to be making an apples-to-apples comparison. In the United States the Congressional Budget Office and the Office of Management and Budget usually, but not always, use net figures. Outside the U.S. the use of gross figures seems more common.

In July the CBO published its latest report on the long-term deficit. One of the many interesting things it tells us is that the rise in public debt will have a significant negative effect on our standard of living. This is shown in the chart below.
The blue line is per capita GDP without the negative effects of debt. The red line shows what CBO thinks will happen after the negative effects of debt are taken into account. By 2020 the effect of rising government debt on per capita GDP is $2,600.

Even worse than the decline in GDP is the decline in GNP (which excludes domestically generated income sent to foreigners). Because so much of the rising debt is being purchased by foreigners, the effect of debt on income accruing to Americans is greater than the effect of debt on income generated in America. By 2020 rising government debt will have reduced the income of the average American by $3,200.

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