Studies have shown that when government debt rises above 90% it begins to have an effect on the growth of GDP. That conclusion is a bit controversial in economic circles, as some say the critical level is higher or lower.
Understand, those studies are not examining some theoretical proposition; they are looking at actual debt and growth levels in countries over a long period of history. And the data show that excess debt inhibits growth.
We can argue why that is true and how much debt takes effect, but the fact is that the US debt level is already way past that point.
The US Is Approaching a 150% Debt-to-GDP Ratio
When politicians talk about growing an economy 3% a year, they face very strong headwinds. That sort of growth is not impossible in our case. But it would be abnormal given historical data.
To grow the economy at 3% today will require tax reform beyond anything that’s on the table right now. It will require real tax reform, not some minor tweaks.
For the next 10 years, the CBO is projecting slightly under 2% growth per year; 2017 is the outlier year at 2.3%. They also project an unemployment rate below 5% for the next 10 years and inflation in the low 2% range. (You can find my 2017 forecast here.)
That gives us nominal GDP growth of around 4%. (You can see this data and scores of other spreadsheets here.)
That growth rate means a deficit topping $700 billion, and it means our debt will be growing faster than our economy can. In addition, there is the off-budget debt, which means that the debt will grow at about $1 trillion per year or more as long as we don’t have a recession.
The CBO basically projects total deficits to add up to more than $10 trillion over the next 10 years.
That is roughly in line with nominal growth projections, so theoretically our debt-to-GDP ratio wouldn’t rise all that much.
State and local debt will also rise, and then there are those pesky little off-budget numbers, which will add another $6–$10 trillion to the national debt. Again, give or take.
Now, we are beginning to talk debt-to-GDP in the 150% range (give or take 10%) if everything is roughly left in place the way it is today.
Reducing the Deficit Must Be a Priority
Debt is consumption brought forward. If you borrow money and spend it on something today, that’s money you can’t spend in the future. In theory, you have to pay the money back, too.
Debt can be a good thing if it is used to purchase a productive asset that contributes to growth or adds to your net worth over time. But the debt that the government incurs is used almost 100% for current consumption and not for productive assets like infrastructure.
Europe, in general, has more debt than the US does, and Japan has more debt than Europe—and both of those regions grow more slowly than the US. If your goal is 3% growth and more jobs, then adding debt at the level we have already reached—much less at European or Japanese levels—is wrong.
So one of the imperatives in this tax reform must be to reduce the deficit enough that the growth of nominal GDP will begin to reduce the negative effect of debt on growth.
John Mauldin is the chairman of Mauldin Economics, which publishes a growing number of investing resources, including both free and paid publications aimed at helping investors do better in today's challenging economy. Mauldin uncovers the truth behind, and beyond, the financial headlines.
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