The Skeptical Optimist

An $800 billion freebie, hidden in the national debt

Once a quarter, I like to update this pie chart showing who owns the national debt—mainly so you and I can keep our politicians honest.  I'll explain the $800 billion freebie below.  Click to enlarge.

Private sector owners of the debt
This time I added a breakout of the private sector's ownership: insurance companies, pension funds, and others.  Well hidden inside the private sector's portion (until now) is $800 billion of treasury securities that, in essence, is merely a token entry on the asset side of the Federal Reserve's balance sheet.  It's the cumulative result of the Fed's so-called money printing operations: the bonds purchased by the Fed from the public, using brand new money the Fed has the authority to create out of "thin air" (...to the unjustified horror of many). 

The Fed's inventory of these token bonds will only get bigger and bigger.  That's because our growing economy will forever (I hope) require more and more money injection—to prevent deflation as we produce more and more goods and services.  And here's the good part about that T-bond inventory: nobody will ever have to "pay it back."  [See end note for even more good news.] 

Why not?  Because the Fed's T-bond parking lot is a lot like that place in the Arizona desert where we park all those defunct military airplanes.  That's why I think of it as the "T-bond boneyard."  Others might like to think of it as an $800 billion freebie.  I don't care what we call it; the important point is, even if you know someone who thinks the $8.9 trillion federal debt is a problem, you can at least make them feel $800 billion happier about it.  Just explain the Fed's boneyard to them; they'll be all smiles after that.

Foreign owners of the debt
Anyway, the Chinese still don't own nearly as much of our federal debt as the Japanese do—and neither of those countries has been purchasing nearly as much as the British have.  Here's an idea: Maybe if the Chinese would sell their excess US treasury securities to the Brits, everybody (Chinese, Brits, American doom-peddlers) would be happier, and we could spend more time debating how best to grow the economy faster, and less time conjuring up nightmares about when the Chinese government might turn itself into a financial suicide bomber by dumping their US treasuries all at once. 

Dream on, Steve.

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End Notes:

Data sources
• US Treasury data (breakout of foreign holders)
• SIFMA summary of Federal Reserve data (breakout by institution)

For-what-it's-worth fact about paying back the debt:

The present value of paying back all of the debt principal is exactly equal to the present value of never paying back one penny of the principal (i.e., of paying interest forever and ever). 

The backwards-ticking debt clock, and how to fix the debt-limit farce

Imagine opening up the sports page to see how your local sports teams did yesterday, and seeing the following "scores":

• Baseball:  NY Yankees 4
• Football:  NY Jets 28
• Basketball:  NY Knicks 101

That wouldn't tell you much about what happened yesterday, would it?  In fact, you'd probably consider switching your subscription to a better newspaper.  I would, anyway. 

Why, then, do so many editorial writers and Capitol Hill politicians think we'll keep taking them seriously when all they tell us is "The national debt is at an all-time high of $8,942,383,522,008.61"?  Or "The debt is growing by $8,872.90 per second"?  Or "Each person's share of the national debt is $29,610.54"?  Do they really think that kind of meaningless drivel won't make us switch to a better source of information?

Why don't they think we'd also like to know that "The size of the economy is at an all-time high of $13,818,809,181,973.50"?  Or "The economy is growing by $19,869.16 per second"?  Or "Each person's share of the national output is $45,757.65 per year and growing"? 

I can't explain why.  But I can provide the complete score for anyone who prefers the bigger picture. 

The debt clock shifts into reverse
I knew this had to happen sometime soon, and it did: The debt clock is now ticking backwards.  [Notice the clock at top right, which I recalibrated yesterday.]   

As a portion of GDP, total debt is 64.6% and dropping; publicly held debt (the more important statistic) is 36.2% and dropping.  This blog is one of the few places on the web, if not the only one, where that good news is prominently displayed.  Everyone else is just giving you a partial score; try googling "debt clock" and see what I mean. 

The reason for the backwards-ticking clock is simple: the economy is growing faster than the debt.  GDP is growing at an annual pace of about 4.5%; total debt is growing at 3.1%; publicly-held debt is shrinking at 0.8% (all current-dollar rates).  Those relationships cause the ratio clocks to tick backwards. 

In short: The Yankees beat the Blue Jays 4-0, and GDP growth is beating debt growth 4.5% to 3.1%. 

Isn't that information a lot more useful?

The debt-limit farce, and how we could fix it
Here it comes again: the political farce about the debt limit.  Here's an article predicting the same old political game we are about to witness once again:

The U.S. debt limit is set by statute, so the Treasury has to seek Congress' approval for an increase. With both houses of Congress now under Democratic control, the request likely sets the stage for a debate about the Bush administration's management of the economy and of the national debt.

It doesn't matter which party is in control of the agenda; the game is the same: a completely meaningless, time-wasting parade of politicians trying to make political hay out of the dollar value of the debt (...which, conveniently for their rhetorical game, looks like it's approaching Avogadro's number).  It is a disgusting waste of valuable debate time. 

But I have a way to fix the problem of the debt-limit farce, and get the debate onto a far more productive track.  All it would take would be one simple little change to the debt-limit law to put some real teeth into it.  All it would take would be to change the debt limit from a dollar number (currently $8.965 trillion) to a percentage of GDP (say, 80.0%). 

Think how that would change the debate for the better: it would force our politicians to address economic growth, instead of just continuing to demagogue the debt number ad nauseam.  All of a sudden, a "new" way to keep the debt below its legal ceiling would be to pass growth-friendly laws. 

Unfortunately, I'm afraid that opening up the debate to growth ideas would be too scary for many of our politicians, because debating how to enhance economic growth can become complex very quickly.  Let's face it, it's a lot easier to leave growth out of it, and just demagogue the debt in the headlines and in front of the C-Span cameras.   It's a lot more difficult to reject theatrics and start engaging in real leadership. 

As a result, I pessimistically look forward to another inane, meaningless debate about the dollar debt limit in the coming weeks.

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End note, added 8/9/07:

To clarify why the publicly-held debt is shrinking, here are two graphics, which I explain in more detail in a comment below.  Click to enlarge.

GDP growth, Q2 2007

As everyone expected (except for a select crowd that's always hoping for bad news), real GDP growth for second quarter was 3.4% and trending upward.  Good riddance to the first quarter slowdown. 

Here are the monthly charts:

Not yet sure if these new growth rates, combined with the shrinking deficit, will cause the debt clock to start ticking backwards, but that should happen sometime in the next few months if not this time; I'll recalibrate it as soon as the end of July debt tally is available. 

FQ.07.29: Favorite Quote for This Week

Alexander Hamilton wanted to be sure our [Revolutionary] war debt was the beginning, not the end, of our borrowing history.  Realizing that the country could use borrowed money for an emergency or a project that it otherwise could not afford, he immediately established our good credit... This ability to borrow came in rather handy when President Jefferson [in 1803] received an offer he could not possibly refuse.
—Elaine Schwartz, Econ 101½

How to replenish the social security trust fund in six years, painlessly

As the election season approaches, I'm detecting an increased decibel level in the rhetoric about the social security trust fund.  We raided it.  It's bankrupt.  There's nothing in there for our grandchildren except a bunch of IOUs.  In other words, it's SSDD (same stuff, different day).  No surprise, though, because trust fund sob story still seems to score political points.  [Feel free to replace "stuff" with the word of your choice.]

In this election season, I would personally prefer to hear the scarce time for issues debates devoted to topics of substance instead of wasted on meaningless malarkey about intragovernmental trust funds, so I decided to take another run at this topic.  Rather than trying to explain again why it's malarkey, I thought it would be better this time to propose a quick fix.  In that light, here's a little-known fact:

Believe it or not, our legislators on Capitol Hill have it within their power to replenish the social security trust fund in six short years—and here's the best part—with absolutely no effect on anybody.  That's right: nobody's taxes will increase, nobody's social security check will decrease, and the trust fund will be 100% paid back by the general fund at the end of that time, or maybe even before.  All it will take is a brief, four-point law that expires six years after it takes effect. 

First, a brief diversion in the form of a mini-brain-teaser.  Examine the cash flow diagram below; can you spot any difference in the net effect of scenario 1 versus scenario 2?  [Hint: the correct answer is "No."]

Good.  I presume your three representatives on Capitol Hill could also get that answer correct(?).  In any case, now click on the thumbnail below to reveal the key to those scenarios:

Note that cash inflows equal cash outflows.  That's important. 

Now for the magic-wand law.  The six-year trust fund fix is described in the blue thumbnail below.  Click on it to read how simple it will be to completely replenish the trust fund, painlessly. 

With this law in place, the general fund would pay back the trust fund at a rate of more than 600 billion per year.  At that rate, six years would make the trust fund whole again—and we wouldn't have to waste any more national debate time on the financially phony topic of the "trust fund raid."  (Conveniently, if the trust fund ever got out of whack again, we could reinstate the law for as long as necessary to accomplish the two-pronged goals of keeping the general fund out of debt to the trust fund, and getting the doom-peddling politicians to shut up about it and talk about something substantive—such as how to grow the economy.)

Comments are open, of course.  I was in a hurry when I wrote the new law's wording, so let me know if you spot any flaws, and how you'd fix them.  (I would, however, like to keep it short enough to fit on a postcard.)

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End note:
As Bob has probably detected already, my tongue is firmly planted in my cheek.  Although this truly would balance the intragovernmental funds, the chances are zero that our politicians would consider it.  Maybe this little exercise would turn on a few light bulbs, however.

Growth versus class warfare in the tax system debate

"Don't tax you, don't tax me.  Tax that guy behind the tree."
—Russell B. Long 

It should be obvious by now that no tax rate increase is necessary to "fix" our current fiscal situation; economic growth is making the deficit disappear.  The economy should soon be growing faster than the debt, which will make the debt clock (at upper right) tick backwards.  The power of economic growth, I hope by now, is unarguable.   

How might our leaders enhance the private sector's ability to grow the economy?  Growth-minded people invariably agree that one of the biggest obstacles to growth is the complexity of our tax system; simplification, one way or another, would be very growth-friendly, for about a million reasons. 

Unfortunately, growth-friendly tax simplification ideas face formidable political opposition, fueled by extremely effective class warfare rhetoric.  Although there are several proposals for simpler tax systems (e.g., single- and dual-rate flat tax, sales tax, and others), the single rate flat tax proposal will serve as a good example of how we might overcome the stalemate and rid ourselves of the status quo tax system we're saddled with.  Here's the single-rate flat tax example...

Proponents of a single-rate flat tax lead with their strength: simplicity. 

It's so simple, all it takes is a postcard-size form to do your taxes each year.  All income over and above an exempted amount is taxed at the same flat rate, no matter how much you make and no matter who you are.  The private sector can stop wasting resources on tax compliance and redirect those resources to innovation, job creation, and growth.  Because every taxpayer pays a single marginal rate, the divide-and-conquer class warfare strategy would no longer be available to tax-hiking lawmakers—because a rate increase would affect every taxpayer, not just a small fraction of them.

Opponents immediately counter with their strength: class warfare. 

Tax system fairness requires progressive tax rates, not a flat rate; the rich can and should pay a higher percentage.  A flat tax would cause a huge shift of the tax burden from the rich to the middle class and poor.  Besides, a flat income tax does nothing about the regressive payroll tax, which is especially unfair to the non-rich.  We will fight the flat taxers with everything we've got, to protect the middle and low income taxpayers, and make sure the rich are shouldering their fair share of the tax burden.

History tells me that this particular duel is a stalemate.  Result: We are still saddled with the status-quo.  But I strongly dislike the status-quo, and prefer a more growth-friendly, special-interest-unfriendly taxation system, so I took some time constructing the beginning of a compromise that would address most of the purported concerns against the idea. 

The basic idea of the compromise is to retain the growth-friendliness of the proponents' ideas while deflating the opponents' purported objections.  For starters, we need to include the payroll tax in the analysis instead of isolating just the income tax.  Here's a chart showing total tax dollars paid by a self-employed individual for various levels of taxable income (note the hypothetical income tax scenario at bottom of chart):

The higher one's income, the more tax one pays.  No surprise there.  But look at the bend in the payroll tax line.  That's where the FICA tax stops, even though the Medicare tax keeps going.

Now the bad news: look at how that translates into effective tax rates.  Although the effective rate on the so-called flat income tax is progressive, due to the exempted amount, the regressive payroll tax drags the total tax into a regressive shape.  As history has demonstrated, that is politically untenable. 

If growth-minded people can't think of a way to fix the total-tax regressivity, we might as well get used to the status quo.  I don't care how good the economic argument might be, because politics trumps economics.

But guess what: I thought of a way to fix it (...and yes, it requires a change of thinking on both sides).  To get the desired flat rate on the income tax side (above the exempted amount), replace the payroll side's regressive rate with a revenue-neutral, reduced flat rate that never runs into a cap.  Here's the result (for the hypothetical scenario):

The entire system is progressive, because the payroll tax is no longer regressive; admittedly, we'd have to reconstruct the explanation of FICA taxes paid in versus SS benefits paid out, but that was coming our way within a decade or two anyway.  Is the system not progressive enough?  Okay, then tweak the exemption amount to adjust that.  Still not progressive enough?  Okay, then think up a rebate scheme on the spending side of the budget.  Just do something, because the additional growth this would foster would pay for any transition headaches many times over.

Last but not least: My fear
The above measures are economic remedies for the purported flaws in the single-rate flat tax system chosen for this illustration.  What I fear is that the true agenda of the opponents of tax simplification is not above-board economic concerns, but hidden political concerns.  A simplified tax system would shift power from favor-dispensing lawmakers to a huge, unified block of private sector taxpayers, all of whom pay a single flat rate (above the exempted amount).  That would be a double-whammy to power-broker politicians experienced in working today's complex system: it would mean (1) more difficulty dispensing tax goodies to special interests; and (2) more resistance to any proposal to increase the single tax rate (i.e., all taxpayers, not just a small group, would protest).  That's a double-whammy that many politicians would find impossible to take.  But at least we'd flush out the true agenda by proposing the compromise, wouldn't we? 

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End note:
I've been writing for years about why growing incomes and productivity are so important to our economic future; it's time I started addressing how our government could help the private sector enhance our country's economic growth rate.  This is the first article in a series I've been planning on the subject of taxation systems.

Deficit Watch, July 2007

This is very strange: The White House has "lowered" its deficit forecast for fiscal 2007 to $205 billion. 

The White House must be looking at a different set of numbers than the Monthly Treasury Statement I'm looking at.  Not only is the most recent 12-months' deficit of $163 billion already a lot lower than $205 billion, it is also trending toward $135 billion three months from now (...at which time the "most recent 12 months" happens to coincide with the official "fiscal year"). 

The White House's $205 billion forecast is foreboding to me, because if correct, it would mean that we are in for a sudden and unpleasant change in trend for tax receipts or outlays (or both) within the next ninety days.  The simple diagram below illustrates my point: to change a favorably-trending 12-month deficit from $163 billion to $205 billion in three months, something dramatically negative has to happen very soon.

I doubt that's the problem, though; it's rare for a rolling 12-month trend to reverse itself so sharply and suddenly in the absence of some kind of unexpected shock.  I therefore suspect one of two things: (a) intentional padding of the deficit forecast—unsurprising in the game of politics—or (b) unintentional padding due to excessive caution by those calculating the forecast. 

In either case, I think the deficit for fiscal 2007 will be a lot lower: $135 billion (i.e., a harmless 1.0% of GDP).  I also see that if the current trends continue, the unified budget would move into balance in October 2008.  [The Democrats are still saying there's "no way" the budget will balance even by 2012; I don't know which numbers they're looking at, either, but I will be listening closely to their reaction if the budget does balance in 2008 or 2009.] 

Here's the usual chart; click to enlarge. 

Unfortunately, I can think of several things our politicians could do in the interim that would unfavorably disturb the current trends.  As a result, I'll refrain from making "budget balance in 2008" my official forecast until a few more months of momentum make the trend virtually impervious to political blunders.  But I do remain optimistic that the disappearing deficit we are witnessing under the current tax rate structure will become undeniably obvious to every voter prior to the 2008 elections.

International Debt Thermometer

It's been a year since I posted this snapshot of how various countries rank on the debt scale, according to the CIA World Factbook, so it's time for a refresh. 

This is usually a pleasant surprise to anyone who's been hearing about the USA's "crushing" debt burden from people who don't place it into proper context.  And it's usually an unpleasant surprise to those who like to use fear of debt as a political lever, and therefore intentionally refrain from placing into context. 

Although the USA's "total" national debt is 66.3% GDP (see note 1 on the graphic; it's based on the "$9 trillion debt" that always appears in the headlines), the more important number is the publicly held debt level of 37.5% GDP (see note 2), for reasons I've explained many times at this blog. 



After WW-2, publicly held debt was 121% GDP; although the debt level has increased many times over since then, the debt ratio has dropped to 37.5% because of sixty years of economic growth.   

By the way, I haven't found anyone yet who can justify an estimate as to how high that ratio could go before the markets would start giving unmistakable negative signals, and that includes me.  At least we know that our current debt level is perceived favorably, because interest rates, inflation rates, and exchange rates are remaining steady in safe territory.  I've always wondered if a ratio of 150% or more might be a tipping point (still lower than Japan's)—but am not sure I want to find out empirically.  I do think 40%-80% would be a good target for objective, long-term fiscal policy—even though I have no argument as to why 80% should be a ceiling, and little hope of finding objectivity in the fiscal policy debate, especially in an election year. 

In any case, the USA appears to be in very safe territory—especially considering that the outstanding public debt is denominated in US dollars. 

===============
End note:
The data came from the CIA World Factbook's Public Debt Ranking page.

If you have questions about any of the numbers, especially Canada's number (which is always controversial for some reason), please take it up with the CIA Factbook folks.  Last year I tried several times, with no success; maybe you'll have better luck than I did.

Deficit Watch, June 2007

The latest Monthly Treasury Statement shows that the trend towards a balanced budget has a little less momentum than last month.  October 2008 is when revenues and spending would move into balance if the latest trends continue.  (For the last two years, the projected balance date has been oscillating between early 2008 and mid 2009.)

Here's the usual chart; click to enlarge:

On the spending side, I thought the following numbers were interesting. 

• Military, most recent 12 months:
$520.2 billion, growing at 4.7% annual rate.

• Dept. of Health and Human Services, most recent 12 months:
$660.4 billion, growing at 9.2% annual rate. 

Seems to me the HHS numbers are not getting their fair share of attention from the spending-conscious mainstream media.  Or maybe I'm not checking the right news outlets(?).

Taxpayers "on the hook for $59 trillion." Wait; is that a big number, or a small one?

USA Today's reporter Dennis Cauchon knows how to sell newspapers: just put a huge-looking number like "$59 trillion" in a headline about how much US taxpayers will have to come up with to cover social insurance programs.  Here's the article that got so much attention yesterday. 

Conspicuously absent was any mention about how much time taxpayers would have to come up with the money, or the estimated tax receipts that would flow into the government over that time period. 

I hunted and hunted in Cauchon's article for a reference or link to those (and other) important assumptions behind the $59 trillion; no luck.  Then I hunted and hunted for Dennis Cauchon's email address or telephone number, so I could ask him directly; no luck there, either.

I hope he sees this article, so he can send me an email explaining those important little tidbits behind their analysis.  Reason: Just as any mortgage holder plans to pay the mortgage gradually over a period of years out of future income—instead of coming up with the money tomorrow—so does the federal government plan to pay the social insurance costs gradually over a period of years out of future tax receipts—instead of coming up with the money tomorrow.  The scary-sounding "unfunded promises" really means "future costs to be funded out of future tax receipts"—although the article doesn't explain that. 

Just for fun, I added up how much tax revenue the federal government would collect between now and 2052 (the approximate timeframe it looks like USA Today's analysis covered), for various productivity growth scenarios.  After verifying the timeframe, all I'll need to know is the discount factor USA Today used on the way to their $59 trillion result.  After that, we can see what portion of future tax receipts will be required to pay the future social insurance costs.  For reference, it takes 15% of tax receipts today. 

If anyone knows Dennis Cauchon's email address or telephone number, please send it to me via private email.  My gut feel is that $59 trillion will look small compared to tax receipts over the same time period, using reasonable assumptions about productivity growth, but I can't confirm or disprove that without some help from him. 

Until then, I'll have to file this story in the folder I titled "Single Entry Accounting."