"Taxing our children" - how big a deal is a big debt?

[Surlethe]

I've been thinking about just how bad the tax burden on future America will be. There are several consequences of a large national debt - one is the drain on the budget in financing it by paying Treasury bonds and interest on them, and one is the need to actually pay it off by raising taxes. We don't hear the former often, while the latter is a chief rallying cry by conservatives (many of whom didn't care about Bush's deficits ... but I digress) against Obama's $1.75T deficit next year.

So I decided to crunch a few numbers about my expected future tax burden, since, being young, I'm one of the poor kids who's going to be paying it off. Suppose we have a debt that's 100% of GDP, or about $14 trillion. That means the per-capita debt is some $50,000 per person. I'm headed for a uni job as a PhD, so supposing (conservatively) that I make $50,000/year for 30 years and pay about 20% of that in federal taxes, I'll pay some $300,000. Paying off my share of the debt in addition to my expected outlays (i.e., the government doesn't cut back on its services considerably) would be accomplished by raising my taxes to a modest 23%, or $350,000 over 30 years. That's a modest $1500 per year.

This little example analysis doesn't even take into account the fact that if taxes rise, they'll do so progressively, which means that rich people will be paying far more than their per-capita debt; economic growth (debt of $14 trillion is 100% of 2008 GDP, but will be maybe 75% of a $19 trillion GDP in 2020, assuming average 3% annual growth); expanding population (the debt burden will be spread out across an additional 50 million people or so in ten years, assuming average 1.5% annual growth); and inflation.

That doesn't seem so bad. What's the deal, then? The problem with this emotional rallying cry is that it sneaks in the assumption that the debt is going to be paid off all at once, which I do not think holds water at all.

N.B.: This analysis does not take into account the interest payments on the debt, which are, I think, the more serious issue when it comes to the debt. Hopefully, I can add to this later.

[Forum Troll]

A few observations:

1. You express that debt figure as $50000 per person, apparently using the entire 300 million population of the U.S. down to the elderly and babies. Active workers and taxpayers are about half the total, so most of your figures are underestimating the more relevant result by about a factor of 2.

2. You assume a debt of only $14 trillion. A few years of $1 trillion to $2 trillion annual deficits could rather quickly more than double the present $11 trillion federal debt. You apparently assume the deficit disappears or decreases drastically in the future instead, yet that's all hypothetical.

3. Why not break this down into some of the most relevant figures?

A quick lookup confirms 116 million households in the U.S. with a median household income of $50200 each in 2006 / 2007.

The federal budget of $3.55 trillion in 2010 with a $1.75 trillion deficit amounts to annual rates of $30600 spending and $15100 deficit increase per household per year.

We can see that deficit spending is concealing from the ignorant multitudes the true situation: Since half (49%) of this coming year's federal spending is deficit spending, to instead balance the budget with it would require about doubling current tax rates.

Even with a progressive tax system, even if you taxed the richest at 90% or whatever you wanted, even their income pool isn't enough by itself, and you'd still have to raise tax rates on more than them alone.

(Such is the federal budget, separate from an additional $3.1 trillion or another $27000 per household spent by state and local governments in 2010).

That's not to say there is something wrong with spending in itself. The debate as always would be over the details of how much is spent, where it is spent, and whether you think your household is getting its money's worth for the typically $15000 increase this coming year in its share of the federal debt.

This analysis does not take into account the interest payments on the debt, which are, I think, the more serious issue when it comes to the debt.

Yeah, those are a pretty big deal.

[aerius]

N.B.: This analysis does not take into account the interest payments on the debt, which are, I think, the more serious issue when it comes to the debt. Hopefully, I can add to this later.

Yup, the interest is the killer. For instance depite the record deficits of the past couple years, the total debt service charge has actually decreased because high demand for Treasury bonds has driven the yield & interest rates to record lows. Problem is we can't maintain these low rates indefinitely, at some point the Treasury market hits saturation or goes "no more!" and stops or scales back buying which ramps the yields & interest rates and this then causes a corresponding increase in the debt service charge. Interest rates doubled? Well, so did the debt service charge, and the longer it goes on the worse it gets thanks to the compounding. I think we're getting close to saturation since rates are beginning to edge back up, if/when we see a dislocation wherein rates double, triple, or worse overnight is anyone's guess, but if that happens we could easily be looking at over $1 trillion a year in debt service costs. Paying that off is going to suck.

[Gerald Tarrant]

A few problems in your analysis.

1. The economy has already contracted somewhat, and may continue to do so. In that case debt as a percentage of GDP will go up.

2. As the level of debt goes up investors are likely to downgrade their willingness to finance that debt. That means higher interest rates. In his letter to the shareholders Warren Buffet was perplexed by the low yields on government bonds"

The investment world has gone from underpricing risk to overpricing it. This change has not been
minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that
yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free
governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the
financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the
housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost
equally extraordinary.

from this PDF page 15

2. continued. The consequences of the popping of the T-bond bubble are probably going to be much higher interest payments.

3. The appropriate model that people should be using is Japan's lost decade. The Japanese averaged about 2% growth over the decade and came out of it with 180% debt to GDP ratio.

4. Savings rates are already going up, the big driver in the US since the 80's has been consumer spending, if savings increases we'll be seeing a reversal of that trend. Consumer spending may pick up when folks are sufficiently de-levered, but in the mean time any recover is going to be slow. This may more appropriately be an addendum to 3. But it just emphasizes the point that your 3% is probably optimistic.

[SirNitram]

Interest payments are always the snag(They have similarly disasterous effects under a Low-Cost Social Security projection, but in the other direction). But I find it useful to examine the debt in context of how the USA has handled debt in the past.

Link

This graph helps. Examining the spending/taxing policies of the declining parts are the best measures(It probably helped that 1951-63 the top income bracket was 91%, and they sure as fuck weren't poor and destitute.). In short, I suspect that unless the US can truly never break free of Reaganomics and they're disasterous cuts for the top earners and other ridiculous policies, it will be sorted out.

[Forum Troll]

That graph ends in fall of last year. The debt will reach again as high as the highest point of the graph (90% of GDP) this coming year, reaching $13 trillion. It wouldn't take many more years of deficits anything like this coming year's $1.8 trillion (counting federal only, neglecting lower levels of government) to push U.S. debt to a higher level relative to GDP than any time in history. This isn't just a repeat of the post-WWII period.

The higher the debt gets, the more interest payments on it increase, tending to reinforce the annual deficit.

In 2008, federal payments for interest on the national debt were $410 billion, proportionally $3500 per household a year. Once the debt goes from $11 trillion to beyond $20 trillion, I think it is apparent where this heads.

[Straha]

So I decided to crunch a few numbers about my expected future tax burden, since, being young, I'm one of the poor kids who's going to be paying it off. Suppose we have a debt that's 100% of GDP, or about $14 trillion. That means the per-capita debt is some $50,000 per person. I'm headed for a uni job as a PhD, so supposing (conservatively) that I make $50,000/year for 30 years and pay about 20% of that in federal taxes, I'll pay some $300,000. Paying off my share of the debt in addition to my expected outlays (i.e., the government doesn't cut back on its services considerably) would be accomplished by raising my taxes to a modest 23%, or $350,000 over 30 years. That's a modest $1500 per year.

Alright, let's start with the beginning and work our way down.

Firstly, as someone already pointed out, the national workforce is about half of the national population. So that means that the per capita share of the national debt, spread out amongst earners, is ~$100,000.

Secondly, the national debt keeps increasing as long as we run a major deficit. To truly start paying down our national debt we need to kill our deficit. In order to do that we need to increase taxes. Currently the deficit is about half (actually, 47.22%) of our annual expenditure ($1.7 Trillion out of $3.6 Trillion) so in order to cover that we have to double your taxes to roughly 40% a year. (Already that's a $10,000 increase over what you were paying before.) Total Cost in Taxes: $20,000, leaving you with $30,000 a year.

Third, the interest on the national debt is incredibly low right now, hovering around 1%, so to pay your "fair share" you'd have to increase your taxes by 2%, adding $1,000 a year. That would make your yearly payments $21,000. However, as already covered, this is abnormally low and for long term calculations let's make that interest (a still low) 4%. This would increase your taxes by 8% and make your total outlay $24,000, or roughly half your income. And that's just to keep down the interest!

Let's take a brief detour here and calculate the total cost of your "share" of the national debt over thirty years with compounding interest at 4%. The formula is: Future Total=PV(1+i)^n. That is the Total value of your interest=Present Value * (1+interest rate) ^ number of time periods you're accounting for. So, it works out to Future total= 100,000*(1.04)^30 (assuming you want to pay it out over your entire career, and don't want to pay it off earlier). Using a calculator because I am A. Lazy and B. rusty at my math that works out to:

$324,339.75 . That's more than what you were going to "originally" pay as taxes, and, if you were actually going to pay that amount, would require us to roughly triple your tax burden from your original 20%!

Thankfully, (and now we're back on the main subject) you're not going to pay that much, because we'll assume you're paying off your share of the debt over time and preventing the huge accrual of compound interest. Running with the $100,000 figure with 4% yearly interest we can figure out how much you have to pay annually to leave yourself completely paid off at the end of 30 years. Rather than do the math myself I got lazy and went over to a mortgage calculator (here) to figure it out and it amounts to a yearly payment of $5,729. That's more than 10% of your income, and essentially a 50% increase on your initial tax rate!


So let's total it up with a before and after:

Your current income: $50,000
Current tax rate: ~20%
That gives the federal government: $10,000
Leaving you a hefty: $40,000.


If you want to pay off the debt:

Your current income: $50,000
Tax Rate to cover current government expenditures: 40%
Tax rate to cover paying off the debt*: 11% ($5,500)
Total Federal Tax Rate: 51%
That gives the federal government: $25,500
And you: $24,500!

That's, of course, before state taxes and other such payments you have to make.

This is, of course, a rough guide. Actually, you'd probably end up paying far more money for two reasons:

1. Government expenditure is going to skyrocket over the next thirty years due to entitlement programs like Social Security, Medicare and Medicaid. Which means all taxes have to go up.

2. You earn more than the average American. You can't just cut up the national debt amongst all earners per capita, because then you drive the poor schmuck running the McDonald's into destitution. Because you earn more than the median income you have to pay more to cover the people who earn less.

And now, if you will excuse me, having just realized how much I'm going to have to pay to cover the national debt I need a good stiff drink. Actually, lots of them.

[Darth Wong]

It's probably worth pointing out that many countries have had higher debt:GDP ratios in the past, and they did not collapse into Mad Max-esque post-apocalyptic wastelands. If you can simply balance the budget at some point in the future, then you stabilize the situation and you can begin slowly paying it down. You don't need to look at paying off the whole thing right away.

The national debt currently works out to around $100k per household, assuming ~110 million households. That's high, but let's keep in mind that people often pay off mortgages much larger than that, using a fraction of their income which is often considerably less than what the taxman takes.

PS. I looked up Canada's national debt. Apparently, we owe $458 billion. We have roughly 12½ million households, so that works out to $37k per household. Our debt:GDP ratio is around one third. Unfortunately, it's headed back up now, but it looks like we have quite a bit of breathing room before the situation gets as bad as it is for the US.

[Veramocor]

If you can hold the deficit at 0 (unlikely) for 30 years at 3% target inflation will cut your real debt by over half. 10 trillion today would be worth about 4 trillion in 30 years in today's dollars.
http://www.hellodollar.com/archives/200 ... calcu.html

[Arthur_Tuxedo]

The real problem isn't the national debt, it's the unfunded obligations of medicare and social security, which is more like $56 trillion or some such ghastly figure.

[Guardsman Bass]

The real problem isn't the national debt, it's the unfunded obligations of medicare and social security, which is more like $56 trillion or some such ghastly figure.

Yeah, but those are spread out over, what, fifty to sixty years? Whether or not they become crushing depends on how the economy does in the meantime - and the figure above also depends on the age limit being kept as is.

[Forum Troll]

If you can hold the deficit at 0 (unlikely) for 30 years at 3% target inflation will cut your real debt by over half. 10 trillion today would be worth about 4 trillion in 30 years in today's dollars.

I don't know if you've personally experienced debts like student loans, but they don't just disappear with inflation like you imagine.

Read the earlier post by Straha. Debts are subject to interest.

By default it increases over time, not decreases (especially with the new levels of deficit spending!). China and other debt holders didn't invest in return for zero or negative interest or getting less than their original money back later (and defaulting on the debt would be disastrous, for, while the U.S. has the military power to preclude more than economic action in response, the U.S. is quite dependent on foreign imports now).

It's a debt of $100,000 per household rapidly increasing (at a $15000 / household annual rate in 2010) towards $200,000 per household in not many years more. A budget where spending is double tax collections isn't getting balanced anytime soon, not if one knows how Congress operates.

[Darth Wong]

The real problem isn't the national debt, it's the unfunded obligations of medicare and social security, which is more like $56 trillion or some such ghastly figure.

But you can change those with the stroke of a pen.

[Teleros]

Trouble is how popular changing Medicare etc will be, especially with Democrats (ok or Dubya-style high-spending Republicans).

[Surlethe]

If you can hold the deficit at 0 (unlikely) for 30 years at 3% target inflation will cut your real debt by over half. 10 trillion today would be worth about 4 trillion in 30 years in today's dollars.

I don't know if you've personally experienced debts like student loans, but they don't just disappear with inflation like you imagine.

Read the earlier post by Straha. Debts are subject to interest.

I haven't had time to really get into this thread, but first: does the US debt operate like a student loan? I had thought that it was chiefly held in bonds, which pay a coupon payment annually. That interest isn't compounding, at least, and since coupon payments are fixed nominally, they'll decrease in value, too. Also, when debts are subject to interest, you have to make sure you're using real interest payments - if you're paying interest of 2% and inflation's 3%, your debt is depreciating at 1% a year.

[aerius]

I had thought that it was chiefly held in bonds, which pay a coupon payment annually. That interest isn't compounding, at least, and since coupon payments are fixed nominally, they'll decrease in value, too.

Except for TIPS, those Treasury bonds are inflation adjusted, good thing they only make up a fairly small part of the total T-bonds outstanding.

One other problem I see is that the Treasury has loaded up the short term bonds market, most of the recent issues have maturities of 3 months to 5 years, with a disproportionate number of 3 month to 1 year issues starting last year. This is another part of why the debt service charge went down, the coupon on those issues is practically zero.

The problem is that the government has to keep rolling over these bonds (like revolving credit on a credit card) so in the case of a bond market crash, the government won't be able to roll the bonds over and we have an auction failure. Which puts yields & coupon payments through the roof, either that or Treasury has to fire up the presses & print to monetize the debt, but if they do that there's a good chance buyers will go "fuck this!" and force the yields & coupon payments sky high in the next auction. In either case you get stuck in a death race, can you inflate faster than the coupon payments are going up without completely fucking over the economy & the country? Historically, this is a loser's bet.

[Darth Wong]

Trouble is how popular changing Medicare etc will be, especially with Democrats (ok or Dubya-style high-spending Republicans).

If the situation gets as bad as some project, then the voters will be more amenable to changes such as nationalizing health care (which would actually save money compared to this "nationalize it but only for the poor and elderly" bullshit), changes to the retirement age, etc.

Right now, people are comfortably able to look at government policies by thinking "what will I personally get out of this in the short term". When it reaches the point that even Joe Sixpack realizes "we have to do something drastic or we're ALL fucked", then political flexibility will increase.

[Straha]

If you can hold the deficit at 0 (unlikely) for 30 years at 3% target inflation will cut your real debt by over half. 10 trillion today would be worth about 4 trillion in 30 years in today's dollars.

I don't know if you've personally experienced debts like student loans, but they don't just disappear with inflation like you imagine.

Read the earlier post by Straha. Debts are subject to interest.

I haven't had time to really get into this thread, but first: does the US debt operate like a student loan? I had thought that it was chiefly held in bonds, which pay a coupon payment annually. That interest isn't compounding, at least, and since coupon payments are fixed nominally, they'll decrease in value, too. Also, when debts are subject to interest, you have to make sure you're using real interest payments - if you're paying interest of 2% and inflation's 3%, your debt is depreciating at 1% a year.

In theory, you're correct. In practice, you're wrong. Ignoring the broad variety of Treasury Bonds out there think about it this way: Because we have not balanced our budget in order to pay off our debt we have to issue new treasury bonds, which accrue interest. In order to pay off that interest we have to issue new treasury bonds, which also accrue interest, and so on and so forth. So while individual bonds just pay coupon payments, the whole bond structure acts as if it had compounding interest. As for inflation, right now we're fine and dandy. The interest rate is so low that inflation is far greater and the government actually, in essence, saves money by borrowing it. The problem is that this is a severe aberration and cannot last for any prolonged length of time. In fact far from it. As the debt increases treasury bonds will become less and less attractive and the interest rate will need to increase far higher than normal. The 4% interest rate I quoted before is probably a low ball estimate.