How to Look at Debt: Did You Get Something or Just Run Up Your Card?


If you knew your salary was going to increase by 76 percent in the next 30 years, would you increase the amount of debts you incur during that time by 240 percent? No? Well, consider this.

Some of the debt you incur is used to buy useful stuff — like the home you live in. It's a huge chunk of change, but you agree to sign a mortgage contract because you're getting a house to live in and an asset on your balance sheet.

But some of the debt you take on is just paying for the equivalent of a vacation or a fancy gym membership. Sure, you may enjoy it and find "value" in relaxing or pumping iron, but ultimately, you end up with nothing to show for it (tight physique aside, you can't really write that on your ledger as an "asset").

Yet, most of the debt that the government is incurring is the latter form.

The federal debt currently stands at $14.8 trillion (trillion with a "T"). It sounds like an astounding figure, but some of that debt may be OK.

Here's how Alex Brill , a former chief economist in the House Ways and Means Committee and a former staffer at the White House Council of Economic Advisers, explains it:

There is an important difference between debt accrued to acquire an asset and debt accrued to make a transfer payment. For example, the USS Gerald R. Ford — the first of the newest generation of aircraft carriers — was commissioned in early 2017 and cost approximately $13 billion to build. All else equal, the federal debt is $13 billion (or 0.088 percent) higher as a result.

However, the federal government now owns an asset worth $13 billion with an expected useful life of 50 years. This is not the case when federal outlays are transfer payments, which they often are. For example, federal spending in response to hurricanes has averaged $14 billion annually in recent years just to restore affected areas (CBO 2016a). All else constant, the federal debt is $14 billion higher per year as a result.

The point is not that one type of expenditure is good and the other bad, but that, despite the similar amounts, the transfer from the federal government is not economically equivalent to the purchase of a long-lived asset. Similarly, from a capital accounting perspective, federal entitlement spending on Medicare and Social Security has a distinct effect on the budget compared to investments in infrastructure.

Brill notes that the money being collected today also pays for promises to be kept in the future, which means the debt we see now isn't truly a reflection of what's to come because we're comparing current revenues to current expenses, even though the current revenues are supposed to be paying for future expenses.

Imagine what happens when you pay so much to your credit card every month that you don't have enough left to live on so this month you charge your grocery bill on your credit card. Good. You get to eat today. But next month, you have to pay for last month's meal.

Yeah, it's like that.

So what's to happen? Eventually, and this is not even a far-off prediction, the debt-finance ratio is going to reach the fulcrum on the see-saw, and we're going to have more debt than finance. When that happens, benefits like Social Security and Medicare are going to go away. This isn't a panicky or apocalyptic prediction. There just won't be money to pay for these "grocery bills."

Is there anything to do about it? Yeah, there are ways of making the economy more productive so that tax burdens remain the same but produce more revenue. There's the option to pull more money from more people, or to pull larger amounts from those with larger incomes. Or the government could stop buying things it can't afford. It could hand off some programs to private interests who can more efficiently manage them. Of course, that would take cooperation in Washington, the rarest of commodities at this point in time. And it's not a question of doing one of these things. All the remedies together may or may not be enough to close the debt gap.

Some people say just print more money, the way the Great Recession was handled. The problem with that is that it doesn't increase economic output, it just causes inflation, which causes the value of cash to decrease. Why is this a problem? Because the national debt is financed by government bonds. If inflation occurs, the government would have to pay higher interest on those bonds to get people to buy them. How does incurring a larger future promise of repayment help to reduce the national debt? This is exactly today's problem. It's a vicious circle.

There are options, but they are few. But if government doesn't make changes in a planned insightful way, it's going to do it in a disastrous way in the future, when it runs out of choices.

What do you do to manage a reasonable amount of debt?