There’s a couple of things that interact to cause a debt crisis. IMHO they come directly out of what happens as debt levels get to over about 150% of GDP, and “austerity” measures cause a simultaneous reduction of tax revenues to the central government AND a driving out of businesses and with them employment and that all important GDP.
(It is a terribly flawed metric, GDP, and has a bunch of variations. It also includes a load of crap that has nothing to do with actual production of valuable goods or services; but it is what we are stuck with in the general press. If time permits, I may add a posting on the various ways to measure national production, but I doubt it would help much for this topic, as “the statistics are what they are” and rule of thumb ratios are based on them as they stand. So I’ll be using GDP “unadorned” and without many qualifiers on it, though in reality it needs a boat load of qualifiers and caveats.)
The Usual Metrics
When dealing with what is called Sovereign Debt (debt of a nation, or in prior times, of the king, queen, or other sovereign) the usual way to measure how far in debt a country might be is to make a ratio of the debt to GDP. The idea being that the country makes a load of “stuff” (that Gross Domestic Product) and you want to compare their debt to how much they make every year. So Debt/GDP ratio is “the usual metric” and at 100% you are “tight”, while at about 150% you are pretty much up against the wall.
Now the problems with this metric are legion. Along with the question of GDP vs NNP (Net National Product) as to which is a better measure of production, or do you use DGP raw, or “real” inflation adjusted (with what deflator?); there are a load of things packed into GDP that are not really production. Along with the iconic ‘broken window’ example where breaking a window and fixing it counts as increased production, but no net wealth was created; there are other issues. This article is an easy read that touches on some of them:
Aside from “real” GDP being inflation adjusted with a rubber ruler, and things like counting wars and the damage they cause as a positive in GDP, there are a load of other detailed problems with it. But it is the statistic used most.
The assumption is that the “junk” in “real” GDP is, on average, about the same from place to place and time to time so a rule of thumb ratio of it is as good as anything.
What Debt/GDP Today?
The wiki has a nice chart of the world. Pretty much accurate as to who is “having issues”. Just a bit more finesse needs to be added to it:
Debt / GDP ratio shows who is in trouble as of 2013
Click on it for a bigger image.
Now folks love to point to the USA and Japan as deeply in debt, but “no worries” so why not everyone join in the debt fest. IMHO, that’s wrong on a couple of counts. But for the moment, notice the other countries.
Sudan, Eritrea, Portugal, Ireland, Italy, Greece, with honorary mention for Iceland and Spain. Next notice that the graph tops out at 100% of Debt/GDP ratio. The SHTF moment comes in at about 150%, so there’s an important tranche of difference hidden by that cut off.
Japan was about 180% in 2013 and now is about 280%, the USA was at about 102% in 2014. Greece is now at about 170%, but was 150% just a year or two back (despite austerity, this has increased. More on that below.) Italy is 132% while Spain is “only” 98%. While the wiki puts Puerto Rico at about 150% right now.
United States Government Debt to GDP 1940-2015
The United States recorded a Government Debt to GDP of 101.53 percent of the country’s Gross Domestic Product in 2013. Government Debt to GDP in the United States averaged 60.81 percent from 1940 until 2013, reaching an all time high of 121.70 percent in 1946 and a record low of 31.70 percent in 1974. Government Debt to GDP in the United States is reported by the U.S. Bureau of Public Debt.
It also includes some nice charts at that link.
So that’s most of the Debtors Row. So “why are Greece and Puerto Rico toast and the USA & Japan OK?”
1) Greece and Puerto Rico can not inflate away their debt via currency inflation as they use a currency controlled by someone else.
2) Someone else sets their economic context (laws, regulations, minimum wage rates, etc.).
3) The USA & Japan are not OK.
Let’s take those in reverse order. Japan is moribund. They have a zero interest rate from their central bank (JCB) and it just isn’t doing a thing to make the economy grow. As seen by that 180% to 280% balloon, they are a rapid railroad to debtor’s prison. However, the JCB is floating tons of money into their economy to try to keep it going. Not doing much other than preventing a massive deflation of real estate and stock prices; but since a lot of perceived wealth is tied up in those, that’s enough to prevent a run on the banks and currency flight. For now… Japan also has a strongly cartel driven economy (the Keiretsu System) and strong barriers to entry for foreign competition. This is not very efficient, but can keep things from collapsing even as the growth rate is near zero (or perhaps actually a bit below zero but hidden in the web of happy talk…). Everyone is whistling past the graveyard and nobody is going to touch the money bubble and pop it. Then there is the regulatory environment. It strongly encourages and works with major corporations. You can get a lot of mileage out of easy credit and compliant regulation. Just not enough to cause any real growth.
The USA is almost as moribund. We have, until the last decade or so, had fairly light regulation of industry, and a very low cost infrastructure (roads, rail, power, fuels, etc.) Add in our own ‘near zero’ interest rates and we’ve managed a growth rate of not quite 2% (on average of the last decade or so) and only a tiny bit below inflation (or a medium bit below actual inflation…). We are essentially “Japan Lite” with an attempt to paper over real lack of competitive posture with a flood of paper money. The biggest issues going forward are that our government has gone on a Regulatory Jihad (that kills companies and jobs), and is determined to drive our power and fuels costs to astronomical levels (and road / rail transport with it). Add in that at $1 Trillion or two a year of new debt, that near zero interest rate will be hard to maintain. Stealth inflation is also reaching the point of being obvious and once the inflation demands kick in, the debt service will be lethal. We are in the stage Japan was in just as they went stagnant. Oh, and the government wants to drive the minimum wage up at a fantastic rate, to better drive jobs out of the country.
For item #2, both Greece and Puerto Rico can’t have their own policies to let their economies do what is best. The EU sets policy for Greece, while Puerto Rico has to conform to USA law. So we have a Federal Minimum Wage that is set so high (compared to other nearby countries in the Caribbean) as to drive unemployment sky high in Puerto Rico. Had they their own laws and their own minimum wage and their own regulations; they could attract foreign investment and companies more readily. Furthermore, they could employ their own people in local home grown businesses. (At one time Puerto Rico was fully self supporting for food. Now it’s about 50%. Wage rates too high to justify local farming…)
Finally, currency. For Greece, they can’t devalue their currency to get the prices low enough to attract a load of tourists, nor can they cut the VAT. So “no Greek tour” for me, as I’m not going to pay 23% VAT Tax on an over priced room and meals. Simply put, a free nation can ‘go on sale’ via currency exchange rate cuts and low taxation / regulation and be up to their eyeballs in new companies and business in a hurry. A vassal State is stuck with laws, regulations, tax structures, and currency exchange rates that put it “out of business” compared to the competition. Similarly Puerto Rico. With a Federal Minimum Wage, they can’t “go on sale” and have a low price tourist package (in Euros or $US ) based on a lower priced local peso. Traditionally, countries with too strong an economy have their currency appreciate until their products don’t sell as well, while those countries not doing well “go on sale” compared to the others as their currency inflates. This attracts more sales until the drop stops. But being unable to do that, Greece and Puerto Rico lose business to the nearby countries who can do it.
And it is that “loss of business” that starts the death spiral.
Another Metric: Debt/Taxes
Now a government does not tax away the entire GDP. Tax rates vary. So using Debt/GDP is a bit less rational as that whole GDP is not available to the country to pay the debt. Using Debt/Taxes gives a better idea what the actual ability of the government to service debt really is.
This also gives a bit of clue why Democrats and Socialists love to raise taxes. You get too far in Debt on the OPM (Other Peoples Money) credit card, then just jack up the taxes so that the Debt/Taxes is OK (and screw the GDP ratio, who cares about production anyway…)
The problem, of course, is that GDP depends on a thriving economy, and as you raise taxes “too high”, you drive away businesses and suffer a reduction of GDP; that then leads to a reduction of tax revenues… Oops.
Forbes has a nice write up on it here:
Forget Debt As A Percent Of GDP, It’s Really Much Worse
/12/2014 @ 10:00AM
When central bankers, macroeconomists, and politicians talk about the national debt, they often express it as a percent of gross domestic product (GDP) which is a measure of the total value of all goods produced in a country each year. The idea is to compare how much a country owes to how much it earns (since GDP can also be thought of as national income). The problem with this idea is that it is wrong. The government does not have access to all the national income, only the share it collects in taxes. Looked at properly, the debt problem is much worse.
I collected national debt, GDP, and tax revenue data for thirty-four OECD countries (roughly, the developed countries worldwide) for 2010. The data are a bit old, but that is actually the last year available for government tax revenue numbers. The debt figures are for central government debt held by the public (so the debt we owe to the Social Security Trust Fund does not count) but the central government tax revenue includes any social security taxes.
A better comparison is to examine each country’s debt to government tax revenue, since that is the government’s income. This also offers a better comparison because different countries have very different levels of taxation. A country with high taxes can afford more debt than a low tax country. Debt to GDP ignores this difference. Comparing debt to tax revenue reveals a much truer picture of the burden of each country’s debt on its government’s finances.
When I compute those figures, Japan is still #1, with a debt as a percentage of tax revenue of about 900 percent and Greece is still in second place at about 475 percent. The big change is the U.S. jumps up to third place, with a debt to income measure of 408 percent. If the U.S. were a family, it would be deep into the financial danger zone.
To add a bit more perspective, the countries in fourth, fifth, and sixth place are Iceland, Portugal, and Italy, all between 300 and 310 percent. In other words, these three are starting to see a flashing yellow warning light, but only three developed countries in the world are in the red zone for national debt to income. The U.S. is one of those three.
This does not factor the several trillion dollars owed to Social Security, yet it includes the Social Security taxes collected. If Social Security taxes are not counted, the U.S.’s debt to income ratio rises to 688 percent (still in third place). This tells you something about the likelihood of increasing Social Security taxes in conjunction with declining Social Security benefits.
Debt / Capita
Occasionally you will see the debt listed per citizen. I actually like that method. It makes it clear just how much of YOUR credit card the politicians have loaded up with crap for their friends.
But that isn’t used much, so I’m not going to do anything more than mention it here.
It would be an interesting “Dig Here!” to compare national debt loads in terms of Debt$/person and Debt€/person and Debt-local_currency/person across national boundaries and see if there are any patterns, but this is not a personal research posting ;-)
Still, at the end of the day, that debt lands on the heads of the individual citizens.
The Death Spiral
Now a naive approach to that problem might well be to just say “Well, then raise taxes!”. The problem with that approach is in some ways part of why Japan and the USA are not (yet) in trouble, yet Greece is.
Country Corp Indvidual Payroll/SSI VAT / Sales
Greece 26-33 22-42 44 23 (16 health and services)
Italy 27.5 23-43 49 22 (or 10 on some things)
Japan 38 15-50 25.6 8
USA 15-39 0-56 ~16 0-11
Hong Kong 16.5 0-15 5% (pension) 0
Singapore 17 0-20 11.5-36 7
I’ve included Hong Kong and Singapore as two examples of places iconic for their incredibly fast growing and rich economies.
A simple scan of the chart shows that the places with the highest taxes are the ones “with issues” and those with the lowest taxes are those doing fine, thanks. In the middle, the USA and Japan have lower VAT/Sales taxes (so not a wet blanket on consumption spending) along with lower ‘entry point’ tax rates on income for individuals (and also for corps in the USA) and mid-level payroll taxes (so not killing employment entirely).
In essence, the higher tax rates just kill the economy, so the employment rate drops, GDP and tax revenues with it, and those Debt Ratios start to balloon even if NO more debt is added. In short, the economy can do fine with a ‘commensal’ government taking about 20% to 25% and returning it as infrastructure and all. At about the 40% to 45% level, it’s a parasite slowly sucking the host dry, but not killing it; just stagnating the economy. Then, at those insane EU rates (combined at about 30% income, on top of a 45% payroll so 75% round trip, then 22% of the 25% that got to the paycheck taken in VAT… so what’s that leave, about 20% if you are lucky to run the economy? As a rough ‘rule of thumb’.) And folks wonder why EU unemployment rates run up around 25-50% in various categories in those countries…
This, of course, is just a clear example of the impact of The Laffer Curve. Rates are higher, but tax ‘take’ is lower as the victim gets sick and eventually dies…
President Kennedy proposed massive tax-rate reductions, which were passed by Congress and became law after he was assassinated. The 1964 tax cut reduced the top marginal personal income tax rate from 91 percent to 70 percent by 1965. The cut reduced lower-bracket rates as well. In the four years prior to the 1965 tax-rate cuts, federal government income tax revenue–adjusted for inflation–increased at an average annual rate of 2.1 percent, while total government income tax revenue (federal plus state and local) increased by 2.6 percent per year (See Table 4). In the four years following the tax cut, federal government income tax revenue increased by 8.6 percent annually and total government income tax revenue increased by 9.0 percent annually. Government income tax revenue not only increased in the years following the tax cut, it increased at a much faster rate.
The Reagan Tax Cuts
In August 1981, President Reagan signed into law the Economic Recovery Tax Act (ERTA, also known as the Kemp-Roth Tax Cut). The ERTA slashed marginal earned income tax rates by 25 percent across the board over a three-year period. The highest marginal tax rate on unearned income dropped to 50 percent from 70 percent (as a result of the Broadhead Amendment), and the tax rate on capital gains also fell immediately from 28 percent to 20 percent. Five percentage points of the 25 percent cut went into effect on October 1, 1981. An additional 10 percentage points of the cut then went into effect on July 1, 1982. The final 10 percentage points of the cut began on July 1, 1983.
Looking at the cumulative effects of the ERTA in terms of tax (calendar) years, the tax cut reduced tax rates by 1.25 percent through the entirety of 1981, 10 percent through 1982, 20 percent through 1983, and the full 25 percent through 1984.
Prior to the tax cut, the economy was choking on high inflation, high Interest rates, and high unemployment. All three of these economic bellwethers dropped sharply after the tax cuts. The unemployment rate, which peaked at 9.7 percent in 1982, began a steady decline, reaching 7.0 percent by 1986 and 5.3 percent when Reagan left office in January 1989.
Inflation-adjusted revenue growth dramatically improved. Over the four years prior to 1983, federal income tax revenue declined at an average rate of 2.8 percent per year, and total government income tax revenue declined at an annual rate of 2.6 percent. Between 1983 and 1986, federal income tax revenue increased by 2.7 percent annually, and total government income tax revenue increased by 3.5 percent annually.
The most controversial portion of Reagan’s tax revolution was reducing the highest marginal income tax rate from 70 percent (when he took office in 1981) to 28 percent in 1988. However, Internal Revenue Service data reveal that tax collections from the wealthy, as measured by personal income taxes paid by top percentile earners, increased between 1980 and 1988–despite significantly lower tax rates (See Table 8).
Simple and clear proof that they were on the wrong side of the Laffer Curve peak. Cut rates, revenues spike up. Lower rates, higher total tax take.
Now run the other way, raise RATES and you get less REVENUE.
So what is the proposed “fix” for the problems of Greece? Higher VAT, lower pension payments, and lower wages. So what would that do? First off, less spending in the economy as those cuts in pensions and wages hit. That, then, will reflect in lower economic activity, and lower taxable activity. Higher tax rates are the killer, though. Increasing tax rates on an already strangled economy will result in LESS tax revenue. So simultaneously less economic activity to tax, and less “take” from it. That, in a nutshell, is why “austerity” doesn’t work.
What does work? CUT tax RATES. Also let the currency drop to a naturally competitive exchange rate and lower regulatory and compliance burdens. Business booms. Employment spikes up. Overall tax take (Revenues) spikes up, and you can start to retire the debt. Now Greece can’t let the currency drop, as they are in the Euro zone… But the rest can be done. In an ideal world, they would leave the Euro, and have the Drachma inflate relative to it for a while. This would leave wages and pensions constant inside Greece in local terms, but dropping relative to other countries. It would also cause a boom of tourism and exports, until such time as wages naturally started to rise, employment neared 95%, and the exchange rate started to push the Drachma up.
Just run the Debt Death Spiral backwards. Lower tax rates, lower regulatory burden, lower cost basis of doing business (and wage rates in other currencies or via lower minimum wage rate for Puerto Rico – i.e. return to States and The Commonwealth setting their own local minimum wage rates as appropriate). Get on the right side of the Laffer Curve.
As the economy picks up, GDP grows as does Tax Revenues. Both the Debt/GDP and Debt/Taxes ratios get better even without paying off any debt.
It really is that simple. There are dozens of “existence proofs” in economic history. This is neither a new insight, nor an unknown thing.
But What About Keynes?
Keynes had a couple of very important caveats on his observation that flushing cash into the system could hold off or reverse a recession. Those caveats are typically forgotten by politicians (and many current economists too, sadly). The two most important were that the added liquidity could only work for a short period of time, as long as there was a lot of slack in the economy and before inflation got started; then the second, that during times of high growth, the excess tax revenue was NOT to be spent, but applied to retiring the debt from the recession so that it would not be a burden on the economy and strangle it going forward.
So Keynes is fine, IFF you apply all of his requirements. Only “stimulate” for a year or two, and as soon as things start picking up, don’t spend budget surplusses.
I’d also add that “What Keynesian Stimulus giveth, excess regulatory zeal and high tax rates taketh away.” You can stimulate all you want, but if undergoing strangling rules, regulations, compliance burden, and taxes; companies just don’t thrive and often die; leaving no growth, no tax revenues, no jobs, and a Death Spiral. This is obvious in looking at Spain and Greece and comparing them to Hong Kong and the USA of the 1960s. ( Or comparing Illinois and Detroit to Texas and Orlando today.)
So once that debt millstone is around the neck, it becomes ever harder to “do the right thing” and cut tax rates to grow the economy. Eventually you end up trapped in a parasitized state, with too much economic life blood (money) being sucked out for “debt service” and no longer available to either the productive growth side (investment in capital stock) or the demand pull side (wages paid and then spent to stimulate more growth).
At that time there are often government boondoggles that waste even more money on Subsidy, Crony Capitalism, Public Works, and more in an attempt to substitute even more Government Debt for the natural “demand pull” of wages paid. It doesn’t work. That money comes either from the productive sector, further sucking it dry and driving it away, or from the already too onerous Debt Monster making the blood sucking even worse.
The only “good answer” is to avoid ever getting to that state. Once in that Debt Trap, getting out is very hard to do. Politicians, especially, do NOT want to hear that the answer is to take money flows away from them and leave them in the hands of those much more capable of putting that money to work in a way that grows the economy, grows the capitol stock, grows the employed base, and generally brings prosperity. They especially do not want to hear that their rules, regulations, laws, and compliance are a large part of the problem and need a good pruning too. And they absolutely refuse to hear that they did not pay attention in their one Econ class (or worse, their 10 minutes with ‘the Econ guy’), when Keynes was brought up, and that they’ve got it all wrong: it is NOT a free ride print all you want monetary stimulus always works… Then Lord Help You if you try to get them to understand that raising tax RATES is going to result in less money for them to spend as tax REVENUES fall.
But all is not lost. It is possible to get out of the pit. Unburden businesses. Cut the red tape (and with it, the size of deadweight government employees causing that red tape and tax burden). Let wage rates set themselves near a full employment level. Let the currency float to its natural level. And for God’s sake cut employment taxes and income taxes to the right side of the Laffer Curve. Oh, and get about a 2 to 3 year “Grace Period” from your lenders to let the system cycle and provide the revenue needed to start paying the debt down. IFF they say no, well, as a Sovereign Nation you can just default and move on. Since the whole idea is to reduce debt, you won’t be taking on more debt for many years anyway. Just let them know that you will be paying the debt, with interest, as the recovery kicks in.
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