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A new Congress has convened. Soon the battle of the budget will begin. On one side will be the advocates of stimulus, who think the economy needs help to recover fully from the damage done by the pandemic. On the other side will be the deficit hawks, refreshed after their long slumber during the Trump administration.  

The case for a sharp turn toward fiscal austerity rests in large part on the idea that we are at the edge of a precipice, poised for a plunge into insolvency, default, hyperinflation, and who knows what other disasters. A new book from the Cato Institute, A Fiscal Cliff conveniently gathers the views of fiscal conservatives into a single volume. This commentary reviews some of the most common arguments for fiscal austerity and explains why they don’t hold up. 

How high is the debt ratio, really?

The signature chart of fiscal conservatives, one that appears no fewer than four times in A Fiscal Cliff, shows a soaring ratio of federal debt to GDP. An up-to-date version is shown in Figure 1. The blue line tracks the most widely used measure of federal debt, federal debt held by the public (FDHP), based on historical data and projections from the Congressional Budget Office (CBO). 

The historical peak of the debt ratio, 106.1 percent, was reached in 1946. By 1974, a combination of real economic growth and inflation had shrunk the ratio to 23 percent. After that, it moved within a fairly narrow range until 2007 and then began rising rapidly again. The CBO projects that the debt ratio will exceed its wartime high by 2023. Just how alarming is that, really?

In part, the answer depends on which measure of the debt ratio we use. As the bipartisan Committee for a Responsible Federal Budget notes, the version based on federal debt held by the public is widely accepted as “the most economically meaningful measure of debt.” However, a primer on federal debt published by the Congressional Budget Office (CBO) offers several alternatives. 

Some fiscal conservatives, including John Merrifield, an editor of A Fiscal Cliff and the author of an overview chapter, prefer to cite the gross debt. That measure, which includes money the federal government owes to itself (for example, in the form of treasury securities held by the Social Security Trust Fund) was about 28 percent higher than the FDHP as of 2020, as shown by a red data point in Figure 1. The reasoning behind a preference for the gross debt appears to be that the Social Security trust fund and similar funds reflect promises to pay benefits in the future, so they should be counted along with other financial obligations of the government. 

However, I see problems with that reasoning. For one thing, although the government should, of course, think carefully when making promises, promises to pay future benefits are not analogous to those made when issuing securities. The owner of a security has an actual legal claim against the treasury. A failure to honor that claim would be a default. In contrast, future Social Securities beneficiaries have only an expectation, not a legal claim. They hope that Congress will not change the benefit formulas before their turn comes to collect, but such changes have been made in the past, so they can’t be sure. Ironically, some of the very fiscal conservatives who treat the trust funds as financial obligations are among those who urge Congress to renege on its promises by “reforming” Social Security. Significantly, they do not refer to their proposed reforms as “defaults.” 

Furthermore, even if we were to count promises of future benefits as legal obligations of the government, the quantity of securities in the trust funds are not an accurate measure of those obligations. Suppose, for example, that Congress were to change Social Security to a simple pay-as-you-go basis. Instead of placing social security taxes in a trust fund when collected and holding them in the form of securities until they are paid out, those taxes would be deposited in the treasury’s general account at the Fed, along with other revenues. Benefits would not change but would be paid out of the treasury general account instead of from the trust fund, as they are now. Any securities remaining in the trust fund would be moved to the balance sheet of the treasury, where they would now appear as both assets and liabilities and be canceled out. The whole operation would in no way change the annual federal tax burden, annual government spending, or the deficit. It would have no effect whatsoever on financial markets. But, if applied not just to Social Security but to all similar funds, it would immediately cut the value of the government’s gross debt by 30 percent. 

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