In part 1, we went over the main schools of thought of how the government attempts to pay down the national debt via accumulated savings. Let’s take a moment and gain a grasp of the magnitude of the national debt problem.
As you’ve probably noticed, there’s a national debt clock that is at the top of this blog. I think it’s pretty important to be aware of our situation as a nation. In the same vein, a pretty fun website for finance and economics nerds is http://www.usdebtclock.org/. The debt clock widget above is pretty cool, but USDebtClock is the widget above – on steroids! Check it out, if you dare…
Among all the information that is being continually updated on the USDebt site, here’s an important nugget: the ratio of U.S. public debt to gross domestic product (GDP), is around 62%. Total national public debt (as you can see above) is approximately $13.3 trillion – around $43,000 per citizen – and is growing (coincidentally, the average annual income in the U.S. is around that same $40-45K amount). At current rates of growth, the debt will actually be larger than GDP sometime around 2020. Not good folks.
Now, if there are any savings/surpluses or they just feel like throwing money towards paying back the national debt, the government voluntarily cuts a check to the Treasury.
Guess what? In fiscal 2009, the Treasury received a little over $3 million in voluntary debt-reduction contributions from the government. A whopping $3 Million!!! Based on that rate (known as “service rate”) it would take more than 4 million years to pay off a $13.3 trillion debt. Keep in mind that $13.3 trillion is growing every day too, so that 4 million years expands as the debt swells.
So let’s have some fun with numbers for a minute to get some understanding of the magnitude of our debt (I know, I know – “finance nerd”):
- With an average annual income of $42,000, it would take the country's 139 million workers 2 years and 3 months to pay off $13.3 trillion, if everyone simply wrote a check to the government in the amount of their average income (feel like not earning anything for 2.25 years?).
What if we took our 2009 U.S. household savings of 1.2% (see Cause and Effect), set it aside, and paid it to the government? It would take 188 years to pay off the debt. Hmmm, not very encouraging.
How about if we set aside 3% of household savings that would go to debt reduction? It would take 75 years. Not bad - only one generation of workers at 3% to pay off the debt…sounds good right?
How many of you feel like voluntarily writing a check to the U.S. government for 3% of your income for the next 75 years? No? Hmmmmm… Well, if you won’t voluntarily hand over money, it may become mandatory – spoiler alert: tax increases ahead!
Think I’m joking? Just the other week, Treasury Secretary Timothy Geithner said the current administration will allow the Bush era tax cuts to expire in 2011 (see the following charts for how that may affect you). Estimates are that allowing the tax cuts to expire for upper-income earners would increase U.S. revenue by more than $800 billion over the next 10 years (for perspective, that’s only about a 6% dent in the $13.3 Trillion debt total). There are also plans to reinstate the estate tax to 45%, possibly increase the tax on dividends from 15% to 39%, and add a 3.8% tax on investment incomes for high-income earners to help pay for the new health care legislation (a.k.a., ObamaCare).
I ran across the chart below showing the tax rates under the Bush tax cuts and what the rates would return to if the cuts expire…
You may be flabbergasted to see that the lowest tax bracket’s marginal rate will go up 5%. Don’t worry, the current administration knows how to get votes and won’t let the lower and middle classes be hurt by tax increases, thus they will most likely extend the Bush era cuts for the lower and middle classes and let the cuts expire for upper-income earners (keep in mind, not everyone pays taxes…in 2009, 47% of people didn’t owe any taxes come April 15th). The rich will get hit the hardest under the 2011 proposals (see this second chart below with proposed 2011 tax policies).
Finally, here’s a chart with some different tax scenarios and where that puts national debt as a percentage of GDP. I thought this was a great illustration.1) 100% debt to GDP happens in 2020.
2) 100% debt to GDP happens in 2022.
3) 100% debt to GDP happens after 2030.
Remember from Part 1, we mentioned that tax increases historically have the opposite effect from what was intended: weakened incentives for production and ultimately, lower tax revenues. Not to mention, if you raise taxes on the rich, they tend to find ways around tax laws - having a team of lawyers and accountants to find the loop holes (my personal opinion, of course).
All of these proposed tax changes are just a start. Don’t be surprised if you see more taxes initiated or value added taxes (VATs) proposed in the near future.
So bottom line, what’s the solution here? It’s hard to say. From the debt to GDP chart above, you’ll notice the three trends are still upward sloping. So, all the current proposals will do is buy us a little more time and extend the timeline for us to hit the 100% debt to GDP ratio. Historically, nothing has really worked to curtail spending over a long period of time. As I mentioned in part 1, you don’t get to $13.3 trillion if you’re doing things right.
If true change is to happen, some politicians may have to do some very unpopular things in the best interest of the nation – and they need to be long-lasting changes. Tax increases are inevitable and we may very well have to suffer with tax increases for quite some time. It would be a nice gesture; however, if the government stopped its runaway spending in light of the burden they are about to put on us to bail out their spending. Think they have it in them to stop the spending bleeding?
Then again, “we the people” could always voluntarily write a check to the government to pay down the debt…
Anyone? Anyone?
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