Forget Debt As A Percent Of GDP, It's

Really Much Worse
Comment Now
Follow Comments

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.

Some people hate the notion of comparing a country’s financial situation to a family, but I
think it is useful in many cases with this being one of them. For a family, debt that exceeds
three times your annual earnings is starting to become quite worrisome. To picture this, just
take your home mortgage plus any auto, student loan, or credit card debt, then divide by how
much you earn.

If the answer is two or less, you are in great shape. If you are between two and three, you are
pretty normal. Over three and you probably are feeling some financial stress with debt
payments absorbing much of your paycheck.

When we look at national debt as a percent of GDP, we see few signs of danger by this rule.
Debt-champion Japan is over 180 percent, Greece is just under 150 percent, with Italy in third
place at 109 percent. The U.S. is in eleventh place (out of 34) with debt equal to 61 percent of
GDP.

Economists and central bankers know this is not the same as the family debt to income
concept, which is why they warn of danger at the level of 100, 90, or even 70 percent
depending on which economist you talk to or exactly how you define the total amount of debt.
The reason for the different standard is that the government cannot claim all your income as
taxes or we would all quit working (or emigrate).
Photo credit: 401(K) 2013

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.

Politicians do not enjoy spending funds on debt payments as it produces no photo ops and no
grateful voters. Yet without quick and significant action on the federal budget, as soon as
interest rates begin to rise toward normal the burden of the national debt on the federal budget
will become heavy indeed. Something will have to give.

Measuring the national debt as a percent of GDP may be a common international norm, but it
makes little sense since not all national income is collected in taxes. Looking at debt to
government tax revenue, more akin to a family’s comparison of its debt to its income, the
story of our national debt becomes much scarier.

Somebody needs to drag the President and Congress to a credit counselor quick to begin
repairs on the government finances. Otherwise, one day sooner than we think, the creditors
will be knocking on the door.