The Real Debt
When it tells us how much we owe, the government excludes trillions of dollars in obligations.
What is a debt? In seems like an easy question: a debt is an obligation you must pay. But government accounting follows a much narrower definition, according to which new debt is the difference between what the government paid out and what it took in, and is financed by treasuries. The total debt is the total stock of treasuries, held by individuals, financial institutions, and governments here and across the planet. But this definition is both incomplete and distorted. It confuses our understanding of debt and deficits and leads us to underestimate how much we owe.
A debt is any financial promise. Agreeing to pay a pension benefit 20 years from now is a debt. Promising to provide a high school education in ten years to a five-year-old incurs a financial liability. You could even argue the number of hours a library is open, or any government service, is an obligation that costs money and represents a type of debt. Technically, many services are discretionary, so scope exists to cut them if there’s a cash shortage, and the government even has the right to reduce Social Security benefits. But cutting any of these services or benefits is, in a sense, a default because it represents an obligation not fully paid out.
Financial economics puts a value on different forms of debt based on how likely they are to be paid. Obligations most likely to be paid are more valuable. Library hours are easily cut during a budget crunch, but pensions are rarely cut. In fact, if past sovereign and municipal bankruptcies are any guide, pensions are usually paid before bonds, or at least they take much smaller “haircuts,” or discounts to value. So pensions are not counted as “debt,” though they are often treated as senior to bonds, which are defined as debt.
This is not just about arcane accounting conventions. The number we put on debt can determine interest rates and how much we spend. A trillion-dollar deficit was once controversial, but this year the U.S. is projected to run more than a $3 trillion deficit. And while much of this is Covid-related spending, my Manhattan Institute colleague Brian Riedl sees no end in sight. We’re already projected, under current plans, to run up $24 trillion deficits in the next 10 years, and Joe Biden’s spending plans would add another $11 trillion in debt.
These numbers exclude many obligations. Assuming no changes are made to the programs, unfunded Medicare and Social Security obligations would total $50 trillion. And that’s not all. We could also include military pensions and health care, for another $82 billion. You can also include unfunded state and local pensions, which arguably could be included in federal estimates, since there is a nontrivial chance of a bailout; that’s potentially another $3.8 trillion.
When we don’t honestly assess all forms of debt that we really owe, it becomes too easy not to weigh the costs and benefits of adding new entitlements. Failing to account for the true costs of pensions is one big reason why many states and municipalities are now in such rough financial shape. It’s hard to take away an entitlement once it is offered, yet we don’t include it as a cost in our debt projections. Government should include unfunded benefits in their debt projections if Americans are to get a clear sense of what we really owe.
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