The Government Debt Iceberg

April 7, 2014

Europe and the United States will soon begin to encounter fiscal constraints the like of which we have never seen before, says Jagadeesh Gokhale, a senior fellow at the Cato Institute.

  • Federal debt as a percentage of gross domestic product (GDP) more than doubled between 2000 and 2012.
  • According to the U.S. Congressional Budget Office, total national debt is expected to remain close to 100 percent of GDP during the next decade and begin to increase thereafter as the baby boomers fully enter retirement.
  • Debt levels in European Union countries have surged similarly, from 60 percent of national income during the mid-2000s to 85 percent of national income today.

An ageing population alone does not create greater government indebtedness as long as each generation sets aside adequate funds to meet their own future pensions and health care costs. Instead, however, Western governments have developed unfunded social insurance programs where retiree benefits are paid for from the taxes of the working-age population. Politicians have known about population ageing for around 50 years but ignored the problems it will create for public finances.

  • Under the most realistic assumptions regarding future policy and including commitments that have been made under Social Security and health care programs, the U.S. fiscal imbalance is about seven times the total national debt held by the public.
  • In other words, if current unfunded spending commitments to future generations of older people are included, the underlying national indebtedness of the U.S. government is seven times the published figure.

The underlying fiscal situation in the European Union is worse than in the United States. Its demographic situation (a declining worker to retiree ratio), combined with future pension and health care commitments, is at the heart of the unsustainable budget positions in the European Union.

  • The average fiscal imbalance in the European Union is 13.5 percent of the present value of GDP.
  • At 13.6 percent, the United Kingdom's fiscal imbalance is a little above the EU average.
  • Four countries (Sweden, Cyprus, Luxembourg and Estonia) have fiscal imbalances less than 8 percent.

If countries do not address their fiscal imbalances now, the size of the necessary adjustment will increase overtime, undermining investor confidence and generally worsening the conditions for maintaining economic growth. Instead, appropriate and timely structural changes to bring the finances of public programs into balance would be likely to spur economic growth.

Source: Jagadeesh Gokhale, "The Government Debt Iceberg," Cato Institute, March 2014.

 

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