The federal debt is even worse than it looks
The US government’s total debt is $34 trillion. Is that dangerously high? Maybe not, if you focus on the debt-to-GDP ratio. The figure is approximately 120 percent, which means the debt is in a range it’s been in before. It is a bit above the country’s gross domestic product, which is the country’s total economic output.
The debt-to-GDP ratio is the standard measure for federal debt in Congress, the White House, and the US Treasury. Numerous federal agencies explain that this ratio “reveals the country’s ability to pay down its debt” and is illustrative of the “federal government’s health.” Politicians routinely evoke it when discussing the US government’s debt level, such as when Senator Mitt Romney recently called for the establishment of a congressional fiscal commission.
The problem is that this is not the right ratio to be thinking about.
The debt-to-GDP ratio is completely inconsistent with the way that corporate finance professionals use debt ratios. Calculating debt to GDP mismatches a numerator that is the debt of the US federal government with a denominator that is the total income of all US-based workers and businesses. Importantly, the denominator is not the income of the federal government.
A more meaningful ratio is the government’s debt to the government’s own income — federal revenue, nearly all of which comes from taxes. That is in apples-to-apples terms, a fundamental principle in finance. Indeed, every investment bank teaches this principle to its new analysts on day one.
The mismatched ratio for federal debt originally gained acceptance in the decades after World
War II. The underlying rationale for using a ratio to contextualize debt was sensible; an entity with higher income can support higher absolute amounts of debt. Debt ratios are used in corporate finance all the time; they help us measure how many times a company would need to earn its annual cash flow to pay down the debt on its balance sheet.
Using the wrong income figure in the ratio, however, can vastly understate an entity’s debt problem.
It may be argued that a debt ratio using GDP is illustrative of the total potential revenue of the federal government. But that has no basis in reality, because it would require the government to take as tax revenue every dollar of income earned by private citizens.
If we look at government revenue more realistically, the picture changes. Instead of a federal debt ratio of approximately 120 percent of GDP, we can see that it is 750 percent of annual federal revenue. The first ratio gives the illusion that the problem, while large, is still numerically within manageable limits. The second lays bare the extent to which the situation is out of hand. The debt amounts to more than seven years of the government’s entire revenue.
A similar picture emerges if we look at the growth in the debt ratio over time. Since 2005, the GDP-based debt ratio has increased by around 60 percentage points. In proper apples-to-apples terms, using federal revenue, the debt ratio has actually increased by close to 400 percentage points. (Even using the more lenient measure of “federal debt held by the public,” which excludes debt that different parts of the federal government owe to each other, the magnitude of the miscalculation remains significant.)
What this means is that if we had wanted to keep our debt ratio the same as it was in 2005, total federal taxes in 2023 would have needed to be over $8 trillion — nearly double the $4.4 trillion that Americans actually paid in that fiscal year. This shortfall illustrates that it is very difficult to have economic growth entirely resolve the debt problem, as many want to believe it can.
As Congress contemplates setting up a fiscal commission to focus on this issue, a critical first step should be the replacement of the debt-to-GDP framework with debt-to-federal revenue. The starting point for any discussions should be the use of the right yardstick.
Andrew Liang has been an investment banker at Goldman Sachs, specializing in the execution of financings, mergers, and acquisitions, and he served as a consultant on the staff of the President’s Council of Economic Advisers in 2020.