Richard F. Keevey
Much like individual households, when spending needs exceed available revenues, public entities borrow — or incur debt.
All levels of government in the United States — federal, state and local — borrow money at some time, albeit for varying and different reasons, under different conditions, and with different policy and financial implications. However, while government borrowing can be useful — it can help manage the macroeconomy; facilitate economic growth; and weather unexpected hardships due to natural and/or man-made disasters — it is not without its attendant perils. Indeed, too much borrowing, especially by the national government, can imperil the economic growth and quality of life.
Federal debt: What to know
The federal government is currently issuing debt at an alarming rate. According to the Congressional Budget Office, the total debt held by the public is currently $28.5 trillion (101% of gross domestic product, which is the most often cited measure of the nation’s annual income). Federal debt is projected to reach $50 trillion by 2035, quite a large increase given that it was $14.1 trillion in 2016 (77% of GDP at the time).
The federal government issues debt for just about anything and everything, including capital purposes (long-term investments, such as infrastructure and military equipment) and ongoing operating costs. No distinction is made between the two. While states and local governments have an operating budget and a separate capital budget, the federal does not have the latter. As such, federal bond sales support spending as varied as individual health services (e.g., Medicare and Medicaid), national defense (e.g., purchasing aircraft carriers and fighter planes), government operations (e.g., the IRS and FEMA) and so on. Is borrowing for such a wide range of spending activities generally considered to be sound fiscal/financial practice? I think that most business and public finance experts would answer no. Still, it has been the practice of the federal government since the beginning of our nation.
Without adding too much more to the complexity and confusion of the federal borrowing picture, note that there are several classifications for federal debt. The first — “debt held by the public” — is the accumulation of annual budget deficits since the beginning of the country (last year’s deficit was $1.7 trillion) and totals the $28.5 trillion noted above. The second category is money “borrowed” from several trust funds maintained and managed by the federal government —such as the Social Security Trust Fund — where such borrowing is currently estimated to be about $7 trillion. These loans are repaid by future bond sales when dollars are needed to make solvent the various trust funds whose resources have been tapped.
Thus, the “real” total federal debt is more than $35 trillion — $28.5 trillion plus $7 trillion. Confusing? You bet — and we would need another 5,000 words to explain adequately the various nuances and implications.
Note also that like state and local governments to be considered below, the federal government also has “non-bonded obligations,” such as unfunded liabilities for commitments made to its citizens and employee, such as Social Security (remember it is fully funded only through the year 2033), Medicare, and military and civilian pension and health care benefits.
State and local debt
State and local governments also issue debt, but at much lower levels. Combined state and local bonded debt currently is about $3.5 trillion. These units of government issue debt for different, mostly capital investment-related purposes.
Specifically, states and local units issue debt for three reasons: 1. to finance new capital projects and capital improvements; 2. to finance short-term cash-flow imbalances (e.g., when the timing of receipt of revenues and spending needs do not coincide); and in very rare cases 3. to finance budget deficits. The first two are considered legitimate uses of borrowing, assuming that any short-term bonds (notes) are repaid before the end of the fiscal year. The third purpose generally reflects poor public finance practices, although some states and localities have stumbled in the past. Thankfully, such fiscal transgressions occur rarely.
There are three types of debt issued by subnational jurisdictions: 1. general obligation (GO) debt; 2. appropriation debt — sometimes referred to as contract debt; and 3. debt supported by revenue generated by the project (revenue debt). In most state and local governments, GO debt is approved by the voters for general capital purposes (e.g., buildings, dams, utilities, etc.).
Appropriation debt, perhaps the least familiar to the general public, need only be approved by the legislature and the governor, and these bonds are generally issued by a designated public agency or authority established specifically for that purpose. It is a process that exists in only few states — including New Jersey — and is often viewed as a way to “avoid” or circumvent going to the public for an approval vote.
The third type of bond is issued by a state authority established by the governor and the legislature to finance specific infrastructure investment, and the bonds are secured only by revenues generated by that investment, such as a turnpike authority or economic development agency. This third type of debt does not appear on the state or local government’s balance sheet, and the state or local jurisdiction has no legal responsibility to secure the debt if the revenue from the project proves to be insufficient to meet the debt service payment obligations.
Only GO debt has the full faith and credit of the state or local unit’s taxing power. Wall Street views GO debt as much more secure than the other two types of debt, primarily due to concerns that the issuing jurisdiction’s governing body could fail to appropriate the funds necessary to meet the debt service of the other forms.
Debt comparison across subnational jurisdictions is usually done on either a per capita basis or as a percentage of personal income, but this can be deceiving, because different states assign functions to different levels of government. For example, California finances most school construction at the state level, while Texas finances most of it locally. New Jersey does both (i.e., both the state and local school districts invest in school construction).
Much like the federal government, in addition to bonded debt, most state and local governments have “non-bonded” long-term obligations — the largest two being employee pension and retirement health benefits. Unlike bonded debt, which requires annual debt service appropriations to liquidate the debt, these obligations are funded for a longer period (using a combination of 1. employer and employee contributions and 2. investment earnings from these contributions to fund these long-term commitments).
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Some observations
Is governmental debt a complicated matter? Most observers would say yes. Moreover, further compounding this already complicated situation is the fact that each state and local government has its own idiosyncrasies. Still, this all begs the question of whether public debt is bad public policy. I say: not necessarily.
Most state and local debt is for critical infrastructure investment projects, and more debt will most likely be necessary going forward to accommodate economic growth and improvements in the quality of life enjoyed by residents of the respective jurisdictions. Importantly, and unlike the federal government, state and local governments cannot “print money” to support ever-increasing amounts of debt. Moreover, state and local units of government face constitutional and/or statutory limitations on their ability to issue GO debt. Finally, and perhaps most important, the capital market itself may serve to limit the amount of debt state and local governments can issue, as investors will simply refuse to purchase and hold debt issued by these jurisdictions, or will be willing do so only at exorbitant rates of return.
The issue is different for the federal government, due primarily to its size and resulting (capital) market power. Budgetary trade-offs (e.g., decisions between defense spending, social safety net programs and tax policy debates) all likely affect how much debt the federal government can afford in the future. Just how much debt can the federal government issue and maintain going forward? Is it an unlimited amount? I do not think so, but I truly do not know. However, the answer is much more complicated than a simple yes or no, or a specific dollar amount.
As such, those who say “Just balance the federal budget and cut spending” are not being realistic, and are certainly not well informed. The nation’s needs are too expansive (and growing), especially as the population ages, health care cost increase, and both known and unknown emergencies develop. However, it may be possible to reach a realistic compromise as a hedge against future uncertainties regarding public debt, especially at the federal level.
It is clear to me we must reform the tax code to raise more money. For example, we should consider 1. reducing the (annual) $1.8 trillion of tax expenditures (e.g., tax credits, preferential tax rates, tax base deductions, etc.) — principally those benefiting the richest elements of our society; 2. increasing the top tax rate on individuals and corporations; 3. altering defense policy (the U.S. spends more on defense than the next 10 largest countries combined); and 4. bending downward the growth curve for social safety net programs. None of these suggestions or options will be easily accomplished, but they are, in my judgment, necessary so federal debt amounts are at a reasonable level in relation to the wealth of our nation.
In sum, borrowing by governments in the U.S. is not all good or bad as a public policy strategy. Rather, a deliberate, thoughtful and realistic strategy should be employed — one that considers the trade-offs, including the long-run and short-term impacts on the jurisdiction’s finances, as well as the positive and negative implications on the nation’s overall well-being.
Richard F. Keevey held two presidential appointments as deputy undersecretary at the Department of Defense and as the CFO at the Department of Housing and Urban Development. He was anointed the state budget director by two New Jersey governors from both political parties. He was director of the Policy Research Institute at Princeton University. He is currently a senior policy fellow at Rutgers University. He served as the executive officer of a nuclear missile battery in Europe in the mid-1960s.