Growing Debts and Deficits Pulling Down Our Future

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What’s the difference between “equity” and “resilience?” In real terms, essentially nothing: equity is resilience. Equity gives you, a company, or a government the ability to take a hit – a hit like a recession or a pandemic. The big question now is whether or not the United States has the equity to return to normal after a crisis. To consider this issue, I explore the growing U.S. debt, the concomitant reduction in equity, and the implications of debt growth on government and the economy as a whole.

Current State

The most recent audited financial statements of the U.S. government give us this data1 as of Sept. 30, 2019: assets, $3.99 trillion; liabilities, $26.94 trillion; and equity (net position), -$22.95 trillion. The federal debt held by the public included in liabilities is $16.86 trillion.

The statements are audited by the Government Accountability Office (GAO), which disclaims an audit opinion due to the existence of material deficiencies in the U.S. government systems of internal control.2 So, we cannot be entirely confident that the statements fairly present the net position. But, as presented, we have multiples of debt to our assets as a country.

As of this writing, there were 330,400,989 people in the United States.3 That works out to $69,470 of deficit equity per man, woman, and child. Another way to look at that number is that every child born today owes $69,470 in federal government liabilities.

The Federal Reserve uses a somewhat different measure of the outstanding federal debt. According to the data warehouse of the Federal Reserve, “FRED” from the Federal Reserve Bank of St. Louis, the debt outstanding by sector report indicates there was $18.84 trillion outstanding by the U.S. government,4 higher than the $16.86 trillion in the financial statements.

Another important note is the present value of the net unfunded social funds obligation, which is not included as a liability in the statement of position of the U.S. government. The required (unaudited) supplementary information includes disclosure of the social funds (Social Security, Medicare, Railroad Retirement, etc.). The present value of the net unfunded position of the social insurance funds as of Sept. 30, 2019, was $59.1 trillion.5

Thus, the deficit equity position of the U.S. government could be said to be $59.1 trillion unfunded plus $23.0 trillion deficit equity (net position) for a total of $82.1 trillion. We have spent and committed to spend $82.1 trillion more than we have. That’s $248,843 per man, woman, and child.

Where Are We Now?

So, what’s happened to that status since Sept. 30, 2019? Well, Congress has passed continuing resolutions to extend current budgets and spending, the Secure Act, and four separate coronavirus bills (as of our date of publication). According to the Federal Reserve Bank of St. Louis, the total federal debt outstanding at the end of June 2020, was $22.48 trillion.

The two largest holders of U.S. Treasury securities are China and Hong Kong at 18.92% of total foreign holdings and Japan at 18.24%.7 That means each of China/Hong Kong and Japan hold about 5% of outstanding U.S. Treasury securities.

The Congressional Budget Office (CBO) recently issued An Update to the Budget Outlook: 2020 to 2030 in September 2020.8 It stated, “CBO projects a federal budget deficit of $3.3 trillion in 2020, more than triple the shortfall recorded in 2019. That increase is mostly the result of the economic disruption caused by the 2020 coronavirus pandemic and the enactment of legislation in response. At 16.0% of gross domestic product (GDP), the deficit in 2020 would be the largest since 1945.”

For older folks, a concerning part of the coronavirus legislation this year will be the impact on social funds. Much of the taxpayer relief was in the form of deferrals of social funds taxes. According to the CBO, current collections of all withheld taxes are all recorded using a predetermined allocation between income taxes and the social fund trusts. So, the current accounting is not reflecting the actual impact of the legislation on the social funds tax withholdings. In fact, the impact of lower receipts is causing a reduction in the amount allocated to income taxes.

Some of the legislation provides credits for sick and family care leave via credits toward payroll taxes. Another provision provides a deferral of the company portion of 2020 social funds taxes to 2021 and 2022. President Donald Trump’s executive order on Aug. 8, 2020, Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster,9 permits deferral of the employee portion of social funds taxes to 2021. With all of that deferred tax, what happens if bankruptcies go up by a third over the prior year? While payroll taxes may not be discharged in bankruptcy, the ability to collect the taxes is compromised. And the bankruptcy rate is, in fact, up 33% over 2019.10 What happens to collections if an employee who deferred their social funds tax liability loses his or her job?

The CBO report indicates the Treasury will make reallocations between income taxes and social fund taxes in future years to correct for the misallocations in 2020.11 Starting in fiscal 2020 with a $59 trillion unfunded present value of the social funds, the coronavirus legislation and executive order could easily catapult the net unfunded position to a previously unimaginable level.

Does Any of This Matter?

Interest rates are very low and the Federal Reserve can just print more money, so who cares if we have a lot of debt? Not so fast. There are implications to the massive amounts of federal debt outstanding.

The Committee for a Responsible Federal Budget published a paper on April 16, 2019, that summarizes the reasons why rising debt is significant.12 If you are wondering who comprises this group, it includes previous Federal Reserve Board chairs, senators, Office of Management and Budget directors, among others. Here are the committee’s observations about the consequences of high (and rising) debt:
• Rising debt slows income growth because the issuance of additional debt “crowds out” funds that could be used for productive investment in capital assets. That crowding-out reduces labor productivity, which ultimately negatively impacts income and wage growth.
• Rising debt will cause interest to claim a greater proportion of the federal budget, reducing funds available for other fiscal expenditures.
• Rising debt reduces resilience for future shocks to the economy.
• Rising debt is a claim on future generations. I already identified the per-citizen debt load with and without the social funds present value of the unfunded obligation.
• Rising debt exposes the United States to a fiscal crisis.

As a consumer-goods-driven economy, drops in income slow the overall economy. The current pandemic-induced recession is yielding a significant contraction in GDP.

Interest rates on federal debt are running a little over 2%, with the expectation that interest rates will go lower in the short run as investors seek less volatility. In the intermediate term, rates are likely to rise if and when inflation begins. A 2% increase in rates would double interest costs to roughly $760 billion per year. The interest rate risk does not exist in a vacuum. Because interest rates are linked to inflation, any event that could cause inflation, which reduces purchasing power, would have the double whammy of a rise in interest rates. Therefore, the joint risk of potential inflationary shocks to the economy (global or domestic) and interest rate risk represents a formidable downside to high and rising U.S. government debt.

The Federal Reserve has reduced the discount rate to essentially zero. It has also been undertaking quantitative easing again to keep lots of cash in the economy by buying U.S. government securities and other securities, such as collateralized mortgage obligations. In other words, the Federal Reserve has already used most of its arrows of monetary policy. Both fiscal and monetary policies are in “wide open” stimulus mode to combat the pandemic-linked recession. In other words, the United States is already at full throttle and we’re not yet past the pandemic or the related recession. The economy would be severely stressed if another shock hit.

The current generations in power are not only spending their children’s and grandchildren’s inheritance, but they are spending the future generations’ earnings. That’s right. The current generations have spent all of their money and are now spending future generations’ earnings. Those claims will severely limit future generations’ ability to run the country, potentially representing a massive strategic weakness.

If equity does represent resilience, the United States has a severe lack of ability to take another hit. That represents an economic weakness for sure. The more frightening weakness is the strategic weakness. In the paraphrased words of the Chinese Foreign Minister in the TV show Madam Secretary, “Why would we wage war? If we wanted to take over the U.S., we would just foreclose.”  

1 Financial Report of the United States Government, Bureau of Fiscal Service. https://fiscal.treasury.gov/reports-statements/financial-report/current-report.html
2 U.S. Government Accountability Office, Financial Audit: FY 2019 and FY 2018 Consolidated Financial Statements of the U. S. Government (Feb. 27, 2020). www.gao.gov/assets/710/704983.pdf
3 United States Census Bureau. www.census.gov/popclock
4 Federal Reserve Bank of St. Louis, Total Public Debt. https://fred.stlouisfed.org/series/GFDEBTN
5 Financial Report of the United States Government, Statements of Changes in Social Insurance Amounts, Bureau of Fiscal Service. https://fiscal.treasury.gov/reports-statements/financial-report/current-report.html
6 “Who’s Buying Treasuries?,” Federal Reserve Bank of St. Louis. https://fredblog.stlouisfed.org/2018/04/whos-buying-treasuries/?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=fredblog
7 “Major Foreign Holders of U.S. Treasury Securities,” U.S. Department of Treasury. www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx
8 An Update to the Budget Outlook: 2020 to 2030, Congressional Budget Office (September 2020). www.cbo.gov/publication/56517
9 Deferring Payroll Tax Obligations in Light of the Ongoing COVID-19 Disaster, Federal Register. www.govinfo.gov/content/pkg/FR-2020-08-13/pdf/2020-17899.pdf
10 September 2020 Bankruptcy Statistics - Commercial Filings, American Bankruptcy Institute. www.abi.org/newsroom/bankruptcy-statistics
11 An Update to the Budget Outlook: 2020 to 2030, Congressional Budget Office, page 16 (September 2020). www.cbo.gov/publication/56517
12 “Why Should We Worry about the National Debt: Questions and Answers,” Committee for a Responsible Federal Budget (April 16, 2019). www.crfb.org/papers/why-should-we-worry-about-national-debt-questions-and-answers

 

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Edward R. Jenkins Jr., CPA, CGMA, is professor of practice in accounting for Pennsylvania State University in University Park, managing member of Jenkins & Co. LLC in Lemont, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at erj2@psu.edu.