U.S. Drowning in debt?
(c) Can Stock Photo/Sangoiri

[N.B. This essay was changed on 8/25/2016 to correct an error on the composition of the net federal debt.]

Just when you think the U.S. financial situation just can not possibly get any worse, reality rises up and tells you how really ignorant you are! At the end of the first quarter of 2016, the total U.S. federal debt was $19.26 trillion dollars. With the GDP being $18.44 trillion, that makes our federal public debt 104.4% of GDP!    

You may have seen posts saying the national debt is only about 70% of GDP. That is true only if you count the portion of the debt owed to the public, including U.S citizens and companies, and foreign governments, and leave out what is owed by one federal government entity to another. For example, the federal government currently owes the entitlements (Social Security, Medicare, and Medicaid) approximately $2.0 trillion, or about 11% of GDP.  On the Federal Reserve Economic Database (FRED), you can find the federal debt owed to the public, which produces the plot below. The most recent reading of this in FRED is at the beginning of 2015, when the debt held by the U.S. public as a percent of GDP was 72.7%.

State Public Debt

However, to size up our true peril from government debt, we would have to add the public debt of state and local governments. Below you see a map of the U.S. states color-coded to show each state’s debt as a share of the state’s gross state product.

You can see that there are more than a few states whose debt is greater than 30% of all they produce. In fact, if you count them, there are 20. Another state map produced by the Tax Foundation shows the states color-coded according to their debt per capita.

The state with the worst state and local debt in 2012 was New York with every citizen owing $17,405 of the state and local debt, followed by Massachusetts ($14,517 per person), Alaska ($13,066 per person), Connecticut ($11, 928 per person), New Jersey ($11,623 per person), Illinois ($11,369 per person), and California ($11,094 per person).

In the Tax Foundation post which showed the map above, a very serious exception was noted. At the very end of their essay, they wrote:

It is important to note that the figures here are for bonded debt, and do not include other outstanding obligations—including pensions—which add substantially to governments’ future liabilities and are often considered in broader definitions of governmental debt. 

The emphasis in the quote is mine. That exception turns out to be a very serious irregularity indeed, as we shall see shortly.

One last comparison of the states’ debts is to rank the states by their fiscal condition, which was done in a Mercatus Center post written by Eileen Norcross and Olivia Gonzales. These ladies ranked the 50 states and Puerto Rico based on five separate categories of fiscal solvency:

• Cash Solvency: Can the state pay its short-term bills?
• Budget Solvency: Can the state pay the fiscal year expenditures with current revenues, or must it finance the spending with the sale of state bonds?
• Long-run Solvency: Can the state meet its long-term spending commitments with enough revenue left over to cushion it from economic shocks?
• Service-level Solvency: How much financial cushion does the state have to increase spending if their electorate demands additional services?
• Trust fund solvency: How much debt did the state have to finance with the sale of state bonds? In particular, how large are unfunded pension and healthcare liabilities? 

Clearly, this last item is the very worrisome problem neglected in the Tax Foundation comparison. Adding up their scores, Norcross and Gonzales ended up the the following state map.

As indicated on the map the least solvent “state” is Puerto Rico, followed by Connecticut, Massachusetts, New Jersey, Illinois, West Virginia, Hawaii, and California. Notice that these are all states that have been dominated by Democrats for decades. Also note the correspondence between the states that are least solvent and those that have the largest debt per capita.

Unfunded State Liabilities of Pension Funds

Now we come to the 800 pound gorilla that threatens the very financial survival of many of the states: state and local pension plans. Over the decades state and local governments have pandered to labor unions representing state and local government employees by granting lavish pension benefits. In addition, those state and local pension funds have generally assumed a 7.5% return on their stock market and other investments. After analyzing the costs of risk these pension funds have assumed, Ed Bartholomew, a former banker and currently a consultant on pension financial management, and Jeremy Gold, a Fellow of the Society of Actuaries, and a member of the American Academy of Actuaries, have concluded the unfunded liabilities of these pension funds could be as large as $6 trillion “in benefits already earned and not yet paid for, several times more than the official tally.”

If we ignore all other state debt and add this $6 trillion to the $19.26 trillion dollars of federal debt, we arrive at a grand total of $25.26 trillion, or 137.0% of GDP! And this is just a lower limit on public debt since there is a lot more to state debt than just unfunded pension liabilities. According to the research of Carmine Reinhart and Kenneth Rogoff, countries with large national debts begin to crowd out corporations in the capital markets in search of capital to finance the debt. They concluded:

Median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower.

As national debt gets even larger, the need for funding to finance the debt gets ever larger, denying even more capital to corporations for productive investments. With fewer productive investments, economic growth is even slower, perhaps stuttering to a stop and going into reverse in a recession. Add this as yet one more government failure explaining our economic doldrums. Who needs Keynesian secular stagnation to explain it?

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