From the September 2011 issue of Research Magazine • Subscribe!

September 1, 2011

Deferred Liability

Who’ll inherit America’s debt?

American national debt held steady, in the $2-3 trillion range, for three decades until the early 1980s. It began to rise rapidly at that point, dipping briefly when it reached the $7 trillion mark in the late 1990s and then taking off in earnest after 2000. In recent years, public debt growth has accelerated further, bumping against the notorious $14.3 trillion limit by the spring of 2011 and occasioning the infamous impasse between the White House and Congress.

It is a staggering amount in and of itself, nearly equaling our current-dollar GDP and representing around 25 percent of all goods and services produced annually by the entire world. Put another way, national debt increased from around $20,000 per head in 2000 to $46,000 currently — meaning this is the share of the total U.S. debt for which each person is responsible, every man, woman and child in America.

Compare this to the median household income of around $50,000 (prior to withholding of tax). True, incomes also rose during the same time period, but they certainly didn’t double. In fact, the increase was only about 20 percent.

Since the average household consists of 2.6 individuals, debt per household measures $120,000, or 240 percent of gross annual income. Incidentally, mortgage bankers consider it prudent if the total mortgage taken out by homebuyers equals two to 2.5 times their annual income. In other words, national debt is like a second mortgage for the American family — and one which, unlike the conventional mortgage, only keeps increasing.

Smaller Assets

The story of the debt-to-income ratio seems worrying, but the situation with debt-to-assets seems a little brighter. Household net worth, the value of assets minus total debts, more than doubled from 2000 to 2008, and measured $68.2 trillion by 2008. However, it dropped to almost $50 trillion by 2009 and recovered to just $56.8 trillion by end-2010.

This overall figure can be deceptive. For example, members of the middle and lower middle classes typically have their primary residence as their most important asset, and accumulated equity in their homes makes up the bulk of their wealth. The 2008-09 financial crisis hit the stock market and real estate market equally hard. But the stock market recovered a substantial portion of its losses by mid-2011, whereas residential real estate prices have continued to fall, hitting a new cyclical low in mid-2011. Home values are down around 30 percent from their peak. The share of owner equity in private homes declined from over 60 percent in 2001 to around 38 percent at the start of this year.

In fact, the value of owner equity in homes has dropped to $6 trillion, the lowest level since the late 1990s. It is less than half of the $13.5 trillion level it reached in 2006.

So, if you believe that we’re saddling the average American with the $14.3 trillion debt, think again. The average Joe has neither the income nor the assets to assume this debt, and probably can’t afford to service this debt even at current historically low interest rates. Even with the average rate across maturities of around 1.75 percent, the U.S. government pays over $400 billion in annual interest charges, which adds up to over $1,300 or so per individual, or around $3,500 per household.

As far as the average American is concerned, this country is already bankrupt.

Saving the Country

During the recent nationwide debate about raising the debt ceiling, many Americans told opinion pollsters that they were strongly opposed to the idea. They didn’t want to pass the debt burden down to their kids. Leaving aside the question what our children and grandchildren will think of the current generation, which got from their parents the most prosperous and successful economy the world has ever known and left it to them effectively in bankruptcy, it should be noted that recent graduates in the U.S. are doing even worse than their parents.

Indeed, the last four graduating classes have entered the worst job market in a generation. And, unlike back then, when tuition even at Ivy League schools was still reasonable and scholarships were generous, today’s students are likely to graduate with tens of thousands in debt of their own, in addition to the government debt we have bequeathed them. The job market has not improved substantially and even when companies start creating jobs again, it will probably take several years to absorb all the new entrants into the labor force.

When progressive taxation was first introduced, one justification for imposing higher income tax rates on households with higher incomes was as follows: people don’t earn money in a vacuum but in a particular socioeconomic system; while personal qualities such as energy, ability, education, ambition and desire to success are important, they only work in a system that rewards them. The same qualities that could make you a billionaire in America would have been useless in a feudal society, and could have landed you in jail in Communist Russia or China.

Asking higher income individuals to contribute more in taxes seemed fair. Since they are earning more than the rest of us, they should give back a larger portion of what they have earned. They have a greater stake in the system and interest in preserving it.

This simple logic has been lost in America in recent decades. We have come to regard our system — and the government that ensures its survival — as an impediment to making money, not the partner of business it has always been. Since 1982, there have been more and more rich people, indicating the system is working well. Yet, the government has been consistently starved of income, leading to a deterioration of the quality and level of services from education to transport infrastructure to space exploration.

On the other hand, it has been a splendid time to be rich in America. Tax rates have gone down, falling to 35 percent for the highest bracket after a series of George W. Bush’s tax cuts in the early 2000s. Over the past decade and a half, the wealthiest 25 percent of households have enjoyed some 90 percent of the nationwide increase in net worth.

Gated Community

While not paying much for public services, the rich also have tended to avoid using them. Living in wealthy suburbs, often gated communities, sending their kids to private schools, hiring private security guards and trash collectors and traveling first class, they have increasingly shielded themselves from the deterioration of public services. The nation has been careful to preserve the defense budget, since external enemies threaten rich and poor alike.

The looming national bankruptcy is similar to an external enemy. It is not the kind of thing from which a gated community can offer protection. It is like a plane crash, in which sitting in first class is no safer than in the cheapest seat.

In the final analysis, the rich need the power of the U.S. to protect their wealth as well as the financial and economic system. This includes the dollar, financial markets, the banking system, the system of commerce and the regulatory environment. It also includes a strong international presence by the U.S. and consistent and rational foreign policy in an increasingly globalized world.

The rich will need a stable and strong U.S. because no other country can perform the role of a global leader as successfully as the U.S. has done over the past 65 years. Consider: there is hardly an individual anywhere in the world whose net worth exceeds $1 million who doesn’t hold at least some assets in U.S. dollars, shares of U.S. companies or dollar-denominated bonds, most likely U.S. Treasuries. Most of the world’s billionaires — and probably all billionaires in Latin America — have homes and residency permits in the U.S. It is their insurance policy against the loss of wealth and threat of physical harm.

A bankrupt U.S. will be weak and unstable. Since ultimately that will hurt this country’s rich, the current debt situation will fall into their lap. They have gotten away with paying relatively little in taxes over the past decade, compared to averages since World War II, but as their accountants might say, it has merely been a deferred tax liability.

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