I had originally planned to spend this morning rolling my eyes at Bernie Sanders for saying:
“There is something profoundly wrong in America when one out of five profitable corporations pay nothing in federal income taxes.”
This was after he commissioned a report from the US Government Accountability Office (you can read the highlights here). The explanation offered by the GAO for this profound wrongness:
Reasons why even profitable corporations may have paid no federal tax in a given year include the use of tax deductions for losses carried forward from prior years and tax incentives, such as depreciation allowances that are more generous in the federal tax code than those allowed for financial accounting purposes.
Are “tax deductions for losses” such an evil? Um, no. They’re a necessity, really. It’s something that I’ve already posted about (see here).
But then Twitter exploded with this:
Followed by this:
And then this series of tweets by Cullen Roche from Pragmatic Capitalism:
He then wrote a blog post about it (“Say America’s Bankrupt One More Time…“), which is definitely worth a read.
And here is my take on his take.
The Home Ownership Analogy (because I know how much we all like the Household metaphor)
- Take two guys: Cullen and Jim. Both earn a salary of $100,000 per year.
- Both Cullen and Jim separately decide to buy houses worth $1 million, with a mortgage of $900,000.
- Two years later, the houses are worth $1.1 million, and the mortgages are down to $870,000.
- At this point, both Cullen and Jim take out second mortgages of $90,000, because the value of their houses have increased. They plan to use it for a few home improvements, and also, to cover some running expenses.
By this point:
|House Value||Total Mortgage Debt||Annual Income||Debt to Income Ratio|
So Jim declares:
WOE is me! My debt is increasing! How will I ever repay my debt on $100,000 per year, when I need to eat and live and pay taxes! I am 960% in the red! Oh, the calamity that I am inflicting on my children and grandchildren and grandchildren’s children! #government #publicdebt #creditfordays
And Cullen replies:
No, you pillock. You own a HOUSE worth $1.1 million. That debt paid for an asset. Stop panicking. You’re upsetting everyone.
In the World of National Debts…
So if we’re to extend the analogy:
- The House Value refers to the value of the nation’s assets.
- The Mortgage Debt is the national debt.
- The Annual Income would be GDP.
- The Debt to Income ratio would be the Debt-to-GDP ratio.
Can you see how bizarre it is to only look at the Debt-to-GDP ratio, as though the volume of debt is all that matters, and we can just ignore the asset side of the equation?
The nation has debt, true. But it also has assets, and those assets are supported (and sometimes, improved) by the national debt.
Which is not to say that the debt-to-GDP ratio doesn’t matter. Of course it does. It affects interest rates and one’s ability to borrow further – because it’s not so easy to just “sell off national assets” in order to pay down national debt.
But it does help to keep things in perspective.
Because without looking at net wealth levels, debt is just another number.
Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.