What is the difference between the federal deficit, the federal debt, the real debt of the federal government?
Imagine an iceberg. Call it the debt iceberg. The part that is visible above the surface is the federal deficit. The next layer, just beneath the surface is the federal debt. The broad base is the fiscal gap. The deficit is the difference between revenues and expenses of the federal government in one year. The debt is the accumulated deficits that appear on the government’s balance sheet. The fiscal gap is the net present value of the unfunded liabilities of the government. Only the latter is the real measure of the government’s indebtedness. How so?
The federal deficit and the federal debt as generally reported do not reflect the promises made by Congress that it must fulfill in future years. Why not? Because unlike a private firm which must use GAAP accounting, the government reports on a non-GAAP or cash basis. Under the latter only cash expenses are counted in the deficit and the reported debt includes only cash actually borrowed. But say tomorrow Congress passed a law stipulating that all Americans would get a million dollar check per year for life starting five years out that liability would not show up in the deficit or the debt until actual cash was disbursed. The fiscal gap, by contrast, reflects all promises made.
To give you a sense of the relative orders of magnitude: the federal budget deficit is running at about $500 bn per year currently. The federal debt, on the other hand, is $20 trillion. The fiscal gap is on the order of $200 trillion.
Is the fiscal gap too big? too small or just about right? What yardstick would be appropriate? Well, the net worth of the entire American population, including every billionaire is $90 trillion. So to balance the fiscal gap would be impossible.
To Larry Kotlikoff and other economists that is far too big. For other economists debt is never a problem because future generations are assumed to be much richer than we are and will be able to handle the added interest expense.
To those who do worry, the huge fiscal gap is a form of fiscal child abuse and taxation without representation as it involves passing to future generations the burden of making tough decisions involving raising taxes and cutting spending that the current spineless generation is unwilling to shoulder.
Personally, I think Kotlikoff is right.
Either way, if you don’t know the difference between the federal debt and the fiscal gap and between GAAP and non-GAAP accounting, you can’t possibly understand fiscal and monetary policy.