How Personal Finance Can Help You Think About the Federal Budget
It may be an imperfect analogy, but that doesn’t mean that household financial planning can’t be a helpful way to understand this week's federal-budget fight.
Family financial planning and the current budget debate are guided largely by two basic questions: How bad is the institution's debt burden, and what, if anything, has to be done about it? And both financial planners and federal-budget experts approach the problem in similar ways.
The first step, of course, is to identify whether there is a problem. With household debt, lenders assess whether a family can borrow more by comparing its total fixed debt—think car loans, student loans, or a home mortgage—to its annual income. The target for that debt-to-income ratio can vary, but it should be roughly in the range of 30 to 40 percent, says Eleanor Blayney, consumer advocate for the Certified Financial Planner Board of Standards. In other words, a household shouldn’t let its debts grow beyond 30 to 40 percent of its annual income.
“You may need that debt to get a house, to get a job, to get an education, but you don’t want so much that it will crush you if the unexpected comes up," she says.
Economists use a similar ratio to measure the health of an economy, replacing income with output. To measure that, they use the nation’s gross domestic product—the value of all the goods and all the services produced in a given year. But there’s much less agreement on what constitutes a healthy debt-to-GDP ratio. Many private economists put the upper limit for countries at anywhere from 60 to 90 percent. Even then, some say it doesn’t matter much. It’s that disagreement over the severity of the problem that strikes at the heart of the current debate.
When he unveiled the House Republican plan on Tuesday, Budget Committee Chairman Paul Ryan said it would address “the most predictable economic crisis in this country's history—this coming debt." In an interview that aired the next day, President Obama disagreed, arguing that "we don’t have an immediate crisis in terms of debt."
Under current fiscal policy, the debt-to-GDP ratio will stand at 76 percent at the end of the year and rise and fall by a few points before landing at 77 percent by 2023, according to the nonpartisan Congressional Budget Office. That’s historically high, but not record-breaking.
But much-less reliable longer-term predictions, such as the Treasury Department one below, show debt-to-GDP exploding over the coming decades.
Under the House Republican budget plan, big spending cuts will reduce the debt-to-GDP ratio to 55 percent by the end of the decade. The Senate Democratic budget, unveiled Wednesday afternoon, would bring it down to about 70 percent using an equal mix of spending cuts and new revenue from closing tax loopholes.
The difference in each party's goals is largely driven by how they interpret the nation's growing debt. To Republicans, the debt is nearing crisis levels and needs to be drastically reduced. Democrats, on the other hand, say the nation can tolerate a higher debt-to-GDP ratio. They believe that a crisis is not imminent.
