Why should we not care about Debt/GDP ratios?

Such a title might scare some of my fiscally hawkish readers who have – rightfully – identified me as a fiscal hawk. However, I really do believe that the information conveyed by debt/GDP ratios is only “trivial”. The information that holds more value to my eyes is government revenues as a share of GDP and debt as a share of government revenues.

These two pieces of information convey the most importants regarding solvency. If a country has a debt that is equals to 100% of its GDP, but whose government revenues are only 10% of the economy, then things are not as bad as they look. It means that this country might be able to tax more without hampering economic growth. However, if another government has a debt standing also at 100% of GDP but whose revenues already represent 50% of GDP, there is considerably less room for collecting ressources to pay the debt without hampering economic growth (hence obtaining less revenues than projected). I have written on this issue in the past (with Quebec in mind) and I believe it might be time to refocus the technical debate on these pieces of information rather than only Debt/GDP ratio.

2 thoughts on “Why should we not care about Debt/GDP ratios?

  1. I’d say it depends on the elasticity of tax revenues over GDP. For example, USA tax revenue is very unelastic (about 18-20% of GDP, whatever the top marginal tax rate, also called Hauser’s law), but it may be more elastic in other countries, Canada for example. There is also a risk of flypaper effect, if governement collects more in taxes, it will be tempted to spend more is social programs (maybe that explains why Europe has more social programs). And the supply side economists will argue that if you increase taxes you will shrink economic growth and total GBP, therefore changing debt/GDP ratio. I’d say you have a fair point, but I an skeptical that countries may increase tax rates to pay debt without having any effects on the economy. For me the solution always has been cut spending, which is easier (but harder politically) to do and predict than attempting to evaluate how much more can you take from tax payers and overall economy.

  2. The argument about elasticity holds and is quite relevant, but elasticity (or lack thereof in our case) is determined mostly by degrees of social trust. More homogenous countries like Sweden, Denmark and Finland are less reluctant to being taxed because they are mostly of the same faith, the same cultural backgrounds and they have shared social traits. The United States, being a melting pot, probably generates tax revenues elasticity closer to 1.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s