How Warren Buffett Would Reduce the Public Debt

It is good to see that our politicians managed to find a way to raise the debt ceiling. It is less comforting to see that they only managed to do it when the walls had closed in so much that they had to take turns breathing in.

Needless to say, the deal to raise the debt ceiling does nothing to correct our unsustainable debt trajectory. It simply makes our public debt explode at a slightly slower rate. With the debt ceiling out of the way for now, it is time to focus on debt reduction.

We have all heard the familiar mantras out of Washington. Democrats want to tax the rich, Republicans want to cut spending, some want a balanced budget amendment to the constitution.

A Bad Idea

The latter may be good for sound bites on TV, but it is a bad idea for several reasons.

A balanced budget means that you spend what you take in. However, in order to lower the federal debt burden, we need a surplus. This may be a technicality. Balanced budget proponents presumably really want deficit-free budgets. However, defining a balanced budget as a goal understates the severity of the problem. The public debate should be about how to achieve a surplus.

The Real Problem

The main problem with requiring a balanced budget is that the government cannot adequately respond to crises. For example, it is a bad idea to limit defense spending in the event of an attack just to balance the budget. The same is true if a major natural disaster strikes. The recovery will be much faster if money for rebuilding is readily available, and this is surely in the public interest.

What Buffett Would Do

One could consider providing incentives for politicians to balance the budget instead of a constitutional amendment. Buffett offered an elegant solution: "You just pass a law that says that any time there's a deficit of more than three percent of GDP, all sitting members of Congress are ineligible for re-election."

However, the real problem is not whether there is a budget deficit, the real problem is the amount of public debt. Should a country without debt borrow money, e.g., to build an interstate highway system?  Most people would probably say yes, provided it generates enough revenue to pay for itself and the revenue is actually used to pay back the debt. Should a country as broke as Greece do it? Probably not even if they could.

As we have argued before, the current political system has no incentives for paying back public debts. As a result countries borrow until the markets refuse to lend, at which point they suffer the same fate as Greece.

Perhaps a variation of Buffett's plan could change that. How about a law that renders sitting politicians ineligible for reelection whenever the outstanding debt exceeds some target percentage of GDP. The law would have to specify target Debt/GDP ratios for the next 20 or 30 years to get us from the current situation back down to that final sustainable percentage. That final percentage would then remain constant from there on.

This would drastically curb politician's tendency to buy votes today with debt that the next generation will have to pay off, and it would force them to work together to fix our long-term fiscal problems. The extremists on the left and right whose solutions are financially impossible would quickly disappear from Washington, hopefully to be replaced by people who manage our public finances better.

Think this is just a fantasy? It probably is in the United States, but elsewhere something along these lines has already been done: Germany passed a constitutional amendment (in German) that requires essentially balanced budgets starting in 2016.

About the author

Marc Schindler, CFP®

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