Here, I would like to come back to a topic also raised in a previous article, the debt-to-GDP measures, and their use as indicators of the fiscal state. That article was devoted to the different debt-to-GDP measures that can be constructed by using different measures of debt (external, internal, public, private, net or gross). At that article I focused on the numerator of these measures. Here, I will question the plausibility of even using any of the debt-to-GDP measures. Hence, I am focusing on the denominator of such measures.
The debt-to-GDP measure is a number that reveals how much bigger is the debt relative to the country’s GDP, or how many years of output are required to payoff all the debt. But, the assumption itself that the country’s output is used in order to payoff all the public debt is impractical. This assumption could be implemented only if the government confiscated all the private sector.
In less extreme periods, though, we expect the government to pay back its liabilities with less dramatic measures. Notably, by using the revenues. Therefore, a natural measure of the fiscal state is the ratio of debt-to-revenues or debt-to-tax collections, and it shows how many years are needed in order to be paid back all the debt by giving all the revenues in retiring the debt. This is, also, something that governments never do, as they always face, even minimal, spending needs.
Another measure that have been constructed by Auerbach and Kotlikoff is the fiscal gap. This is measured as the difference between the present value of all the receipts minus the present value of all the obligations for a long period in the future. Both numbers are measured as percentage of GDP, thus, their difference is a percentage of GDP. The fiscal gap can be interpreted as the percentage increase in revenues or reduction of expenditures necessary to balance spending and revenues in the long run.
These two measures, the debt-to-revenues ratio and the fiscal gap are much better measures of measuring the fiscal state than the debt-to-GDP measure, for which a lot of confusion exists, and it also corresponds to an implausible scenario.
