LONDON (Reuters Breakingviews) - The world is over-indebted. Global debt totals $164 trillion, or 225 percent of the planet’s GDP, say Vitor Gaspar and Laura Jaramillo of the International Monetary Fund. And in case that number isn’t troubling enough, the Institute of International Finance uses different definitions to reach a debt-to-GDP ratio of 318 percent.
Experts have many disagreements – from how much debt is outstanding to what type of borrowings are most dangerous. Some argue that rising U.S. deficits court disaster. Others focus on the private sector, and how rapid attempts to cut debt play a big role in economic crises. However, almost all agree that too much debt invites serious economic trouble.
Excess debt is bad because the cost of servicing it can constrain spending on both consumption and investments, especially when interest rates are rising. Even worse is the cascade of defaults that starts when asset-price bubbles burst or when economic growth is disappointing. Banks suffer losses on bad loans, so cut back sharply on lending, which destroys confidence.
If these systemic debt problems were unavoidable, they would simply have to be endured. Such stoic virtue is totally unnecessary, though. Debt levels could easily be kept below the danger level, whatever that is. All that is needed are three sensible and practicable financial revolutions.
First, private debts should be taxed, not promoted by the tax system. As it stands, interest payments are usually treated as tax-deductible business expenses, and individuals sometimes get tax breaks for mortgage interest. That is like inviting drug pushers to hang around schools.
Business loans have more straightforward terms than equity investments, but they are a far less flexible way to provide capital. It would be fairly easy to shift the tax code to favour equity by treating some dividends as a pre-tax expense, and to penalise leverage by taking interest payments out of after-tax income. The result would be a major shift in financing, from brittle debt to sturdy equity.
Of course, investors would resist. They like the way leverage can magnify gains. Tax-favoured debt is the not-very-secret sauce of companies like Blackstone and KKR, euphemistically called private-equity companies. It is also the delight of property buyers, from billionaire magnates to young couples scrambling onto the housing ladder.
But there is no good reason for investors to make a lot of money from merely owning an inert asset, as compared to actually constructing a building or a company. Limits on such unmerited income are likely to promote more solid investments and more equitable growth.
Henry George proposed a way to deal with this problem, back in the 1880s. The American political activist argued that since land’s value comes from the wealth of the whole economy, the wealth really belongs to the whole economy, not the legal owner. Justice, he said, required a confiscatory tax on income and unmerited capital gains from property. Such a tax would be the second financial revolution.
Separating the gains from simply holding property and those from improving it can be hard, but it is worth making the effort to tax the first and encourage the other. Such a land-tax revolution would reduce property speculation, lower property prices and cut back on property debts.
As for the government debts that so worry some people at the IMF, Japan is already, if inadvertently, leading the third revolution. The country’s central bank had created enough new money to buy and hold 41 percent of all outstanding government debt, as of the end of 2017. In effect, the government has been printing money, rather than asking for loans from investors.
That is good policy. Controlled and direct money-printing is simpler and no more dangerous to the economy than most actual government borrowing. And such direct money-creation has the big advantage of not leaving a residue of government debt behind it.
Most economists freak out at the prospect. They think that issuing debt helps discipline governments, by putting them under the scrutiny of vigilant fixed-income investors. In fact, though, those investors generally behave more like easily herded sheep than assertive sheepdogs.
These reform proposals may be revolutionary, but they are far from new. George wrote more than a century ago, direct government money creation was promoted in the 1930s and calls to limit tax subsidies for debt stated in the 1960s. So why have these ideas gone almost nowhere over all these years?
For revolutionary ideas to become policies, the beneficiaries of the current arrangements have to lose power. A debt revolution may require a mega-crisis that forces big changes, since the 2008 global financial crisis left the established system largely intact. Until then, expect many more warnings about excessive debt.
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