Should We Worry About American Debt?: Part V; Debt of State & Local Governments is Low, But…

Executive Summary

The outstanding debt of state and local governments (SLGs) has been flat in recent years, and the sector has a very low debt-to-GDP ratio. However, unfunded pension liabilities, which are currently being accrued, are not included in conventional measures of SLG debt. The pensions of some, but not all, SLGs are seriously unfunded.

We are generally not worried about a full-blown nationwide municipal debt crisis. But, some SLGs have coped with their rising pension liabilities by cutting back on spending in other areas, especially in capital investment. Failure to invest adequately (e.g., replace aging infrastructure) could act as yet another hurdle to faster potential GDP growth in the United States in the years ahead.

Debt-to-GDP Ratio of SLGsIs Only 15%

Presently In Part I of this series, we showed that the total amount of debt in the overall U.S. economy has risen more than $15 trillion (nearly 30%) over the past ten years. We focused on consumer debt in Part II and determined that the financial health of the consumer sector has generally improved over the past decade. In Part III, we analyzed the increase in debt in the business sector in recent years. We concluded that although the financial health of the business sector is not as strong as it was a few years ago, it is not so weak at present to make us unduly alarmed either. In Part IV, we discussed the sizable growth in federal government debt and the factors that have held down Treasury yields, which have made this debt burden easier to finance. In this, our fifth report in the series, we focus on debt of SLGs.

At first glance, there does not appear to be much of a problem regarding SLG debt. Most SLGs have balanced budget requirements, or statutory debt limitations. Unlike the debt of the federal government, SLG debt is utilized in a more project-oriented, capital investment way rather than simply as a means to plug a structural gap between general revenues and outlays. The result is that SLGs generally do not run large budget deficits that lead to persistently rising debt. As shown in Figure 1, the outstanding amount of SLG debt, the vast majority of which is financed via municipal bonds, stood at $2.5 trillion in 2005. It subsequently trended up to more than $3 trillion as SLGs, which reined in investment spending in the early 2000s, started to spend again on investment.

But the absolute amount of SLG debt has been flat in recent years because SLGs have reined in investment spending again, a subject to which we will subsequently return. Indeed, inflationadjusted capital spending by SLGs has contracted at an average annual rate of 1% since 2010. Moreover, the economy has been expanding for ten years, so the debt-to-GDP ratio of the SLG sector has receded to less than 15% today from 21% in 2010. When compared to the federal government sector, where the debt-to-GDP ratio is 78%, and the business sector (74%), this ratio for the SLG sector appears to be miniscule.

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