Americans are so indebted that it’s holding back the economy. These 4 key reforms could give them room to breathe

While government debt has been dominating the news, there is far more private debt than public debt in the U.S. economy–and it represents the greater economic challenge. As of year-end 2022, public debt totaled 123% of GDP, while private sector debt totaled 165%.

The level of private debt–student debt, mortgage debt, small business debt, and more–has more than doubled as a percentage of GDP since 1980. It stifles economic growth because it burdens individuals and businesses. In fact, debt has been consistently growing faster than GDP, which means that the burden on the private sector is almost always increasing.

Debt can be employed productively. In fact, an economy can’t function without debt. Yet debt is a paradox: its overuse can bring harm–and even disaster.

Why debt always grows faster than the economy

Debt grows because it takes new debt to grow the economy. If you want to build a new house or buy a new car, you can either spend proportionately less on something else, which means the overall GDP won’t grow, or you can borrow the money. Reducing spending to save in order to make the purchase reduces GDP during the period in which you save. If your employer increases your pay and therefore gives you more to spend, you can use that to grow the economy–but those earnings essentially are predicated on someone else’s debt growth.

Increased debt, especially private sector debt, is fundamental to economic growth–but it mounts up over time. In the absence of a drastic reconfiguration of economic life, debt growth is essentially perpetual. Total debt–private debt and government debt added together–has grown from 142% of GDP in 1950 to a mindboggling 294% today.

The inexorable march of debt may well be the most important economic factor in our lifetime. It underscores the need for new approaches in addressing this unbridled debt.

Student debt relief

Student debt is a scourge, weighing down the financial lives of millions of Americans, young and old, for years after they’ve left the university. Carrying this burden results in deferred home buying, delayed household formation, and other trends that impact people’s long-term financial, physical, and mental health.

To free Americans from student debt, a government program could offer debt forgiveness based on performing substantial volunteer work for a qualified not-for-profit institution. A student debt holder who has done volunteer community service for an approved government or not-for-profit organization for at least 800 hours, and made payments for 90 consecutive months, would have the remaining balance of their student debt forgiven. This should also include studies at a trade or technical school.

Mortgage debt relief

At the end of 2021, pandemic mortgage payment forbearance programs ended in the U.S., and deferred mortgage payments had to be paid. Often lenders arranged to tack the deferred amount to the end of the loan. Another option would be a “debt jubilee–a program offered for a limited and defined period that would allow missed payments and interest, plus up to an additional 20% of the principal balance, to be written down at the borrower’s option in exchange for giving the lender a partial interest in any gains when the house is eventually sold.

Such a program would provide significantly lower payments–and thus substantial relief–to borrowers who elected to take advantage of the program. The lender would be allowed to amortize the write-down over 30 years, get a current tax benefit, and receive equity upside on any sale, with the equity share and lower mortgage payment both negotiated with the borrower.

Bankruptcy law reform

U.S. bankruptcy laws are in dire need of revision. As currently written, they’re clumsy, counterproductive, and, in some respects, defeat the purported objective of restoring the individual to healthy participation in the economy.

Nearly 90% of families declare bankruptcy for one of three reasons that are often beyond their control: a job loss, a medical problem, or a family breakup. Bankruptcy laws should be designed to repair rather than to punish–and should help borrowers retain their jobs and keep their families together in the future.

Healthy bankruptcy reform should allow borrowers to modify their mortgages in bankruptcy, which is generally prohibited by current law. It should allow renters to continue paying their rent if this would avert eviction. Debtors who are no longer residing in a home should be released from future liability for taxes and code violations. Debtors should be able to keep their cars by paying the lender the fair market value of the car over a reasonable time, as transportation allows them to get to work and care for other members of their household. Student loans should be discharged in bankruptcy, just like other consumer debts–and so should be accumulated local fines and fees.

We must give families a new start after bankruptcy. As their financial lives are rebuilt, everyone benefits: lenders, borrowers, and the economy as a whole.

Stop incentivizing debt in tax law

Under U.S. law, debt gets a tax benefit and equity gets a tax penalty. This is a stunning inversion of what an economic system should incent. The inexorable rise in levels of debt could be muted if the interest deductions for large businesses and the wealthiest individuals were lessened or eliminated. Conversely, eliminating tax on dividends for the bottom 60% of households–which is a form of double taxation–would help encourage stock accumulation among these households.

Reducing private debt by all means necessary will allow households to participate more vibrantly in the economy.

Richard Vague’s career has spanned fields as varied as banking, energy, government, and the arts. He recently served as Secretary of Banking and Securities for the Commonwealth of Pennsylvania. Vague previously was managing partner of Gabriel Investments, an early-stage venture capital company; co-founder, chairman, and CEO of Energy Plus, an electricity and natural gas supply company; and co-founder and CEO of two banks–First USA, which was sold to Bank One, and Juniper, which was sold to Barclays PLC. His new book is Paradox of Debt: A New Path to Prosperity Without Crisis.

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