Five truths about the deficit and the debt

By Neil Irwin, The Washington Post
Posted July 15, 2011, at 6:45 p.m.

WASHINGTON — In the American political conversation, the national debt has become something almost mythical. It has become a metaphor for all that ails the United States, a scary monster under the bed.

It isn’t. It’s an accounting concept. The debate over deficits and debt is frequently clouded with sloppy language and sloppy thinking. Here, as something of a primer, are some basic concepts every American — and every member of Congress — should understand about the U.S. fiscal situation.

1. Deficits are the gap between revenue and spending.

The U.S. government took in about $7,000 in revenue for every man, woman and child in America last year. It spent more than $11,000. The gap between those numbers, about $4,000, is the deficit and it was covered by borrowing money.

Some politicians speak as if high levels of government spending and a large budget deficit are the same thing. This isn’t so. You could have a government that spends $11,000 per person — but with taxes to match it — and no deficit. Or you could have a bare-bones government of a libertarian’s fantasy that spends only $7,000 per person but that runs a large deficit, if the government only raises $3,000 in taxes.

Inevitably, the debates over the proper size of government and the proper level of the deficit are intertwined in each other. But they’re separate questions.

Think of it this way: There are rich people who borrow a lot of money, and there are poor people who live within their means. The question of whether someone is rich or poor is separate from the question of how much money they borrow.

2. The debt is the accumulation of deficits over time.

Looming over Sixth Avenue in Midtown Manhattan is a clock ticking ever upward, showing the accumulated national debt. Let’s change that $14 trillion plus figure into a more manageable number: The national debt works out to about $46,000 per American.

That level of debt has been accumulated over two centuries, rising rapidly in times of war and depression, rising slowly most of the time, and occasionally falling in times of prosperity and fiscal restraint.

But even if Congress and the Obama administration agreed to a budget for next year with zero deficit, the national debt would still be with us. It would take massive budget surpluses year after year to actually eliminate it. No one in public office has offered a plausible plan that would do that.

The good news is that there’s really no need to eliminate the debt entirely. Indeed, having no debt could be problematic: Government debt, in the form of U.S. Treasury bonds, plays a crucial role in the inner workings of the financial system, offering a place for investors to put their money that is considered safe.

3. There’s good debt and bad debt.

There’s no doubt that debt can be dangerous. But used correctly, it can be beneficial. For example, a family might borrow to buy a house or for a child’s education. So long as the family is careful about the amount of debt it takes on, it could pay off handsomely — giving them a comfortable place to live for many years and ensuring their child has higher future earnings.

But if the same family used borrowed money to pay for lavish vacations, a new boat or even just routine day-to-day expenses, then it would probably lead to trouble.

The analogy is straightforward: If the government borrows money to pay for things that have a long-term payoff, such as a highway between two major cities or education for its citizens, deficit financing can make a lot of sense. When the government borrows money just to pay its year-in, year-out expenses, it’s really just a tax increase by another name. When a family puts its grocery bil ls on the credit card, they ultimately have to be paid. It’s just a question of when and for how much additional cost.

Liberals and conservatives tend to have different views of what sorts of government functions have a high enough long-term payoff to warrant deficit spending. For example, when the steep recession came, the government enacted $800 billion in spending and tax cuts paid for with borrowed money. Back to the household metaphor, it would be the equivalent of a family, with one of its earners unemployed, using the credit card to stay afloat during a difficult period, hoping to pay off the balance when conditions improve.

Is that a good use of debt or a bad one? The answer depends on your ideology.

4. Economic growth matters.

The diligent economists at the Congressional Budget Office prepare 10-year forecasts for the federal deficit and debt, under a wide range of policies that Congress might or might not enact.

But to make those forecasts, they have to make guesses about how the economy will do. The simple reality is that economic growth has a massive impact on both the scale of deficits and how sustainable a given debt level might be.

When the economy is stronger — when there is more economic activity, fewer unemployed and higher incomes — income taxes are higher. Simultaneously, there is less need for unemployment insurance, Medicaid and other social welfare programs.

Not only would a stronger economy make the deficit lower — it would enlarge the nation’s capacity to handle a large debt. Just as a $1 million mortgage would be ruinous for a poor family but easily manageable for a wealthy one, the United States can handle a larger amount of debt the greater our national income.

5. Interest rates matter.

Here’s a phrase that most Americans have never heard but will be really, really important over the coming decade: debt dynamics.

That’s the concept that deficits and debt have a built-in feedback loop. So when debt levels rise too high, interest rates can rise, making the debt problem all the more onerous. Debt dynamics are the reason that, even though interest rates are very low now, it is worth worrying about current U.S. debt levels.

A debt level that is manageable when interest rates are 3 percent can become onerous when rates are 6 percent. Every rise in interest rates by a single percentage point increases the annual cost to service that debt by about $140 billion, or $450 for every American.

What that means is that with debt levels high relative to the size of the economy, a country loses control of its own destiny in terms of public finances. If global lenders lose faith that the U.S. government is the safest entity on earth to lend money to, suddenly the fiscal situation would go from being a long-term challenge to a near-term crisis.

There are countries that maintain larger levels of debt than the United States, relative to the size of their economies, such as Japan and Italy. But it creates a certain national vulnerability — to the hard-to-predict whims of financial markets.

http://bangordailynews.com/2011/07/15/news/nation/five-truths-about-the-deficit-and-the-debt/ printed on December 18, 2014