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You Decide: Can we make sense of deficits, debts and all that?
Story Date: 12/7/2012
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Source: Dr. Mike Walden, NCSU COLLEGE OF AG & LIFE SCIENCES, 12/7/12
To paraphrase Dorothy from The Wizard of Oz, “deficits, debts and the
future, oh my.” As 2012 comes to a close, the nation is focused on
discussions and debates about the fiscal cliff and efforts to tame the
federal government’s financial affairs. In this discussion, there have
been many terms, concepts, ideas and relationships bandied about, many
times not in a very understandable way.
Here I want to increase your understanding of the fiscal debate by
attempting to explain the major elements of the conversation. If I do
my job, then you will have a better foundation to make decisions about
how the financial challenge we face can be solved.
What’s the difference between the deficit and debt? The deficit is the
annual amount the federal government borrows to make up the gap
between its spending and its revenues. The debt is the total of all
federal government borrowing -- over all years -- that has not been
repaid. The deficit is like the annual amount you put on a credit
card; the debt is similar to the outstanding balance on the card.
How big are the deficit and debt? This year’s deficit is near $1
trillion, while the debt currently stands at $16 trillion. Of course,
these are big, big numbers. But the better way to judge their size is
relative to our collective national income. As a percent of annual
national income, the deficit is 6 percent and the debt is 100 percent.
Neither is a record (the percentages were higher during World War II),
but they are near the historic top.
Are interest costs on the debt taking an increasing part of the
federal budget? Although the federal government’s debt has tripled
since 2000, annual interest costs today are no higher. This is because
of the tremendous drop in interest rates over that time period.
Are our deficit and debt the highest in the world? Yes in terms of
dollar amount, but no as a percent of national income. Some countries
surpassing us are Japan, Italy and (you probably guessed) Greece.
Who owns our debt? The biggest holder of U.S. government debt is the
government itself, including the Federal Reserve, Social Security and
Medicare. Together government agencies hold almost half (43 percent)
of the debt. Private U.S. investors, like individuals, banks and
pension funds, own 21 percent of the debt. Among foreign owners, China
has the most (8 percent), followed by Japan (7 percent) and the U.K.
(3 percent).
Could foreign countries, especially abruptly, demand payment for our
debt they hold? The answer is no for two reasons. First, each part of
the debt has a contractual term that tells the holder when the debt
can be redeemed. So any holder of the debt can’t one day simply say,
“I want my money back.” Second, if large holders of our debt were to
sell big chunks quickly, they would hurt themselves because the market
value of the debt (what they could receive from a buyer) would drop.
Why have our deficit and debt increased so much recently?
Historically, deficits and debt rise during two situations, in wars
and in recessions. During wars, governments need money fast, and often
the easiest way is through borrowing. In recessions, the private
economy shrinks and so, therefore, do tax revenues. However,
government spending either stays the same or often rises as more
people qualify for public financial assistance. In the last decade,
the U.S. has fought the war on terror as well as military actions in
Iraq and Afghanistan. In the last five years, the economy has endured
the Great Recession and a very slow recovery.
Does the debt have to be repaid? Each component of the debt -- called
Treasury bonds, notes and bills -- must and has been repaid as they
have come due. In fact the federal government has a perfect track
record in paying both interest and principal on its debt. Most experts
think the federal government, like businesses and households, can
carry some debt, so there’s no need to take the debt to zero. However,
what most would like to see happen is for the relative size of the
debt -- relative to the nation’s total income -- begin to fall.
What are the costs of high and rising federal debt? Economists see two
big costs. One is the money used to pay the interest and principal on
the debt isn’t available for other uses, and those uses could be
either private or public. The second is that big borrowing by the
federal government could push up interest rates. Economists worry both
of these costs can lead to slower economic growth.
How can we solve the deficit and debt issues? This, of course, is the
$16 trillion question, and various groups have very strong feelings
about how our fiscal problem should be addressed. There are many who
say a solution will likely include both tax revenue increases and
projected spending decreases. But, as always, the details will
determine the outcome.
Changing the direction of our federal fiscal future may be our biggest
national challenge. I’m hopeful the information here will help you
participate in this collective You Decide.
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