Consider The Deficit: How It Grows...

It toils not, neither does it spin; and yet I say unto you, even Solomon in all his glory did not have nearly this much money. The deficit for FY2004 was about $412,553,000,000 (pdf). The debt is now (Sunday) $7,429,946,398,746.85, or a bit over $22,200 for every man, woman and child in the United States. (This is low, since we hit the debt ceiling recently, and rather than raise it right before the elections, we have been using money from the federal pension funds to pay our bills.) Since George W. Bush took office, the debt has grown by a third (the Times article just cited says 40%, but the government figures seem to indicate a lower number.)

That's a lot of money. A lot of money. Moreover, our fiscal situation is about to get worse: the baby boom generation will be retiring soon, Social Security will stop providing us with a surplus to loot every year, and Medicare costs are going through the roof; in combination, these facts are shortly going to put a lot of pressure on our federal budget. But rather than face this problem and try to prepare for it by paying down existing debt, President Bush enacted tax cuts that have saddled us with nearly two trillion dollars in additional debt. It's the tax cuts, more than any other factor, that drive the deficit: when you consider the change from surplus to deficit over the last four years, three times more of it is due to drops in revenue than to increases in spending, including spending on defense, homeland security, and Iraq. And while some of these revenue losses reflect the deficit, more are due to the tax cuts. If the tax cuts are made permanent, they will contribute significantly more to the national debt over the next 75 years than Social Security and Medicare combined. (cite; see table 1.)

Deficits come in two flavors: cyclical and structural. A cyclical deficit is one that the government runs in response to a recession. Recessions tend to make some government spending increase (e.g., unemployment claims go up), and government revenues decrease (people are earning and buying less; hence the government collects less in taxes.) For this reason, even the most fiscally prudent government can find itself running a deficit when times are bad. And this is, basically, good: it puts more money into the economy, and when people spend this money on things, it helps the economy to recover. Likewise, running a surplus when the economy is booming can prevent it from overheating, and also allow the government to pay off any debt it acquired during previous recessions. This sort of deficit is (other things equal) often a good thing.

While a cyclical deficit is a response to a (temporary) recession, structural deficits are deficits that the government runs year in and year out, in good times and in bad, because it is routinely spending more money than it takes in. (It's the government equivalent of living beyond your means by racking up debt.) The cyclical deficits that a government runs during a recession can be balanced out if it runs cyclical surpluses during good times; structural deficits just go on adding to the debt year after year. And while cyclical deficits are often good, structural deficits like the ones we are now running are bad, for several different reasons:

* All that nice money that the government borrows is not being invested in anything else. This investment, had it occurred, would have brought returns, raising our national income. Because of the deficit, we forgo these returns, and our national income is lower. Two economists from the Brookings Institution estimate that ten years from now, if the Bush tax cuts are not repealed, the deficits we run in those ten years will cost the average household $1,500-3000 per year. And that's not counting the costs we've already incurred by running up our existing seven and a half trillion dollars in debt. It's something to think about when you try to figure out how much you have benefitted from tax cuts that aren't paid for.

* By creating a (huge) demand for money to borrow, deficits drive up the price that borrowers have to pay for that money, otherwise known as interest rates. The study I just mentioned also estimates that the deficits we run over the next ten years will raise interest rates by 80-120 basis points (in other words, a loan that would have been at 6% without the deficit will be at 6.8-7.2% with it.) The authors note that that would raise the annual payments on a 30 year fixed-rate mortgage on a $150,000 house by about $1,000.

* Obviously, we have to pay interest on the debt. In FY2004 the government paid $321,566,323,971.29 in interest on the debt. That's about 14% of the total expenditures of the federal government. This money does not pay for veteran's benefits, medical research, highways, or national security. It doesn't even pay for what we spent money on when we originally ran up the debt. All it pays for is the privilege, in the past, of spending more money than we took in. Had we either raised taxes or cut spending instead of borrowing all that money, we could now pay much lower taxes without running a deficit. As it is, about one in every seven of your tax dollars gets spent on interest.

Moreover, I noted earlier that deficits tend to raise interest rates. If interest rates go up, the amount we have to pay in interest on the debt will go up as well. And not just the interest on any new debt we create: most of our publicly held debt has a maturity of 10 years or less, and it will have to be rolled over when it is mature. If interest rates are higher then, our interest payments will go up. And as before, this is not money we're actually getting anything for; we're paying it solely because we chose to live beyond our means in the past.

* Equally obviously, we will at some point have to pay this money back. All seven and a half trillion dollars of it, plus whatever we add to it in the future. (The budget deficits over the next ten years are projected to total between five and five and a half trillion dollars (Goldman Sachs, cited here (p. 5). This includes the Social Security surplus; if that is excluded, the figures are much worse. I have no idea how we are going to do this.

In talking with some people about the deficit, I sometimes encounter the idea that since the deficits are already enormous, a little more can't hurt. I think this is sort of like thinking: well, I already have $50,000 of credit card debt, which I can't imagine how I'm going to pay off; if I buy a $5,000 plasma TV, it won't really make a difference: my debt is already in at a scary, unimaginable level; if I buy the TV it will still be at a scary, unimaginable level, but at least I'll be able to watch movies on a really big, really cool screen while I figure out how on earth I'm going to get out of debt. It's a stupid way for an individual to think, and it's no less stupid when it's applied on a national scale. (Actually, it's more stupid, since bankruptcy is much worse for countries than for people.) And while the numbers may seem the same when you're racking up the debt, they do not feel the same when you're paying it off; specifically, when you're paying off the price of the plasma TV that you really did not need to buy.

* Deficits and debt cost us flexibility. A government that has not racked up huge quantities of debt, and which does not already run huge deficits, can respond to unexpected events (9/11, a global economic downturn, the need to go to war) a lot more freely than a government that is already in debt up to its eyeballs.

For all of these reasons, structural deficits are a very bad thing. They crowd out investment on other things, thereby reducing future income. They raise interest rates. They reduce our flexibility. They require that increasing chunks of the federal budget be devoted to interest payments. And the debt we incur will eventually have to be repaid.

Some people think that we can simply grow our way out of the deficit (and some of them argue that the tax cuts will provide this growth.) This is not true: our present deficits are too big for that. I noted earlier that deficits over the next decade are projected to amount to between five and five and a half trillion dollars if the tax cuts are made permanent. Those projections are based on CBO numbers which assume that the economy will grow, on average, about 3% each year. Even if average growth over the next decade were a percentage point higher -- that is, if we had the levels of growth that we had during the late 90s for an entire decade -- we would still add 2.6 trillion dollars in debt over the decade, and "the budget would likely remain in deficit over the decade." (cite; pdf, pp. 6-7.)

When we choose to run deficits, rather than either cut spending or raise taxes, we are choosing to pass on the costs of our spending to our future selves and our children. We are in a very real sense mortgaging their future. And they will have to pay not just the money we don't want to pay today, but a lot more (in reduced income, higher interest rates, and the cost of interest on the debt.) This is a stupid and costly thing to do.

However, I have not yet described the scariest part of running deficits at our present levels. That will be the subject of a future post. But, frankly, the costs I have already outlined are bad enough. We should stop this. At the very least, we should not imagine that we can have huge tax cuts without paying a price.

Comments

[Sebastian Holsclaw]

"It's the tax cuts, more than any other factor, that drive the deficit: when you consider the change from surplus to deficit over the last four years, three times more of it is due to drops in revenue than to increases in spending, including spending on defense, homeland security, and Iraq. And while some of these revenue losses reflect the deficit, more are due to the tax cuts."

I don't want to minimize deficits, because I would love to cut them and I would love for the country to have a good talk about what is really necessary spending and what is not--a discussion which hasn't really taken place on anything other than military spending and the Reagan-proposed but not till Clinton enacted welfare reform in almost 40 years. But most of the change from surplus to deficit is from the fact that the surplus projections was due to assuming that economic growth would continue on a pace reflecting what we now call the tech bubble--which burst just before Bush came to office.

However, I will admit that I would not have created the awful new Medicare benefit.

I think your paragraph on the lack of investment when we borrow is spot on.

"When we choose to run deficits, rather than either cut spending or raise taxes, we are choosing to pass on the costs of our spending to our future selves and our children."

I think one of the most fiscally damaging things that our system has encouraged is that over the past four decades one side pretty much refuses to think about drawing down what we spend, and the other refuses to live up to the reality that taxes are needed for what we do spend. And the depressing thing is that Republicans increasingly don't even push the idea of cutting back any major spending--leaving the government spiralling into out of control spending no matter who is in charge.

[Edward]

Reagan-proposed but not till Clinton enacted welfare reform

Ahh, the chivalry of giving credit where it's due is still alive I see. ;p

[hilzoy]

Sebastian: a joint statement by the Concord coalition, the Committee on Economic Development, and the Center for Budget and Policy Priorities says:

"Overall, tax and spending legislation enacted since 2001 accounts for 65 percent of the more-than-$9 trillion decline in the surplus for 2002 – 2011 under our projections.  Changed assumptions account for the remaining 35 percent.  More than one-third of the decline can be attributed to tax cuts, with this share rising over time.  Nearly one-third of the decline is attributable to new expenditures, the majority of which are for defense and homeland security."

That's based on CBO numbers. The projections for FY2005-2011 are amended in the following ways: "the expiring tax cuts will be extended and relief from the Alternative Minimum Tax continued, that a prescription drug benefit costing $400 billion over ten years will become law, that the Administration’s multi-year defense plan will be fully funded, and that domestic non-defense programs will keep pace with inflation and population growth." The CBO (as you probably know) is legally required not to take into account any policy changes in its projections, which means that its generally admirable numbers are required to reflect such assumptions as: that the tax cuts will expire on schedule, which no one expects, and which the administration is committed to preventing. Thus the changes, all of which seem to me reasonable. Note that the domestic appropriations number, which seems to me the most debatable, is a comparatively tiny adjustment.

[John Thullen]

"a good talk about what is necessary spending and what is not"

Seems like we have this talk all the time in elections, in the House, in the Senate, in committees, in sub-committees, you know, under our representative government. Then people want to pass amendments to the Constitution so we aren't allowed to talk any more. Cause taxes are always too high and so is spending. It never seems to be too low.

In Colorado, citizens passed an amendment which has destroyed lots of government. It says the legislature can cut taxes, but not raise taxes. No talking permitted.

[Sebastian Holsclaw]

"Seems like we have this talk all the time in elections, in the House, in the Senate, in committees, in sub-committees, you know, under our representative government."

Ok, we talk about it all the time but almost never cut anything. Is that better?

"Reagan-proposed but not till Clinton enacted welfare reform

Ahh, the chivalry of giving credit where it's due is still alive I see. ;p"

I actually thought I was. That particular example shows that, A) cutting/reforming broken programs takes nearly forever, and B) that such reforms don't take place except when both parties get a handle of things.

[Jadegold]

Welfare reform really had nothing to do with reducing the deficit in the 90's.

[fdl]

A few ecpnomic thoughts from a non-economist.

1. "Equally obviously, we will at some point have to pay this money back."

Uh, no, we won't. We'll roll it over into new debt.

Why should the USG be debt-free? Seems to me that the debt should reflect the capital investment made by taxpayers in federally-funded infrastructure. And while engineering firms regularly bemoan the failing state of infrastructure across the country, it is in fact in pretty good shape. (just maybe the engineering companies have an economic interest in arguing for the failing state of infrastructure?)

2. I agree, though, that the current shortfall in federal revenue is disasterous. But given the rhetoric from both parties during the campaign, they are going to have a tough time finding common ground.

Francis

[John Thullen]

"Oh, we tlk about it all the time but almost never cut anything"

Nope, not better :)

Much of the talk was not just talk, it was talk that could have resulted in spending much more but compromises were made by both sides. So we're spending what we're spending. Many budgets could and should be higher, including maybe defense, but they're not, and then there is inflation, which has cut many agency budgets.

Hey, I compromised on the 91% marginal rate in 1953 and the 70% marginal rate in 1980. Then you compromised a little back towards me. How come it's never enough?

Hint: 39.6 % is enough for me. That's 51.4% below my first offer. What's your bottom line and how come nothing above that is good enough?

Smiley face, Sebastian.

[Oberon]

hilzoy,

Great post. Long, wonky, and 100% accurate.

But if we want get more people concerned about the deficit, we need to frame the debate in terms that people care about. Like:

"In 2004, George Bush raised taxes on our children by almost half a trillion dollars."

[Sebastian Holsclaw]

"Hey, I compromised on the 91% marginal rate in 1953 and the 70% marginal rate in 1980. Then you compromised a little back towards me. How come it's never enough?

Hint: 39.6 % is enough for me. That's 51.4% below my first offer. What's your bottom line and how come nothing above that is good enough?"

A lot more people are paying at or near the top rate now than they were in 1953.

And current spending can't be sustained with current taxes, which implies higher taxes or reduced spending.

Speaking of not good enough: "Much of the talk was not just talk, it was talk that could have resulted in spending much more but compromises were made by both sides. So we're spending what we're spending."

Telling me that it could have been worse isn't comforting. In fact it highlights the problem I raise. I asked about reductions. Why don't we talk about them?

But I would be happier with semi-truthful rhetoric. No more talking about Social Security as a 'safety net' while it still subsidies far more people in the upper and middle classes than it does in the lower classes. No more talking about farm subsidies as 'saving the family farm' when 70%+ goes to the big agri-bussineses.

But I also know that is a fantasy.

[Doh]

"No more talking about Social Security as a 'safety net' while it still subsidies far more people in the upper and middle classes than it does in the lower classes."

Sebastian, I think it fair to say that upper and probably middle classes get less from the social security administration than they pay in social security taxes (except maybe for those with longer-than-expected lives), while the reverse is true of the working poor and disabled.

If I'm right, then why isn't it fair to call social security a "safety net", since it is likely the only retirement and disability benefits the working poor will ever have, and the wealthy are still net contributors to the system?

[Bernard Yomtov]

I couldn't agree more, Hilzoy, but the problem is how we change a political climate that makes it impossible to deal with the deficit in a sensible way. The whole supply-side idiocy - the popularity of which is possibly the worst long-run effect of Reagan's Presidency - has provided a rationalization for fiscal irresponsibility that is hard to penetrate.

As long as a large segment of the public is convinced that having the government reduce Bill Gates' taxes by $100 and then borrow $100 to make up the difference is a great idea it will be hard to avoid disaster.

Anticipating Sebastian, I add that it is also true that the belief held by a large segment that the government can fund new and increasing programs without tax increases also makes disaster more likely.

[Sebastian Holsclaw]

"If I'm right, then why isn't it fair to call social security a "safety net", since it is likely the only retirement and disability benefits the working poor will ever have, and the wealthy are still net contributors to the system?"

I don't think you are right.

"Anticipating Sebastian, I add that it is also true that the belief held by a large segment that the government can fund new and increasing programs without tax increases also makes disaster more likely."

I actually suspect that those aren't two different problems. The problem of thinking that lowering taxes is almost always good is really the exact same fiscal irresponsibility as trying to satisfy nearly unrestrained spending desires. In neither case are people matching unlimited desires with real-world limited facts.

[John Thullen]

Sebastian, we can and will talk about all these matters. But I want to talk to people who haven't taken tax increases off the table in some sort of oath to their constituents. That's not talk.

Also, you're right about so many more people being in the upper brackets now. Were the upper brackets an incentive then to work hard and create wealth? Maybe if we raise the upper brackets, people will work even harder to reach those brackets, too.

Now, if there were some sort of oath all Americans would take to never take away the safety net from lower income folks via Social Security or small farms via agricultural subsidies, where do I sign? But there won't be, because if SS and probably ag subsidies are taken away from higher income folks, it won't be called a safety net, it will be called welfare and let the demagoguery begin. Why should they get ..... when I don't? Etc.

Not you, Sebastian. But too many others.

You're right. It's not efficient. It's how things work in a representative democracy where compromise rules, and it's messy and wasteful and I like it compared to everything else.

Actually, forget the 39.6% bracket. How about a tax surcharge to see us through Iraq, which I don't want to pay for at all, especially Abu Ghraib, but will... just because. O. K.. I'll throw in sugar subsidies, but only if the marginal American sugar producers are bought out to tide them over.

See, talk!

By the way, I know lots of folks here want smaller government, but every time I see a list of stuff they want to get rid of, it's all the stuff on my list of keepers (mostly). It's always their stuff we have to keep and pay for.

And just to head off any attempts to compare the Federal budget to a family sitting around the dinner table making hard choices about their budget, you must know that in my family we zero out the war with the neighbors way before we start cutting the health insurance budget.

[Jonas Cord]

Now, if there were some sort of oath all Americans would take to never take away the safety net from lower income folks via Social Security or small farms via agricultural subsidies, where do I sign? But there won't be, because if SS and probably ag subsidies are taken away from higher income folks, it won't be called a safety net, it will be called welfare and let the demagoguery begin. Why should they get ..... when I don't? Etc.

If wealth distribution is going to be administered on such byzantine principles, count me out. If it were up to me, anyone who suggests that the working poor should pay regressive payroll taxes that go to middle class, upper class and just plain old rich people who hardly notice it, should have their license to be liberal revoked. Alas, that's why they don't let me do it.

Meanwhile, what aside from wholly romantic principles dictate that the government should subsidize small farms?

[liberal japonicus]

Meanwhile, what aside from wholly romantic principles dictate that the government should subsidize small farms?

Well, diversity is a good thing in that it provides some protection for nasty things like BSE, and currently battery farming and mass farm production, while producing surprising efficiencies, gives rise to a number of problems as well as causes a hollowing out in many rural areas.

I don't know what the balance is, but here in Japan, small farmers (especially rice farmers) get subsidized to an extent that I think would be jaw-dropping in the US. If anyone has any links to overviews of ag subsidies in the US, I'd love to see them

[Jonas Cord]

Well, diversity is a good thing in that it provides some protection for nasty things like BSE, and currently battery farming and mass farm production, while producing surprising efficiencies, gives rise to a number of problems as well as causes a hollowing out in many rural areas.

I'd rather have the government deal with the problems of large-scale production than preserve small farms. For the record, I'm against all the ag subsidies, for the big guys and the little guys.

I don't know what the balance is, but here in Japan, small farmers (especially rice farmers) get subsidized to an extent that I think would be jaw-dropping in the US.

That's what I don't get. Everyone is (rightfully) angry about U.S. and European ag subsidies levels; yet every time I hear about Japan, it seems that they are operating at levels a whole order of magnitude worse. What do they do at WTO meetings that lets them get away with it so easily?

[John Thullen]

Jonas: I have a conceal and carry liberal license (:;)

Now, I'm not sure, but wasn't Social Security finally passed in the late 1930s because it was stipulated that everyone was covered, as a way to get Republicans to vote for it, otherwise it wouldn't be fair. It was probably more Byzantine than that; in fact it was, I'm sure, sausage in a free society being made in great loopy, Byzantine ways.

Right. Not efficient.

By the way, can anyone tell me how much it will cost to pay for my retirement and medical care in, say 25 years?

Jonathan Clemets has a sobering little article this week in the Wall Street Journal about probable returns in the stock market during that time. Sorry, no link. How much will hemlock cost in the future.

Isn't Japan some sort of representative government? We don't vote there, although I understand OBL votes here. We neither let them nor prevent them from deciding what they do.

Also, middle class, upper class and plain old rich people who hardly notice "it" will notice "it" just like they noticed the 1% or so of the population that pay estate, excuse me DEATH, taxes or noticed the @2% of the budget that went to those awful welfare mothers or the 3-4% of the Federal budget that goes to the foreigners. They noticed it so much that they thought it was much larger percentages in all categories mentioned.

[Jonas Cord]

Right. Not efficient.

I don't think that's much of an excuse to just sit back, relax and enjoy some disgusting sausage. I think that when we're talking about a program that involves every working American, and according to your formulation that's the only way to help a small portion of the population - well, the cost-to-benefit ratio is looking really, really awful to me.

Isn't Japan some sort of representative government? We don't vote there, although I understand OBL votes here. We neither let them nor prevent them from deciding what they do.

Of course, I'm not implying otherwise. But it's my understanding that the thing the WTO had going for it was the fact that you were to be held accountable for subsidies and trade barriers. I'm just askin', is all.

By the way, can anyone tell me how much it will cost to pay for my retirement and medical care in, say 25 years?

Nope. All I'm saying is, under the Jonas Cord Social Security Plan, if you can't afford it, Social Security and Medicare is there for you. If you can, well, just go back to the country club and leave everyone alone.

Jonathan Clemets has a sobering little article this week in the Wall Street Journal about probable returns in the stock market during that time. Sorry, no link. How much will hemlock cost in the future.

I wrote a sobering movie once about how, 25 years from now, robot armies ravaged the earth. Who will pay for my prescription drugs then?

Also, middle class, upper class and plain old rich people who hardly notice "it" will notice "it" just like they noticed the 1% or so of the population that pay estate, excuse me DEATH, taxes or noticed the @2% of the budget that went to those awful welfare mothers or the 3-4% of the Federal budget that goes to the foreigners. They noticed it so much that they thought it was much larger percentages in all categories mentioned.

It's my opinion that a major reason most people will go along with silly conservatives arguments like this is because us liberals are completely lazy about the administration of these programs. Welfare was, and is still not, a good anti-poverty program. I'd like to see it become one. Meanwhile, because some people would like to get rid of the thing, you're willing to settle for sausage. No good can come of this, friend...

[John Thullen]

Jonas, I'm voting for you, unless OBL is voting for you.

O.K. You enact your programs. I'm going to stand over here and confuse our enemies to give you time to pass your agenda.

It's my opinion that a major reason people go along with silly conservative arguments is because us liberals are completely lazy about the admininstration of these programs and because silly people are demagogued by sillier people.

The public is Groucho; the Republicans are Chico; I'm Harpo making faces behind both of them; you're Zeppo, the guy with the sense to stay out of comedy.

[John Thullen]

Robot armies? When did you say?