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Have you noticed the deficit?                                                                                    

Posted at: Dec/06/2010 : Posted by: mel

Related Category: Economics,

There has been a lot of talk in recent weeks and months the National deficit or just plain deficit. I am by no means an expert on economics or government budgets, and fiscal policy often seems more like magic than logic to me, but I am go to try and wade through some of this stuff. I worry over this because I have kids and like most concerned parents, I think about their future and what kind of a legacy or burden I am leaving them.

With the wealth of information that our public media throws at us some of the terms can get confusing so I am going to begin with a few simple definitions. The “National deficit”, “National debt”, “the deficit” or “deficit” are all terms that describe the same thing. All of the aforementioned are a meant to describe the amount of money the US Federal Government or Treasury spends in excess of the tax receipts and other income it takes in. Please don’t confuse the deficit with another common media phrase, the “trade deficit”. The trade deficit is an important measure, but not a subject for this discussion.

Now it’s time for me to throw a few numbers at you. Don’t worry, it won’t be too many as this discussion does not need to be as complicated as some people like to make it. The federal budget for total expenditures for 2010 is estimated to be at $3.55 trillion. The total revenue for the same period is estimated to be at approximately $2.38 trillion. Since it appears we are spending more that we are taking in the difference is called a deficit. As you should be able to see we are on track to spend approximately $1.17 trillion more that we have in gross revenue. Like anyone who spends more than they take in, they have to borrow to make up the difference. Adding this year’s deficit to the loans from previous years gives us a current total debt of approximately $14.08 trillion. If you are even a little geeky about numbers you have figured out that we are spending 40-50% more each year than we take in and now owe over 5.5 times our annual revenue.

As an individual, when you spend more that you are taking in, you put the excess on a credit card or bank loan, either of which is effectively where a bank loans you money in exchange for being paid back the loan with interest. For our federal government, the process is different, but the results are very similar. Our government cannot go to a bank so it prints treasury notes which are basically IOU certificates and sells or auctions them on the open international market. I want to be very clear right now, borrowing money is not a bad thing if done with good budget planning. Most people could not buy cars or houses without taking out a long term loan to pay back this major purchase. Governments use loans to buy or build big things such as roads, bridges, aircraft and capital ships. In my simple minded view, much like buying a car, a loan that gets you in the car, but is paid off before you sell the car or it reaches end of life is a good thing. If you are still paying on the first car loan when you seek a loan for the vehicle destine to replace the first, you are spiraling into a level of debt that is almost impossible to escape from. In the private sector, whether a loan shark or a bank, neither wants you to default to on the loan and go bankrupt because it means they will not get all their money back. These rules hold true at the higher levels as well. China currently owns a lot of our treasury paper, they don’t want us to collapse anymore than we do. They need us to eventually pay back their IOU’s with interest and they need us to be the consumer engine that purchases many of the products currently made in China to drive their economic engine.

As with many things in life, when a good thing is taken to excess it is no longer a good thing. For the average consumer, running up too much debt for short term items will force that consumer to become a slave to the debt, and sometime enter into bankruptcy. Ultimately our federal government is run on taxes from average citizens. I am sure you have heard talk about corporate tax rates and such thing, but I want you to clearly understand that these are actually fiction. Don’t get me wrong, businesses and corporation large and small pay taxes on their profits, but in the long run only the consumer pays. In the grand scheme of things, business taxes are just one more expense associated with the cost of doing business. Like all expenses, they are ultimately folded into the cost of the product or service and passed on to the consumer. Some people call it smoke and mirrors, but anyway you title it, consumers and ordinary citizens are at the end of the line and get passed all the cost of government ultimately.

When an individual racks up too much debt a couple of things happen. The first is that the individual is forced to use a disproportionate amount of their income just to make debt payments. Sometimes these payments are only paying the interest and the principal is not being paid down. Another side to having too much debt is that you no longer have the financial resources to do extra things when they are needed. Of course there is also the interest rate challenge as well. The more you owe, the higher a risk you become for the next loan. To compensate for the higher risk the new loans are generally only made available at a higher interest rate. Again, these situations are similar for individuals as well as governments. The bottom line is that the accumulation of too much debt means that when you really need money, you’re already over extended and you can’t afford the new and the bank won’t take the risk of loaning you the money.

When an individual ends out owing more than they can afford to owe they either reduce their expenditures and pay down their debt, or declare bankruptcy. Once bankruptcy is declared any future loans are made at a higher interest rate because the individual is viewed as a higher risk.

When a government gets over extended, its list of options is a little bit different. The government can raise taxes to collect more income. But when taxes go up some investors back out of the market and the added taxes make everything cost more potentially slowing down the economy. The government can cut back on promised services, programs, benefits, and entitlements. The problem with cutting back is someone always suffers…especially when benefits and entitlements are attacked. Obviously, since many politicians campaigned on these special programs and fought to get them implemented, letting them get cut hurts their creditability with the home town voters. Austerity is never easy and someone always loses. Another way government can attack its debt is to print more money and inject it in the system by buying up existing treasury certificates (I.O.U.’s). This process is very risky because it generally leads to inflation by forcing all goods and services to go up in price to absorb the extra money.

These hurdles are all the more attenuated by population bubbles like the “baby-boomer” generation who are drawing promised entitlements out of the system faster than current tax payers are paying into the system. Effectively, one generation of Americans has created a massive debt that they are placing on the next generation to have to pay for.

There are also geopolitical issues at stake here as well. A great deal of our treasury paper has been purchased by China. For China this is a great deal since our debt is guaranteed unless the government fails, making this a very safe investment. For America it means a portion of our debt is being held by a country who’s internal and external politics are not always to our liking. Unfortunately, if we voice too loudly disagreement with Chinese policy they could potentially come knocking with a lot of our IOU’s asking to be paid which we can’t afford. Imagine owing money or services to someone you don’t entirely trust and whose behavior you often don’t agree with. Ultimately, America is not at liberty to conduct the foreign policy we would like to or hope to.

There have been a couple of commissions set up recently to study and make recommendations for how to move beyond this looming deficit. The Bowles and Simpson commission recently published their recommendations and they include raising the Social Security retirement age, eliminating many tax deductions, etc. That these ideas are politically difficult doesn’t mean they should be dismissed. The pronouncement by the still-Speaker of the House Nancy Pelosi that the recommendations are “simply unacceptable” is itself unacceptable. Simply put, our federal deficit is unsustainable, and cannot be fully addressed unless serious changes to entitlement programs, calculated cuts in spending, reduced tax deductions and potential new taxes are part of the solution.

As Cliché as it may sound, no real fiscal changes can be done on the backs of the poor and those households struggling at or near the poverty level. The recommendations of Bowles and Simpson to strengthening Social Security would means-test it for the first time with a mix of tax increases and benefit cuts for wealthier seniors, while benefits would increase for retirees close to the poverty line. In the same vein, the cause of deficit reduction would be aided immensely by canceling or reducing some of the tax cuts for the ultra-wealthy. I am not sure any solution can be “fair”, so realistically we have to look for solutions which can actually be accomplished without leaving our most needy out in the cold and taxing our wealthiest to the point where they no longer invest in ways that create jobs.

Current polls show the country split on a deficit solution. Forty-seven percent said the deficit should be reduced with spending cuts including education, health and energy programs. Forty-six percent focused on tax increases including trimming the federal workforce, cutting federal salaries, closing some overseas military bases and ending the tax deduction on home mortgage interest provided a lower income tax rate was implemented.

In response to all the concern President Obama recently proposed freezing the pay of the nearly 2 million government civilian workers for the next two years. No one likes a pay freeze, but this is probably a good first step among many more that need to happen if we are to measurably reduce the deficit.

Reading online polling data I have come to realize that the good news is that a majority of Americans finally realize that reducing the deficit is important, but these same people seem largely divided along consistent party principles with respect to the method going forward. Democrats seem more likely than Republicans to favor tax increases and placing this tax burden on the wealthiest Americans. Republicans seem focused on general spending cuts nearly everywhere except the Defense Department. Ultimately, no one wants the changes to come directly out of their own wallets. Despite the fear of opening their wallets, a majority of those polled said tax increases would be needed to eliminate deficits and almost 80% said government services will have to be cut in some form or another. It just could be that the American taxpayer is more grounded in reality than their elected officials.

The biggest and most controversial deficit reduction targets are the large entitlement programs including Social Security and Medicare which appear to make up approximately a third of the current annual budget. Nothing being discussed looks into why medical care costs continue to increase at 3-4 time the annual cost of living.

Despite not garnering enough support to go directly to congress for action, it appears that many of the Bowles-Simpson commission austerity recommendations found favor in congress. Political ideology aside, the deficit can no longer be ignored and no one strategy will bring it under control. While I don’t like the idea of having to be personally affected by this challenge…it is more palatable to me when I see that everyone will be tightening their belts in one way or another.

Losing some of my tax deductions including mortgage and child tax credits would be painful, but the cost of runaway inflation and a growing indebtedness to the world scares me more. We have had 60 years of assuming that no matter how much we spend today, revenues would be up tomorrow to help pay for our excesses. The tax man has come along with all the bill collectors we handed IOU’s to and it is time to pay. Regardless of how painful, we need to live within our means.

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