GC Explains: Debt vs. Deficit

(First in a series.)

I was going to do the first GC Explains on the platinum coin concept ("Mint the Coin"), but that's an advanced topic and I thought we might want to take that in a few pieces instead of all at once.

I frequently hear people using the term "debt" and "deficit," in relation to the federal budget, in confusing ways. They are related but distinct concepts, and it's important to keep them straight if you want to make sense.

The federal budget deficit is the difference between the amount of revenue the federal government raises through taxes, user fees, and other sources--basically, any source of government funds that the government isn't obligated to repay to anyone--and the amount of money the federal government spends, in a single year.  When we spend more than we bring in, that's a deficit. When we spend less than we bring in, that's a surplus.

By contrast, the federal debt, also known as the national debt, is the total amount of money that the federal government owes due to borrowing.

Key concepts:

1. The federal debt was incurred to make up the difference between the total revenues and the total outlays.  That's basically the budget deficits of the past, netted against any surpluses, and all rolled into one number.  The federal debt is what the government owes on its bonds and other obligations.

2. Debt is only one of several tools the government can use to cover budget deficits.  The government can also raise taxes and fees, sell off property, or print money that is worth more than the cost of the materials used (a concept known as "seniorage").  Or it can cut the amount of money that it spends.

3. You aren't responsible for a "share" of the debt.  Politicians and pundits like to say of the federal debt, "That's $X for every many, woman, and child in America." Currently, that number is about $52,000, or about $204,000 for a family of four.  But don't worry--you personally don't owe the money, and no government agent is going to knock on your door one day and ask for the $52,000 you "owe."  The federal debt is a combination of 1-, 2-, 5-, 10-, 15-, and 30-year obligations. When they come due, the government pays them off out of revenues, or (more frequently) it borrows more money and pays off the old bonds, thus gaining more time to pay. Ideally, over time, revenues will rise significantly because of economic growth, or the value of that debt will decline because of inflation.

4. It's really easy for the federal government to borrow money.  In fact, people are falling all over themselves to loan the federal government money right now, at interest rates that are close to zero.  There are a lot of reasons for that, but the most important ones are (1) the federal government is obligated by Constitution to honor the debts it incurs; (2) we have the best economic system in the world (note that I did not say the strongest economy), and we have a long track record of being an economic powerhouse; (3) everybody agrees that U.S. government bonds are the safest investments in the world and that they carry very little risk, because we have always paid our debts in full as they have come due; and (4) we have a lot of natural and man-made resources to put toward generating economic growth that will allow tax revenues to pay off those debts as they come due.

5. Not even the government can spend money it doesn't have. For the government to spend money, it must first have that money, whether it gets it through taxes, user fees, other revenue sources, or borrowing.  If there is a budget deficit, generally speaking, the government must borrow enough to cover that.

Example. In 1982, the federal government spent about $745.7 billion, but it only raised about $617.8 billion in revenues.  For 1982, therefore, the budget had a deficit of about $127.9 billion. To cover that deficit, the U.S. government sold an equal amount in bonds--plus whatever was necessary to pay off bonds that were maturing during that time.  The net increase in the federal debt that year was therefore $127.9 billion.

Did you know? Over the last 50 years, the federal government has run a budget deficit 45 times and has run a surplus 5 times.  Every budget surplus in that time period has been under a Democratic president (one under Lyndon Johnson, and four under Bill Clinton).

Why it matters.  Debt matters mostly because the federal government has an obligation to pay it off at some point and because the federal government has to pay interest on the debt.  Money spent to service (pay interest on) and retire (pay off) debt is money that can't be spent on other things that we'd like to have.  Deficits matter because they contribute to the debt, and because debt matters.  Sometimes the government has good reasons for spending more money than the revenues it takes in--a sluggish economy, a need for infrastructure, a war that needs fighting. Other times, the federal government runs a deficit because the Congress wants to spend money on pet projects and to put off paying for those projects through taxes.  Over the long term, borrowing money is the most expensive way to buy things, so we should encourage Congress to exercise restraint, to keep taxes at appropriate levels, and to avoid spending on credit when it's not necessary.

I hope you understand a bit more about the terms "debt" and "deficit."

Do you have an idea for the next GC Explains?  Please post it in comments.