A Simple Guide to the US Budget, the deficit, the National Debt, and the Consequences

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1 A Simple Guide to the US Budget, the deficit, the National Debt, and the Consequences By Stanley M. Gray This document hopefully presents the US Budget, the Deficit, the National Debt, and the likely future economic consequences, in an easy-to-understand fashion.

2 The Budget The annual US budget is comprised of two parts. One part is the amount of money the Govt collects in taxes and receipts, and the other is the amount of money the Govt spends. While much more complex, it is very much like a family budget of salary and spending. Figure 1 presents the 2010 US budget as produced by the Office of Management and Budget (OMB). The left column is the taxes and receipts collected by the Govt 1. The right column is the spending by the Govt 2. While there are several ways to think about Govt spending the usual method is by listing the budget of each individual Govt agency. However, the better way to think about Govt spending is by what OMB calls policy programs, and provides a clearer understanding of the way Govt spends. For example Homeland Security spending

3 is accounted for across multiple programs, and is not a policy program in its own right. The right column lists these policy programs and the spending amounts. The block at the top titled all other contains the following combined programs: agriculture production, energy production, international affairs, natural resources and environment, commerce, community and regional development, administration of justice, general government, allowances, and net interest. The Spending A cursory look at Figure 1 indicates the vast majority of Govt spending was in four policy programs: Defense Related, Health Care, Social Security, and Income Security. Combined they totaled nearly 87% of all Govt spending. Figure 2 illustrates the spending on Defense Related activities, and how it was spent 3. Basically, the Defense Department spent 688 billion dollars (130 billion for

4 overseas operations), Energy Department nuclear weapons totals were over 18 billion dollars, and Veterans Affairs was over 124 billion dollars. Additionally, some Homeland Security spending is accounted for in this program. Defense Related spending is a bit difficult to extract due to the classified nature of some spending. The published unclassified spending was 835 billion dollars. Figure 3 illustrates the spending on Health Care. Medicare for the elderly accounted for 55% of the total 4, and Medicaid for the poor (administered by individual states) accounted for 33% of the total. Overall 829 billion dollars was spent on Health Care programs.

5 Except for small administrative costs nearly all of the 708 billion dollars of Social Security was distributed directly to the elderly and disabled. Because of our aging population this program is expected to grow substantially. Figure 4 illustrates this growth. By 2020, at the present rate of growth, this program could consume over 1.2 trillion dollars per year.

6 Figure 5 illustrates Income Security that is not covered by Social Security. The majority of the spending was for assistance in the form of housing, food and nutrition, child care, low income, and the unemployed. The total for this assistance was 523 billion dollars, which was 82% of the total Income Security program. Federal and military employee retirement was 121 billion dollars and accounted for the remaining 18% of the program.

7 The Deficit From figure 1 it is clear there were not enough collections to pay for the spending. Thus, the Govt needed to borrow. Figure 6 illustrates that Govt collection of taxes and receipts only covered 64% of the Govt spending, leaving a shortfall of approximately 1.43 trillion dollars. Therefore, the Govt borrowed this amount by selling US Treasury securities. Anyone can buy these US Treasury securities, including foreign Govts. Buyers receive interest payments on these securities and view them as safe as long as the US Govt remains economically sound.

8 The National Debt This borrowed 1.43 trillion in 2010 was added to past accumulated Govt borrowing which is called the National Debt 5. Figure 7 illustrates that at the end of the 2010 fiscal year the accumulated National Debt was over 13 trillion dollars. Just as with credit card balances, the higher the National Debt the more interest is paid.

9 Figure 8 indicates future National Debt gowth based on current taxes and spending levels. It is clear that as the Govt continues to borrow, the National Debt grows so rapidly that our ability to finance future debt may fall into doubt. Also, there are some economists who claim that Govt liabilities include much more than the National Debt. The direct loans issued by the US Govt were 1 trillion dollars in 2010, and the loan guarantees totaled 2 trillion dollars. Additionally, it is still unclear how much the US Govt may guarantee those home mortgages held by Fannie Mae and Freddie Mac.

10 As stated, the primary problem with an increasing National Debt is that the interest payment on that debt becomes ever larger. Figure 9 shows the possibility that by 2020 the interest payment alone could reach nearly 1.3 trillion dollars per year. The best way to view the interest payment is not as a percentage of overall spending but as a percentage of overall taxes and receipts. For 2010 the interest payment totaled nearly 17% of total Govt collections. By 2020 the percentage could approach 30% of collections. This means for every dollar collected in taxes nearly a third goes to just paying the interest on the Debt. Again, as the interest payment increases potential buyers, as well as current holders, of US Treasury securities may begin to doubt the US Govt ability to continue payment. This can lead to substantial social and economic problems.

11 The Consequences In truth there is a wide range of economic views on the deficit and the debt. Most economists agree that a large National Debt is bad, but some feel that as long as the nation s economy (gross domestic product or GDP) grows commensurate with the debt then the US can sustain deficits and a large debt. However, nearly all economists agree there is a certain point at which future deficits will become unsustainable. That point is related to the GDP. Figure 10 illustrates the ratio of our gross National Debt to the US GDP. For the first time since World War II we are faced with the fact that the amount of the National Debt is starting to surpass the yearly production of the US economy. Even with an assumption of a 3.25% growth in GDP (the average is 3.3% since

12 1947) the National Debt growth will exceed the growth in our economy. If this trend continues, and the US economy does not grow as fast as the National Debt, then many economists see severe economic consequences. As stated earlier, the first sign of potential consequences is when the US Treasury begins to have trouble selling securities at a reasonable interest rate. In other words, potential buyers, and current holders, of US Treasury securities start to view these securities with increased risk, and begin to demand higher interest rates. A second sign is when debt rating agencies (Moodys, etc) lower the quality of the US Treasury securities. The result of either of these events will make the cost of Govt borrowing much more expensive. These two events are currently ongoing in several European countries. If we begin to see rising interest rates as a result of the US Treasury difficulty in selling securities there are a multitude of economic predictions as to what the Govt can do. The most likely prediction is the US Govt will be forced to reduce the deficit by either dramatically raising taxes/receipts, or to dramatically cut spending. It is not likely, however, that increased taxes could substantially reduce the deficit; therefore the most likely result will be a massive reduction in spending. Additionally, some economists suggest the US Govt may begin to print money to continue financing the deficit and debt. There are many historical examples of a nation forced to print money in such circumstances; all of which have led to massive inflation, and a debasement of the country s currency. Assuming a forced massive reduction in spending the result could be a very high level of unemployment, a reduction in our overall economy, and a reduced standard of living. Most predictions claim the entire world would suffer economically, due the size and importance of the US Govt and economy. Finally, the US Govt may simply default on the US National Debt which would, indeed, be catastrophic.

13 Footnotes 1. All Govt collection figures were derived from Table S-3, US 2011 Budget. Personal income taxes, Social Security taxes, and Medicare taxes are withheld from salaries. Corporate taxes are from businesses. Other taxes and receipts consist of excise and estate taxes, custom duties, and also interest the Govt earns from its loans. 2. Most OMB publications list the Govt collections higher, and the spending lower, than my figures. The reason for this is that OMB applies nondistributed net receipts and net interest income as offsets against spending. I feel this masks much of the spending, most especially the overall interest payment on the National Debt. Both my accounting method and the OMB methods result in the same overall net deficit, which is the important issue. 3. For the Defense Related Program I added the Veterans Administration, since that represents the cost of past military spending. 4. For the Health Care program I added Medicare, which OMB lists as a separate program. 5. The National Debt is comprised of two parts: Public debt held by the public (foreign and domestic), and debt that is held by other US Govt agencies. By far the larger of this second type of debt is that held by the Social Security trust funds. The combined amount of these two debts is called the Gross National Debt. This is the figure I use. Addendum: Why We Can t Solve This Problem Since 1950 the US Govt has repaid a small part of the National Debt only once (in 1969). Also, since 1950, fifty US budgets have run deficits, and only nine budgets have run surpluses. The reason for this seems clear: A large part of our economy is dependent entirely on Govt spending. Millions of people are employed directly by the Govt, and many millions upon millions more rely on Govt spending for a large part of their livelihood. Thus, we do not want our political leaders to stop the growth in

14 spending. In fact, we tend to reward those who can provide us with an ever greater amount of Govt growth. We are simply unwilling to elect leaders who raise issues about deficits and debt and who understand the potential consequences. Some economic facts- Figure 11 illustrates the explosive growth in the cost of federal Govt employees. Salaries have increased 38% faster than privates sector employees since From 2000 to 2010 the Congress increased its legislative budget by 47%, which was much beyond the rate of inflation. We spend more than the next 13 combined largest countries for National Defense.

15 We have 820 military installations in at least 135 countries. Three million people are employed directly by the Defense Department, with millions more who are reliant on its spending. The Defense Department consumes more oil per year than any other country. We have two land armies with 29,000 combat vehicles. We have a 400 ship navy that just announced it has the capacity to take out 10,000 targets in a single day. We have fighter aircraft that cost 140 million dollars per plane. We have a bomber that cost $700,000 per hour to fly. The Govt owns 45,000 buildings, all requiring maintenance, electricity, water, etc. The Govt owns 642,000 cars. Unfortunately, the likelihood of reducing (to any degree) this spending is remote. The entrenched interest whose jobs and benefits are affected is just too powerful for any political leader to recommend a reduction in spending. For example, Social Security and Medicare programs are known as the third rail in politics. Over 59 million people receive Social Security benefits, and 46 million are on Medicare. More than 50 million Americans are on Medicaid and 40 million people receive food stamps. This means that any political leader who recommends any reduction in benefits will not last long. The entrenched interest is too large and too powerful for any change to these programs. Another example is Defense Related spending. A good argument can be made that the US military budget has little to do with National Defense. Rather, it has to do with jobs and the millions of people who benefit from the massive spending. Everyone understands that a nation has a need to protect itself, but we have spent great amounts on developing capabilities that are far beyond any foreseeable threat. We should begin to ask ourselves: Is it worth having such a

16 force if it leads to an economic catastrophe? One could even argue that our military spending is one of our greatest economic threats. However, as stated previously the entrenched interest whose livelihood depend on Defense spending is too large and too powerful for any change to the spending.

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