Of Debt and Deficits

It seems these days that the political talking heads and politicians are always mentioning "the debt" or "the deficit." People often use these terms loosely, and sometimes interchangeably and it's always with the assumption that deficits and debt are a "bad thing." But let's be clear what these terms mean, and in so doing, establish whether it is good or bad.

Debt

This is the accumulated debt the government owes.

Deficit

This occurs when the money spent by government over a particular time span exceeds the revenue to the government during that same time. If the government takes in more money than it spends then it has a surplus.

With these definitions in mind, it's obvious that the deficit and the debt are two different things. And while debt increases if the budget is constantly in deficit, the debt doesn't go away if the budget is in surplus. During discussions on TV pundits often make the point that "the American people have to live within their means and so should the government." The implication is that families don't spend more than they receive but this is not necessarily true. People routinely by things like cars, or houses, that they can't afford and they borrow the money, using the car or house as collateral and pay it back over time. Clearly, there are other events, like college tuition, where people are spending more in a year than they are taking in, or to put it another way, they are deficit spending. When it comes to mortgages, people, again routinely, borrow more than they make in a year. So it's not uncommon for someone to make,say $100,000 per year, and yet have a mortgage in excess of $300,000. None of these situations causes us to panic. So why the tremendous hullabaloo about the current debt and deficits?

I think there are several answers to this question. One is undoubtedly that some politicians just get a thrill out of scaring people, presumably because scared people are more malleable. This is especially true since 9/11 after which Americans have been trained, rather like Pavlov's dogs, to be scared of anything and everything and beg the government to save them. Ironically this tactic is most often used by the party that demands "small government". It appears that the answer to every scare is more government oversight, bigger military, greater border control, etc. All of those things increase the size of government. But I think a more pressing reason is people insist on mentioning the amount of the debt or the amount of the deficit in a year in dollar terms, as though this were a meaningful number. While it is meaningful in context, the size of the deficit is really only relevant in context. I mentioned earlier that someone making $100,000 a year might have a mortgage in excess of $300,000. Does this mean that the same mortgage would have the same impact on Bill Gates, or on someone earning minimum wage? Clearly the answer is no. What matters is the debt, or the deficit in relation to assets and to income. But, you ask yourself, what does this matter?

Imagine for a minute that you are "concerned" about the debt, and also that you are none too bright and easily led. Then it's easy for someone to convince you that"raising the debt ceiling is bad, because it indicates that the country is incurring more and more debt. And, by golly, someone needs to draw a line in the sand and stop it. But this is simplistic thinking. This is because Congress, when it raises the debt ceiling, specifies a new dollar amount. This is a fundamentally mistaken approach. What Congress should do is specify the debt ceiling as a percentage of GDP. That way, when the debt ceiling has to be raised, it would be because the debt as a percentage of GDP had risen. And not, as is usually the case, at least in part, because inflation has reduced the value of the debt.

So what does this mean? Is the deficit crippling the US? Is the US broke? We constantly hear politicians saying "We can't afford it, we're broke." While it is true that the deficit is currently fairly high and the debt is relatively high, neither is near record levels. When you look at the deficit and the debt as a percentage of GDP, which is the equivalent of you taking into account what you make when eyeing your credit card bill. Charts showing all of this information are available here but I will quote some recent numbers.

In 2010, the federal deficit as a percentage of GDP was 8.92 down from 10.01 in 2009. The debt as a percentage of GDP was 93.25 To put these numbers in perspective, the highs for both numbers were related to World War 2 and the debt was 121.96% in 1946 and the highest deficit was 28.05% in 1943. In 2000 the debt stood at 56.56% and the deficit at -2.37% (That is the government was taking in more than it was spending)

So the bottom line is that neither value is at historical highs and the real point worth noting is that far from crippling the US in the aftermath of WW2 the US recovered financially very quickly. This is not to say the problems don't need to be addressed, but the numbers are far from sufficient to cause panic. It is also worth noting that this follows one of the biggest recessions we have ever faced. During a recession, by definition, the GDP drops, so the numbers automatically get higher in percentage terms, even if they stay the same numerically. And as a reference, Japan's debt as a percentage of GDP is above 200%.

When people suggest that the US government should do what people do when they are short of money, that can also be instructive. People don't start by cutting out food. The first thing people do is to see if they can bring more money in. So this might mean one spouse goes back to work, or the other gets an extra job, or the older kids are told they have to pull their weight. Only when those methods fail do people start cutting and then they start with "luxury" items. The current US government refuses point blank to address the possibility of raising revenue. This is hardly rational. But, to restate, the US government last year spent 8% of GDP more than it took in. This is not a huge gap to close. So it should be possible to do it without draconian measures. It is interesting to speculate where the US would be today had the budget surplus in 2000 had not been given away in tax breaks and unfunded wars!.