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April/May 2010

APRIL REVENUE (in millions): SALES TAX: $1,682.7 NATURAL GAS: $98.6 MOTOR FUELS: $266.8 MOTOR VEHICLE SALES: $224.4 TOBACCO: $130.3

High Tide for Red Ink

“Even when we recover from the recession, deficits will remain extremely large.”

– Dr. Edgar Browning,
professor of Public Economics at Texas A&M

Federal Deficits and the National Debt

by Bruce Wright

Weathering the Storm: A Series of Reports on the Texas Economic Climate

One troubling aspect of the nation’s financial crisis has been a soaring federal budget deficit. To learn more about the federal government’s sea of red ink, Fiscal Notes recently spoke with Dr. Edgar Browning, professor of Public Economics at Texas A&M University and author of the recent book Stealing from Each Other: How the Welfare State Robs Americans of Money and Spirit.

Dr. Edgar Browning
Professor of Public Economics
Texas A&M University

The national debt and the national deficit are big news these days. Could you begin by explaining the difference between the two?

It’s important to keep “debt” and “deficit” distinct. The national debt is the outstanding value of all government obligations – Treasury bonds and bills. It’s basically the accumulated value of past federal borrowing. The official national debt, which stands at about $12.8 trillion now, is simply the sum of all past deficits, minus the occasional surplus.

The deficit is the annual excess of spending over tax revenue that is financed by borrowing. Over the last 60 years, we’ve run deficits in something like 55 of them.

One of my old professors said it’s very simple: our leaders like to spend money and provide benefits that people can see, and they don’t like to raise taxes and impose costs on voters. Thus there’s a natural but unfortunate tendency to use deficits to finance expenditure programs.

For 2010, the deficit is projected to be about $1.4 trillion.

Read the entire “Weathering the Storm” series:

That’s a disturbingly large number. Is this kind of debt unprecedented in our history?

Well, we came out of World War II with a very large national debt. I don’t think the debt, as a percentage of our gross domestic product (GDP), is as high now as it was then. But it’s certainly unprecedented over the last 50 years.

Some commentators describe the debt situation in pretty disturbing terms.

I don’t think it’s at a level yet that suggests a national catastrophe. A number of other countries have higher debt-to-GDP ratios now. But they’re not countries we would necessarily want to emulate.

The more alarming thing about the current situation, though, is that even when we recover from the recession, deficits will remain extremely large. And if that continues, it’s going to be very bad for the American economy.

I think most people just feel intuitively that these kinds of deficits can’t be good for the economy. But just what effects could we expect?

Deficit finance has two significant implications for the future. One is that you’ll have to have higher taxes to pay the interest on the public debt. The $12.8 trillion in current debt – that’s all interest-bearing securities. Future taxpayers will pay more to fund government spending that took place in the past. They will get no current benefit from these higher taxes.

You might support that kind of debt in wartime, since future taxpayers have a stake in whether or not you win, and it’s not unreasonable to have them bear some of that cost. But in peacetime, when all you’re doing is funding the welfare state, it becomes a more problematic issue – do you want to see future generations bear the cost of that?

The other problem is that deficit financing tends to crowd out private investment. When the government borrows money, it’s competing with private borrowers, and a large share of the funds it gets from borrowing would otherwise have funded private investments. And the reduction in private investment has a definite effect on our future output and productivity.

How so?

Our capital stock in this country – all the buildings and vehicles and computers and stuff – all that buttresses our productivity as workers. Deficit finance tends to pull funds that would add to that capital stock. This lowers future generations’ productivity and thus their income potential. So it’s not only that deficits mean higher taxes in the future; it also means lower incomes. That’s the hidden cost of deficits.

And it’s what makes the cost excessive, to many economists. If you have a program that you are going to undertake, we’d typically say that it’s better to pay for it with taxes than by borrowing, because the costs are lower, and they fall on the people who are getting the benefit of the expenditure, rather than future generations.

Can you give us an idea of the magnitude of this “hidden cost?”

In the late 1990s, two well-known economists made a rough estimate that accumulated deficits had reduced GDP by about 3.5 percent. Today, if you did the same analysis I think you’d find it was 5 percent or more.

That doesn’t sound like a lot, but you’re losing 5 percent of your income each year – and it goes up and up as we add more and more to the debt. My guess is that, with the deficits projected over the next 10 or 15 years, by the end of that time our incomes will be about 10 percent below where they’d otherwise be.

Are you speaking of personal income or GDP?

GDP is our total incomes. I know that when a lot of people hear the term “GDP” on the news, their eyes glaze over. It might be better if they called it our gross domestic income, the combined income of everybody in America.

If deficit finance siphons off money that would otherwise go into private capital investment, future wages will be lower, because workers will be less productive. You get lower wages as a direct result. That’s the insidious thing about the federal deficit. Many people are unaware of this. But economists are well aware of it, and that’s why we tend to think that deficit finance should be used only in extreme situations.

It’s important to emphasize that the real problem is the continuing increase in spending. A permanently enlarged welfare state seems like a very likely outcome. That will make us more like the European countries – which have not done particularly well economically during the last 30 years.

So what are our options as a nation?

The future is very troubling, and it has been for some time. We’ve known about the coming retirement of the Baby Boom generation. Look at the aging of the population, and its effects on Social Security and Medicare and Medicaid – we’ve known this was coming for a long time.

We can continue running large deficits, which is not good for the health of the economy, or we can raise taxes, which is not good for the economy either, although most economists would say that it’s better than running deficits. Or we can reduce spending. Those are our choices.

If we don’t, the federal government will inevitably take a larger role in the economy. In 30 or 40 years, it will be spending 30 or 35 percent of our income, instead of the 20 to 25 percent now.

Given the options, I think we should bite the bullet and make plans to cut spending in our entitlement programs. But politicians, as I mentioned, like to spend money and not raise taxes – look at the major proposed spending increase called “health care reform.” So I expect higher taxes and continued deficits in our future. And later generations will pay for our profligacy. FN

For the most current data on the federal deficit, visit the Congressional Budget Office.

Oceans of Debt

According to the Congressional Budget Office’s March 2010 baseline budget estimates, enormous deficits will be a fact of American life for the foreseeable future.

table below
Federal Budget Deficit 2009 – 2020*
Years 2009 (actual) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Total
Deficit (in billions
of dollars)
-$1,413 -$1,360 -$995 -$641 -$525 -$462 -$471 -$512 -$520 -$533 -$640 -$683 -$5,984

*CBO’s baseline estimates assume current laws and a growth in discretionary spending that matches the rate of inflation.

Source: Congressional Budget Office

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