Economics 101: Defining deficits, debt and a looming debacle

Published 1:30 am Saturday, May 13, 2023

By Paul Roberts / For The Herald

The terms debt and deficit are often used together in discussions and publications regarding the nation’s finances, and they are often confused with one another.

The term deficit refers to a given budget year when the government spends more than it takes in. The term debt, or national debt, refers to the total accumulation of those deficits as all outstanding debt.

Deficits are shortfalls between revenues and expenditures: more money is going out than coming in. The difference is referred to in the context of deficit spending or deficit financing. Annual budget expenditures routinely exceed revenues resulting in a deficit. The deficit is financed through borrowing. The last time the budget was balanced was in 2001, and in the past 50 years has been balanced only five times. Spending and/or tax cuts increase the deficit. Tax revenue and/or spending cuts reduce the deficit.

The national debt is the sum of all deficits; the accumulation of borrowing along with interest on the debt. To pay this debt, the federal government borrows money by selling treasury bonds, notes and other securities. The current debt, according to the U.S. Treasury, is $31.4 trillion, the result of decades of spending and tax cuts.

Economists generally understand that deficit financing in moderation is an appropriate tool to address budget priorities and critical needs. It is a common practice, and there are many circumstances where deficit financing serves to manage the budget and vital national interests (think wars, stabilizing economic downturns such as the 2008 financial crisis and the covid-19 pandemic and infrastructure). However, most economists also believe large deficits contribute to inflation, rising interest rates, reduced fiscal headroom and capacity, and slow economic growth. And, the current trajectory of borrowing is unsustainable.

Economists are keenly aware of the difference between deficits and debt. Virtually all of them support raising the debt limit; paying the bills. They understand the nation and world face financial crisis if lawmakers fail to raise the debt limit and the U.S. defaults on its obligations. This would dramatically increase risk, interest rates and the debt, itself, and bring chaos to markets likely resulting in a recession.

A balancing act: Appropriately managing debt and deficits is at the heart of the current debt and budget controversy. Think of it as a line in time.

Debt is the total of obligations already incurred by the federal government. We have already borrowed and spent the money, issued the bonds, and the payments are due to bondholders including nations around the world. The dollar and U.S. Treasury obligations are the benchmark against which all currencies are measured.

Deficits on the other hand are part of the debate around national priorities. Indeed, that is what the budget process is supposed to do and what the Constitution requires.

There’s a whole herd of elephants in the room where the budget fight is occurring. Here are three of them:

First, the debt limit does not authorize any new spending, it allows the U.S. to pay its bills. The 14th Amendment to the Constitution requires that the debt be paid. Failing to raise the debt limit would result in the first default in U.S. history. The Treasury would be unable to pay the bills including interest on the debt, military salaries, retirees’ benefits and most other services. It could instantly create a deep recession at a time when there are signs of inflation recovery.

“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans and global financial stability,” Treasury Secretary Janet Yellen said recently. “In the past, even threats that the U.S. government might fail to met its obligations have caused real harms, including the only credit rating downgrade in the history of our nation in 2011.” Moody’s Analytics called the risk “cataclysmic” in a 2021 report.

Second, growing deficits and debt levels are unsustainable. The federal deficit for FY-22 was $1.38 trillion. The FY-23 deficit is currently $1.1 trillion, on a pace to exceed FY-22. The federal budget is comprised primarily of defense, entitlements (Medicare and Social Security) and debt service (interest on the debt). As noted, the large and growing debt is contributing to inflation, rising interest rates, reducing fiscal head room and slowing economic growth. The FY-24 budget process is the appropriate policy forum to debate national priorities, budget and deficit issues.

Third, over decades both Republicans and Democrats have approved budgets contributing to deficits and the debt. Both parties supported economic rescue or stimulus packages in 2008 and 2020. Republicans have passed numerous tax cuts, and House GOP rules favor further tax cuts, which would add to the deficit and debt. Democrats have passed programs without tax offsets, and both Republicans and Democrats have passed large defense budgets.

A U.S. debt crisis and global recession benefits our adversaries, notably Russia and its President Putin. It would be difficult to aid Ukraine in the war effort while battling a global recession. Russia has sophisticated cyber warfare capabilities. It is easy to imagine they are already attempting to manipulate American tribal politics with propaganda spread via social media, bots and fake accounts.

Economic issues are often described as kitchen-table issues. Choosing not to pay the credit card bill is not seriously discussed around the kitchen table, and would have consequences. Congress, specifically House Republicans, need to raise the debt limit as required under the Constitution. Budget issues should be addressed in the FY-24 budget.

The last article in the series “The Road Ahead” will tackle future challenges.

Paul Roberts is retired and lives in Everett. His career spans over five decades in infrastructure, economics and environmental policy.

Economics 101

This is the second of three articles intended to unpack complex economic issues, expose myths and provide context for the news and social media reporting on the economy, debt and deficits. It intends to provide a reliable signal in the cacophony surrounding these issues. Sources for this work are respected publications and economists including: The Economist (a weekly publication), Moody’s (a financial rating organization), Bloomberg and Forbes (respected media organizations reporting on business and economics), Trading Economics (an economic data reporting firm) and the U.S. Department of the Treasury.