Sunday, March 3, 2013

Misunderstanding on budget deficits and debts

Vijay K. Mathur

Published in Standard-Examiner, February 10, 2013, Ogden, Utah

Many Americans, including politicians and media pundits, are not well informed about federal budget deficits and debt and their role in fiscal policy. Most equate it with consumer debt. They also believe that state and local governments and consumers balance their budgets, and hence by implication have no debts. They assume that debt is burdensome on our children, without realizing that children also inherit substantial federal assets. However, the view that federal government should follow the example of states and consumers to balance its budget and reduce debt is not based on sound economic reasoning.
Budget deficit occurs when consumers’ spending exceeds income received in any given year. Borrowing, on credit cards or from other sources, must finance budget deficits. Debt in any given year is accumulated deficits over a period of time. Data shows that consumers in general are not debt-free in any given year, as many tend to assume. For example, New York Fed reports that in September 2012, total consumer debt, including mortgage debt, was $11.31 trillion, almost the same as federal debt held by the public in 2012. Consumers willingly tolerate debt if they have enough disposable income to service their debt. However, as opposed to governments at all levels, consumers do not have the power to tax or issue securities to finance their obligations. Individually, they also do not have the power to regulate business cycles or promote economic growth and development.

State and local governments also have debts in any given year. According to state government finances, total debt (excluding pension obligations) across all states was $1.132 trillion in 2011, and Utah was no exception. Federal government, as opposed to state and local governments, uses deficits and debt as a tool of fiscal policy to fine-tune the economy and build and accumulate national assets. In addition, the federal government has the constitutional obligation to provide national security against enemies and may have to incur deficits and debt to finance those obligations. 

In recessions, private consumption spending and private investment tend to decline. If exports are not increasing to offset imports, as is the case for the U.S. since 1976, the only component that can increase gross domestic product (GDP), a measure of a nation’s income, is to increase federal spending and hence deficits. In recessions tax revenues also decline. However increasing taxes, on all Americans at all income levels, in recessions is counter productive. Therefore, the only option to finance budget deficits is to issue Treasury securities (debt obligations). In 2011 the deficit was $1.3 trillion (8.7 percent of the GDP), decreasing 0.11 trillion from its recessionary peak in 2009.

No one is forced to buy Treasury securities. Individuals, businesses, foreign governments, pension funds and other investors and institutions buy these securities as a safe investment. As long as the federal government is able to service its debt and meet its obligations given its capacity to pay, the problem of default does not arise. Note, there is a distinction between “total debt” ($14.7 trillion in 2011) and “debt held by the public” ($10.1 trillion in 2011). In addition to “debt held by the public,” “total debt” includes obligations for entitlements such as Social Security, Medicare and other intra-government debt obligations. However, a significant part of “total debt” burden can be ameliorated, while at the same time assuring future benefits, by increasing income limit for Social Security and Medicare tax on higher income people. 

“Debt held by the public” includes debt to domestic and international investors, state and local governments and the Federal Reserve. The Congressional Budget Office (CBO) estimates that this debt was 77.8 percent with net interest cost of only 1.4 percent of the GDP in 2012; it is expected to decline to 58.5 percent of the GDP in 2022 with slight increase in interest cost. Federal debt poses no threat to inflation and crowding out private investment, since interest rates and inflation rates have been so low for quite some time. 

Americans should also know that total foreign debt is close to 48 percent of the “debt held by the public” and mainland China holds only 10 percent of our debt obligations in 2012-Q3. Moreover, no one is forcing China to buy U.S. Treasury securities. Given the economic conditions elsewhere in the world and China’s stake in the U.S. as an export market, it considers our securities a safe investment. Moreover, debt to foreigners should be viewed in terms of their substantial debt to us.
It should be understood that we cannot keep on piling up debt beyond our capacity to service and meet other debt obligations, but recessions are not the time for spending cuts. 
Taxes and spending should be tailored to stimulate investment in research and development, private and public physical capital, and human capital. All eyes should be focused on policies that stimulate growth now, and on deficit and debt reductions when the economy picks up robust growth.

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at,etc.

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