Understanding Congress’s solution to the federal deficit problem

News accounts on the latest federal budget deal gave the numbers in a vacuum, e.g., “The deal cuts $38 billion from last year’s budget. It’s being called the largest domestic spending cut in U.S. history” (source). How can an individual voter make sense of quantities that are ordinarily written in scientific notation? I think the easiest way is to divide everything by 100,000,000 (10^8).

Let’s start with federal spending. The FY 2011 federal budget is approximately $3.82 trillion (3.82×10^12). Of that, approximately $2.17 trillion will be paid for by taxes collected and the remaining $1.65 trillion will be borrowed from our grandchildren. If we divide everything by 100 million, the numbers begin to make more sense.

We have a family that is spending $38,200 per year. The family’s income is $21,700 per year. The family adds $16,500 in credit card debt every year in order to pay its bills. After a long and difficult debate among family members, keeping in mind that it was not going to be possible to borrow $16,500 every year forever, the parents and children agreed that a $380/year premium cable subscription could be terminated. So now the family will have to borrow only $16,120 per year.

74 Comments

  1. Greg

    April 14, 2011 @ 12:02 pm

    1

    David: not really analogous to the situation of the government, but many people do run up roughly half their income in debt for several consecutive years for a significant portion of their lives: this is known as “college”. In those cases, though, the expected value of the degree is substantial enough to make that debt worth taking on.

    Actually, that last bit does start to verge on being analogous: the government’s priority is (should be?) the health of the economy, and deficit spending that promotes employment, economic activity and growth during a recession is thus worthwile, just as taking on debt in advance of a degree that enables a better-paying job can be a sound investment.

    That said, not all deficit-creation corresponds to sound investments, certainly.

  2. philg

    April 14, 2011 @ 12:12 pm

    2

    Greg: As noted above, the U.S. was supposed to have come out of recession in June 2009, nearly two years ago. The world economy has been expanding since 2010 at a rate of 4.4-5 percent, according to the IMF: http://www.imf.org/external/pubs/ft/weo/2011/01/index.htm . Where is the recession that would make it sensible, under classical Keynesian economics, for the U.S. government to borrow $1.65 trillion per year? And for state and local governments to indulge in deficit spending by promising pension benefits that aren’t being funded? For a politician, it might make sense to spend more than the tax dollars flowing in. Imagine a politician who cut taxes to $0 and borrowed 100% of the amount spent. He or she could run for reelection by saying “Look at the wonderful services I delivered to you and it didn’t cost you a penny in taxes.” But that’s a pragmatic argument based on an individual’s self-interest (i.e., the politician who wants to remain in power); it does not have a theoretical basis in economics.

    As far as comparing the U.S. economy to a college student, that made a lot of sense in the early 19th Century. http://www.rootsweb.ancestry.com/~meandrhs/history/usdebt/1834.html shows how the U.S. borrowed in the late 1700s and paid off the debt finally in 1835. http://en.wikipedia.org/wiki/History_of_the_U.S._public_debt has some later data showing another period of indebtedness around the time of the Industrial Revolution, the expansion into the West, and the development of the railway network. I guess you could argue that we needed to borrow a lot during World War II in order to graduate to the status of international military power (“bully”?) and we certainly did. But it isn’t clear to me what kind of historical transformation the U.S. is undergoing right now that would make borrowing sensible. Contrary to the statements of politicians, we are not substantially shifting from fossil fuels to renewable energy. The Internet is built and wired up to most households. Our airports and railroad lines are built. We’re not dramatically changing our human capital. Americans today are about as likely to graduate from high school than they were decades earlier (see http://nces.ed.gov/pubs2009/dropout07/figures/figure_04.asp ). Our high schools use the same instructional techniques that they were using in the 1950s.

    Naively, it would appear that the U.S. has a mature, developed economy, not an immature developing economy of the kind that classically needs to borrow. What makes you think that we’re more like a college kid whose future will hold a vastly greater earning potential than his present?

  3. Jonathan

    April 14, 2011 @ 12:14 pm

    3

    I think there’s something people who are concerned about these issues (both Debt and Deficit) are ignoring.

    The United States is fiat in our own currency. The real value of the US Dollar has nothing to do with what we owe another country, or what we pay in taxes, or what congress spends. In fact, if the US government wanted to, they never have to borrow money from another country again. It’s “rules” but not laws that say we have to borrow money from other counties to fund the national budget.

    Quite literally, we just tell the treasury to print more money, or even more accurately, we just tell the fed to add a few more 1’s and 0’s into the bank accounts within the fed. Then we have money. We are no longer on a gold standard.

    You should read up on this. Really.

    Check Warren Mosler’s writings on the subject: http://moslereconomics.com/

  4. Skenw

    April 14, 2011 @ 1:03 pm

    4

    @heroineworshiper
    The difference is that with people and their houses is they actually have an asset that is possible to own outright after it’s paid for but more importantly it’s not possible to raise their own credit limit and print their own money. Plus they can’t force every other American to pay for their house like the govt. can.

  5. JCC

    April 14, 2011 @ 1:43 pm

    5

    I commend you all for a very civil, substantive and interesting series of posts. I even saw at least one person admit to an error. If only our elected decision makers could communicate like this. New bookmark!

  6. Michelle

    April 14, 2011 @ 2:05 pm

    6

    “Oh, FFS. You cannot make family/government comparisons. Governments are supposed to borrow through recessions to stimulate growth. Families should do the opposite. It’s not rocket science.”

    Ken: If families are supposed to be doing the opposite in a recession, which means not spending. How then can the governments extra spending, “to stimulate growth”, stimulate growth since we as families are to not spend in a recession? That just doesn’t make sense.

  7. Michelle

    April 14, 2011 @ 2:16 pm

    7

    Adding more money = inflation. Inflation leads to many problems such as you have all this paper money, that no longer has a standard, but things still have prices and standards, especially since we import many of our goods. More money in the system also internationally would bring down the value of the dollar internationally meaning that we would have to give more dollars for the same product. This has been tried before and it doesn’t work; Germany post WWI and a more recent example Brazil. More money is not necessarily the answer. The best answer is just what many “families” are doing now tightening their belts and just doing without stuff. Using the cable example. Do you really need such service when most programs are online for free or for a much lower price? I am sure that there are many things that the government could and should cut but when we talk about government we get in the realm of politics; the realm of power and greed. What we think it seems doesn’t matter since they have their own personal agendas and ideas of what is best for the country.

  8. Greg

    April 14, 2011 @ 3:26 pm

    8

    Ken: If families are supposed to be doing the opposite in a recession, which means not spending. How then can the governments extra spending, “to stimulate growth”, stimulate growth since we as families are to not spend in a recession? That just doesn’t make sense.

    Michelle, it’s called the difference between individual self-interest and aggregate self-interest. For individual households, scaling back expenses when money is tight makes a great deal of sense. When everybody across the entire economy does this, though, the lack of economic activity causes a recession, which in turn makes money even tighter for everyone. The aggregate of everyone’s action in rational service of their individual self-interest creates a sitution that’s worse for everyone. It’s a textbook example of a the Prisoner’s Dilemma playing out in real life. And, the argument is that the government, which (theoretically) has no interest beyond the public interest, should step in in these moments to counteract the contractionary impulses of the rest of the society.

    Honestly, if there’s any problem here, it lies in the fact that the government tends to forget itself in times of plenty, and seldom acts on contractonary policies (i.e, including the scaling back of spending) during times of boom. In terms of the atrocious family analogy, it’s that the government doesn’t save up for a rainy day when it has the money, but still ends up being obliged to spend the economy out of recessions when it doesn’t.

  9. jennyg

    April 14, 2011 @ 4:41 pm

    9

    I love the family comparison. It puts it in prospective so more people understand. Mom and dad not only have to get rid of the cable, but also the cleaning lady and gardener. These are all the subsidies that are given to businesses to “stimulate” growth. Then we stop paying the accountant (Senate and Congress) until they can come up with a budget that works. And lets call in some of those “loans” we made to those banks that were going to fail. There, we just freed up a few hundred billion more.

    There are many places that the government could cut spending, but we keep electing the same kinds of people to run this country. Maybe if we don’t make it so lucrative to become an elected official – stop paying them – maybe the right people will start running.

  10. Alan

    April 14, 2011 @ 5:07 pm

    10

    What’s extraordinary is the American belief that all is well with the world, meaning their world.

    American has a crippled political system – for ‘checks and balances’ read paralysis and horse-trading, oh, and an inability to live up to the economic facts of life.

    For health system read the democratic right for poor American babies to suffer the higher fatality rate in the developed world, with overall health outcomes generally no better or worse than European countries, but at many times the cost.

    For standard of living see American towns clogged with trailer parks because in American people are too poor to buy a decent place to live.

    For ‘national unity’ read American High School that are little more than propaganda machines brainwashing Americans into believing they live in paradise (they do that in N. Korea too).

    For ‘education system’ read an appalling mess in schools that treat people like factory products that leave Americans on the whole surely the most ignorant people in the developed world.

    For ‘politics’ read Beck, Bush, and Palin, who have made America a laughing stock worldwide when the world is not too horrified with the influence these people have – influence based on the appalling aforementioned ignorance.

  11. Jefferson Howell

    April 14, 2011 @ 5:41 pm

    11

    It certainly is an interesting conversation. A couple of comments could be clarified.

    “I don’t associate unionized public workers and government contractors with innovation.”

    Really? A lot of current technology exists as a direct result of government spending or research. Is your assumption the private sector could have gotten there faster? I’m in agreement that unions are generally in existence to preserve the status quo but I’m not sure they are incapable on innovation. Frankly, I’m not sure a private company is any more capable of innovation than a union member. It just isn’t how it works today.

    “Our grandchildren who will be paying back these borrowings are not going to be getting a return on the investment of a firefighter or teacher being kept on the payroll or being given a pay raise.”

    To oversimplify for the sake of making a point, an education is, in my mind, the ultimate investment a nation can make in it’s people. The problem is there is no way of quantifying the return. My grandchildren could be making a substantial living working for someone who is receiving a free education today. If we are going to continue to borrow at this rate I’d much prefer to see a much larger portion put into education. Though to concede a point, not necessarily into pensions.

  12. philg

    April 14, 2011 @ 6:40 pm

    12

    jennyg: Thanks for the perspective, but I don’t think that stopping salaries for elected officials would make the job substantially less lucrative. Most of the money in politics comes from the lobbying jobs that are available to former politicians and staffers. In fact, various economists have found that the return on investment to lobbying is greater than anything else a company might invest in.

    Alan: Thanks for the UK perspective. Now we can kill ourselves! I don’t think Bush, Beck, and Palin are to blame, though. In fact, I think that the U.S. should outlaw the Republican party nationwide for the next 50 years. Then Republicans would stop dreaming that the arithmetic would work out if only we had Republicans running state legislatures, Congress, and the White House. Similarly, Democrats would then realize that it isn’t the Republicans who are screwing up the country but rather the citizens not being productive or numerous enough to pay all of the taxes that are necessary to support all of the schemes that are in place?

    Jefferson: Does the government or government-funded activity generate any innovation? Probably. If you spent $3.82 trillion every year, you’d probably generate some innovation too, whether you wanted to or not. My inkling that government, on average, is less innovative than private industry comes from having visited public schools (exactly the same as when I attended in the 1970s) and McDonald’s (completely different from my recollection of the McDonald’s of the 1970s). As for borrowing to educate today’s children, I don’t think the idea makes sense unless you think that educating children is a temporary function of government or that we will have many fewer children in the future. If we need to spend $X per year educating children, in the long run we need to find a way to raise $X in taxes to pay for it. I guess you could have the idea that today’s children are more important than children will be in 20 years. So it makes sense to borrow a lot of money today and spend $25,000 per child today and $5,000 per child in 20 years (plus another $30,000 per child to pay back the debt plus interest from educating today’s children at the higher rate).

  13. Russil Wvong

    April 14, 2011 @ 6:54 pm

    13

    Scaling down the numbers to make them comprehensible is definitely a useful exercise. I did a similar calculation a while ago (Canadian Tax Facts 2004).

    But I’d suggest dividing by the US population to get per capita numbers, rather than simply dividing by billions. US GDP is 14 trillion, population is 300 million, so GDP per capita is about $47,000. In other words, that’s the annual income of the average American.

    Of that, 41.1% is going to 2011 government spending at all levels of government (federal, state, and local), i.e. about $19,300. But only about $15,200 is being paid for (total government revenue is 32.3% of GDP). The rest is borrowed. (Figures are from the OECD.)

    Looking at the federal budget alone, if it’s the federal government is spending 3.82 trillion, that’s $12,700 per capita, out of the $19,300 total bill; but people are only paying $7,200. The gap between the two is the federal deficit. Closing it will require (a) an improving economy, (b) spending cuts, and (c) tax increases.

  14. Jefferson Howell

    April 15, 2011 @ 10:19 am

    14

    Don’t disagree at all on the quality of innovation. However, people tend to speak in absolutes today when referencing the future, which crushes the optimist in me. Theoretically there is no reason that government or unions couldn’t be as innovative as private industry. Competition is a strong motivator, no doubt, but certainly not the only one. That said, I realize as it stands today that is an almost comically misguided or naive statement.

    With regards to education, my main point was money spent on education today could be recouped with new revenue in the future and is certainly a less risky financial investment than military action or defense spending. I believe a healthy economy is intrinsically linked to a educated and innovative workforce so I’d prefer to see the government allocate resources in that direction if resources are to be allocated.

    I think we can all agree we have to get this thing under control.

  15. philg

    April 15, 2011 @ 10:35 am

    15

    Jefferson: If there government workers can be as innovative as private workers, then certainly there is no reason to have a private economy, with all of the inherent disruption, heartache, suffering, and inequality. And we could save a huge amount by eliminating the crony capitalism that results from our current 60/40 or 55/45 private/government GDP split (see http://www.rollingstone.com/politics/news/the-real-housewives-of-wall-street-look-whos-cashing-in-on-the-bailout-20110411 for one small example). If 100 percent of working Americans held government jobs, we would not have any unemployment and qualified experts in Washington, D.C. could make sure that every worker received a fair salary.

    Your point that it may make financial sense to spend money on education is not something anyone has argued against (except me: http://blogs.law.harvard.edu/philg/2010/06/12/americans-lets-stop-investing-in-our-kids/ notes that we’ve built an education so inefficient and ineffective that it probably doesn’t make financial sense to continue to run schools in the U.S.). That’s a separate question from whether it makes sense to pay for current government functions with current taxes or future taxes (through borrowing). The classical rationale for the government to borrow money is to finance a one-time expense, e.g., building a highway. As noted above, unless you think that the government won’t have education expenses in the future, it doesn’t make sense to borrow to pay for today’s government-run schools. We’re simply taking away money that will be needed to run tomorrow’s government-run schools (because the money will instead be used for interest and principal repayment).

  16. agrestal

    April 15, 2011 @ 10:37 am

    16

    Too bad we American’s can’t seem to use a bit of common sense and elect a successful businessman or businesswoman into office (as have run in the past with minimal votes). Turning a blind eye to the problems and continuing on our merry way as most of us do won’t ensure success in the future. That huge black cloud above our heads does in fact mean we are going to be in the downpour. We can’t solve the root of the problem until we change our mindset as a society. What we need is Dave Ramsey to get in here and give America the smack in the back of the head that we so desperately need! The road to recovery isn’t easy and there won’t be instant gratification, but if we ever get there, it will be SO worthwhile!

  17. philg

    April 15, 2011 @ 10:52 am

    17

    agrestal: The voters of New York City elected a successful businessman, Michael Bloomberg. Once in office, he behaved like almost every other American politician. He handed out massive pension promises, to be paid for by taxes raised by future mayors, to public employees in exchange for their electoral support. He got the rules changed so that he could continue in power longer than previously allowed. New York City would probably have gone bankrupt by 2020 due to Bloomberg’s and Albany’s guarantees except that the Federal government keeps pouring tax dollars into the city, e.g., with programs such as the one described in the Rolling Stone article referenced above.

    As long as public employees can unionize and vote and politicians can spend future money by handing out unfunded, but guaranteed, defined benefit pensions, the future taxpayer will be impoverished. I don’t think it is a question of personal integrity or experience (though obviously a lot of politicians in Washington, D.C. betray a complete lack of understanding of what it might require to induce a company to invest in the U.S. versus a foreign country).

  18. Michael Campbell

    April 16, 2011 @ 1:30 am

    18

    I just want to respond to heroinegirl. She stated that we’d borrow 10x our income to buy a home. Which is true and fine. We’d also pay it back over 30 years plus interest.

    Let’s use the above #’s. Income is $21,000. So with HG’s logic, we buy a $210,000 house.

    You guys have said you can’t compare the govn’t to a family. It’s not really that. You’re missing the fact that the family does that loan ONCE in a lifetime.

    The federal government is essentially spending its $21,000 and buying a $16,000 Honda Accord once per YEAR.

    Once the tipping point is reached and the interest rate we are financing all these Honda’s with goes up simply because of the # of Honday’s we are leasing, just imagine that.

  19. agrestal

    April 16, 2011 @ 11:39 am

    19

    Hey PhilG, I’d be interested in hearing your thoughts on how to improve our position!

  20. philg

    April 16, 2011 @ 2:54 pm

    20

    agrestal: That’s kind of off-topic (the original topic was how to evaluate the significance of $38 billion in cuts (which might in fact be $352 million or even -$3.3 billion, according to the Washington Post)), but since you asked…

    http://philip.greenspun.com/politics/economic-recovery

    and

    http://philip.greenspun.com/politics/health-care-reform

    (both getting old, but since Congress hasn’t done any of the things that I suggested, both still relevant).

  21. QT Luong

    April 16, 2011 @ 5:34 pm

    21

    Most families have more control over their spending than their income. For governments, it’s just the opposite. The causes of the current deficit seem to come from fluctuation in income rather than vast increases in spending. The two main causes of diminished government income are the recession (cannot be controlled) and tax cuts (can).

  22. philg

    April 16, 2011 @ 9:53 pm

    22

    QT: I don’t think it is simple to say that, especially in a globalized economy, government can control its income (how much tax revenue it receives). As a first approximation, if one assumes that politicians are skilled and that their objective is to run as large a government as possible, my best guess is that any competent government is already maximizing its tax revenue. A government might cut a tax rate, but it is doing so in hopes of reducing the number of businesses and citizens that flee the tax, not in the expectation of reducing its overall revenue. There may be some exceptions, e.g., when General Electric gives money to Charles Rangel and receives special tax exemptions in return, but a reasonable overall model seems to be that a competent set of politicians and bureaucrats will figure out how to squeeze the most juice from any given lemon.

    http://www.nytimes.com/2010/10/10/business/economy/10view.html is a good guide to the array of taxes that apply to a dollar of marginal income. He doesn’t even get into gasoline tax, property tax, sales tax, excise tax, registration fees, etc.

    What U.S. federal, state, and local governments really need are better educated, harder working, and younger taxpayers.

  23. anon

    April 18, 2011 @ 3:58 pm

    23

    heroineworshiper wrote: “Most everyone borrows 1000% of their income for housing.”

    Uh – no they don’t. In fact, the latest issue of Consumer Reports recommends a maximum ratio of 200%. I’m sorry to hear that you overspent so profoundly.

  24. minty

    April 18, 2011 @ 9:43 pm

    24

    You talk of numbers in a vacuum, without noting a multitude of key points for context. Surely you are aware of these opposing data points, and yet you choose to ignore them?

    Here’s Bruce Bartlett:

    Without the Bush tax cuts – and those added by Obama – revenues would likely be more like 17.5 percent of GDP, which is where they were at the trough of the last three recessions.

    … If revenues had been 2 percent of GDP higher over the last 10 years, the federal debt would be about $2.5 trillion smaller.
    http://capitalgainsandgames.com/blog/bruce-bartlett/2215/obamas-budget-message-you-cant-have-your-cake-and-eat-it-too

    And behold, our wildly progressive tax scheme.
    http://motherjones.com/kevin-drum/2011/04/tax-day-charts
    The average effective tax rate for the top 1% and 20% was about 20% of income, virtually indistinguishable from the tax rate for average-income Americans. Oh dear! Sounds like socialism to me.

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