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 thoughts on “Understanding Congress’s solution to the federal deficit problem

  1. Simpler analogy:
    1 year of Obama = 80% of 8 years of Reagan,
    minus the benefit of bankrupting the Soviet Union.

  2. Most everyone borrows 1000% of their income for housing. That’s the ratio of debt to income which is considered normal. Only a fool would hold the government to a ridiculously low ratio of debt to income like 110%, after borrowing 1000% themselves. Unfortunately, 1000% is beyond the counting range of most Americans, so you’d have to divide by 1000%.

  3. Heroineworshipper: Borrowing money for a capital expense is not primarily what the federal government is doing with its current deficit spending. Only a very small percentage of the federal budget goes to build roads, bridges, or other items that will have continuing value beyond the current fiscal year.

    Separately, could an individual afford to borrow 10X his or her income? Interest rates are at a historic low, but let’s say that 5.5 percent is the effective rate that must be paid for a mortgage. The interest portion of the mortgage would therefore be 55 percent of the individual’s income. Property tax and principal payments would add another 4 percent or so, wouldn’t they? Add in homeowner’s insurance, a percentage of the value of the house, maintenance, and utilities, and I think very quickly we find that our individual is paying more than 100 percent of his or her income for housing. I guess that is what Americans tried to do during the Bush Bubble years, but it did not prove to be sustainable.

  4. for comment number #1,

    its interesting how people is blaming on Obama, but almost nobody is analizing the economical situation of EEUU after 8 years of Bush Jr. presidency. He left EEUU with a public debt of 10 Trillion of public debt, including two wars. Right now is a snow ball of 14T and growing.

    There is a huge problem in EEUU, and are the taxes. The public debt is growing like this way because of a continue political way of thinking based on decreasing the taxes collection year per year, plus a way of living based on credit card thanks to a very low FED interest. Thats the heart of the problem. but in EEUU is still a huge problem, because compares taxes with comunism. Its like an alienation.

    nowbody in EEUU thinks and analyze the reason behind the power of north european countries (Sweden, Polony, Norway, Finland,etc), where their unemployment is under 2%, and are having the most powerful wellfare in the world, in terms of public protection, but with the highest taxes in earth. They are not having the most poweful GDP like in EEUU or Japan, but are having the best indicator of wellfare by far. Until now it was said as a ‘mana’ that the better GDP, the better quiality of life. But things are changing. And of course, are totally integrated into the world capitalist economy. How could it happen, when the ortodoxy from chicago says that only with low taxes and small public influence, an economy can grow?

    and is when i shut up my mouth … 🙂

  5. 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.

  6. Pedro: I didn’t mean to start a debate on whether a society will be more prosperous with high taxes versus low taxes, only to see if I had a useful way to put into perspective the $38 billion that was the subject of so much debate and news coverage.

    But since you raised the issue… Does the example of Norway and Finland suggest that high taxes are a guaranteed path to prosperity? Possibly. But it could also suggest that being Norwegian or Finnish is important. There are plenty of countries that have a similar endowment of natural resources as Japan and reasonably similar tax rates, yet very different levels of prosperity.

    [I’m not sure about the inclusion of Sweden. Google says the unemployment rate there is 7.6 percent. http://discardedlies.com/entry/?14684_swedens_enormous_hidden_unemployment_rate claims that the official rate is understated. http://www.oecd.org/dataoecd/28/8/38164205.pdf says that the unemployment rate among foreign-born residents of Sweden is more than double that of native-born (i.e., the prosperity cannot be replicated for non-Swedes). http://www.thelocal.se/27180/20100611/ indicates that the unemployment rate for immigrants to Sweden is as high as 71 percent in some areas. Whatever the benefits of high taxes for native-born Swedes, they don’t seem to be helping the foreign-born.]

  7. The size of the deficit doesn’t bother me. What bothers me is that so much of the spending underlying the deficit contributes so little to the nation’s future. If, for example, Americans had spent as much on developing alternatives to burning petroleum as they’ve spent on maintaining their sphere of influence in the middle east, I suspect they’d no longer need to worry about the latter. It also bothers me that moneyed interests, having become the de facto owners of the government, have relieved themselves of paying for much of what the government does on their behalf, leaving that to the rest of us (and our grandchildren).

    Doubtless commenter #1 was an enthusiastic supporter of Bill Clinton, in view of the budget surpluses under his administration. What, no?

  8. Ralph: Let’s say that we accept your hypothesis that the U.S. government exists to transfer money from our grandchildren to the current “moneyed interests”. I don’t think that explains why the “moneyed interests” would want their hirelings to be debating $38 billion in spending. The same amount of time and effort could have been spent coming up with a way to transfer an additional trillion dollars or two.

  9. Great example of the value of contextualizing/scaling numbers to enhance comprehension. You don’t mind if I steal it for class, do you?

    I recall reading in an old business book that debt length should approximate the lifetime of the asset it was financing. So short-term loans for current expenses and long-term loans (or securitized debt) for investments. This is technically wrong, it turns out, but it is very uncommon that it makes sense to keep expanding a revolving line of credit to finance current expenditures (which is what the government is doing). The outcome of such expansion tends to be insolvency (we’re there if entitlements are correctly accounted for) followed by a sudden lack of liquidity due to a lack of lenders, followed by receivership.

    In related thoughts, what is the purpose of having a “debt ceiling” if it gets raised any time the debt approaches it? It’s like a calorie restriction diet where the dieter is allowed to raise the restriction to match intake.


  10. I think you should take this idea of 100,000,000 dollars, call it Greenspun’s number, and make up a new unit, say, the Sammy, for use in calculations. Hey, it worked for Avogadro and the mole.

  11. @ Philg,

    thank you for answering my post :-).

    If you dont mind, we can continue talking about official numbers, and not articles written by a person. If we read at wikipedia, it takes an official rate of unemployment of 8% (Jan 2011, in the middle of the crisis), a number collected from an official european agency named Eurostat. We can add that has a public debt of 43% and one of the most powerful welfare system in the world, like a universal gold medic insurance, a public unemployment subsidy to help while you are looking for another job, or the rights of having an off period at work because of pregnancy (to tell just some examples). And of course, Sweden is totally incorporated into the world capitalism through companies like Motorola, Volvo, Ikea, etc. Secret? fight against hidden economy, right distribution of wealth among population, society cohesion, high taxes, public basic society investment (hospitals, universities, ..), etc.

    So we can conclude that there are other posibilities of creating a society apart from 100% free market way of thinking, where there is a balance between free market and employee rights and society welfare. And this other posibilities are real, like Sweeden, Finland, Holand, Poland, etc.

    thanks for reading my comments! 🙂

  12. Pedro: If the Eurostat number is 8 percent, why does your original comment say “under 2%”? What’s the source for that number? The U.S. has never been that low, I don’t think, despite the fact that our statistic has been thoroughly cooked by politicians over the decades.

    My response to your idea that Sweden represents an example to the U.S. remains that it is unclear that Sweden’s system works for immigrants. It may work only for Swedes. The U.S., by contrast, is a nation of immigrants and our politicians need to let in another few hundred million over the coming century in order to have enough taxpayers to pay off pension and bond obligations. So we cannot simply copy a system from a stable society elsewhere.

  13. Big numbers — as do really teeny tiny numbers — do throw people off. I agree that the cuts are largely rhetorical. But I think focusing on this (or next year’s) budget is misguided.

    The macroeconomic argument is a complicated one and I suspect that here is the wrong place to drone on about it. While it is true that there are people that dispute the effect of stimulus given the present conditions, there is a lot of support for Keynesian expansion — e.g., Krugman. In short, I’ll just note that the 2-3% growth you observe is with our foot on the gas pedal on both fiscal and monetary policy and taking our foot off the pedal when businesses are still complaining about demand might not be a great idea. (http://tinyurl.com/66fs5ac)

    Our debt situation really is not that bad in that the problem is largely political instead of an inability to pay. Moreover, the temporary deficits we’re running are a small problem relative to the burdensome (and sometimes perverse) tax code and the stream of payments into the future. Two large spending elements, Social Security and defense spending, are pretty easy to modify for a more sound future. Moreover, Simpson-Bowles demonstrated how much simpler we could make our tax code, improve economic conditions, and raise revenue. Health care remains tricky since it appears to me that the trade-offs between different strategies are significant. Nonetheless, I think that other countries have effectively demonstrated that one can have pretty good health care at a lower cost. So again it seems like a political problem to me. We simply have to muster the political will to force policy makers — and the public — past the myopic choices they have been making all too often.

    CBO has a good summary here. http://tinyurl.com/4aj47v5

  14. As Ken points out, a government is not a family. You are reducing a fiscal and monetary problem to a purely fiscal problem. A family can’t devaluate their debt.

    Government debt is not a terrible thing — in fact, governments are not supposed to be money-making machines. Nowadays austerity and budgets are being used to promote political agendas, not to actually improve living standards of a country.

  15. Pedro,

    We just finished discussing at length that basically 50-70% of US taxpayer income is siphoned off into the government at one level or another and in addition discussed that of the total output of the country, 30% of it is spent by the government.

    Then you go out and make the preposterous statement arguing against having a 100% free market way of thinking.

    I think the free market way of thinking went the way of the Dodo. The US economy is effectively 50-70% of the way to communism and is currently just masking it in Debt.

  16. @heroineworshiper The old rule of thumb is actually 200-300% of your main breadwinner’s income should be the max value of your home. So given these numbers it sounds like your suggesting it’s ok for the government to buy a new home every other year . . .

  17. @Philg,

    you are right. I didnt point out that the 2% was on 2008, before the crisis. Nowdays, they have 8%, in the middle of a global crisis, that in fact, i think is very valuable.

    Anyway, you are right. I think i posted the wrong answer at the wrong post :-).

    Above all, continue posting, because i am a fan of your site.

  18. I see that this article is a nice way of highlighting the sham success of the re-negotiation of last year’s budget.

    Going forward with the non-equivalent analogy:
    If the interest on the credit card debt (0.3% 1yrTbill) is smaller than inflation (2%), it’s a brain-dead stupid business decision to not borrow. It really is free money. It is sheer stupidity for the family to not borrow and pay off their home, get dental work, buy infrastructure, etc., while the money is free. The family should raise their credit limit as long as the money is free and put the parent that manages the budget into surpluses back in charge.

  19. Dave X: It might make sense to borrow free money if one had good investments to make, but the U.S. government hasn’t been investing in infrastructure. The borrowed money is mostly used to pay day-to-day expenses, e.g., higher salaries for government workers. Separately, most infrastructure investments in the U.S. aren’t very lucrative because we already have a lot of infrastructure. It would make more sense for the U.S. government to borrow money and build toll roads in China. But that’s an academic argument because almost none of $1.7 trillion that the federal government borrows every year isn’t used for anything that could conceivably be considered an “investment”.

    Pedro: http://www.bls.gov/fls/intl_unemployment_rates_monthly.htm#Rchart1 says that the Swedish unemployment rate, “adjusted to U.S. concepts”, was 6 percent in 2007 and 2008, not 2 percent. In both cases it was higher than the U.S. rate at the time. A 2 percent unemployment rate is almost impossible to achieve. It would mean that every worker who moved or changed jobs voluntarily was able to find work immediately.

  20. Ralph’s comment provides good perspective. The political face of the debate appears to be one party that’s focused on abetting the accumulation of wealth through lower taxes, direct payments (bailouts), subsidies and reduced oversight. The other party seems just as myopically focused on the preservation of entitlements and unions.

    Neither perspective benefits or addresses the needs of most Americans. Whether it’s energy dependence, infrastructure or education the real drivers of prosperity don’t seem to merit their focus, attention or dollars.

  21. “The borrowed money is mostly used to pay day-to-day expenses, e.g., higher salaries for government workers.”

    Salaries? That isn’t where all of that borrowed money is going. Take a look at the numbers: that borrowed money is being spent on Medicare, Medicaid, and defense. The problem isn’t that there are too many government workers or that those workers are overpaid, it’s that health care costs continue to skyrocket largely due to massive subsidies of “free” borrowed money and the price-masking effect insurance companies have on the health market. The same happens in the defense sector: as long as free borrowed money will be available, the price of anything related to defense is going to rise.

    In other words, a “toaster” might costs $20. But if you call it a “medical toaster” or a “tactical toaster,” the cost rises to $1000.

  22. I can’t quite agree with that statement.
    in my opinion you’ve got to compare it to a family owning a huge farm but currently only having the income that was stated above because of a drought.Spending money on seeds for the next year can be quite reasonable – otherwise there would be no / just a small harvest the next year round.
    The problem is not putting enough money away during the fat years / buying insurance, spending on items with very little return (sports car instead of a tractor).
    sseing a small uptick in unemployment
    Currently working in Austria (since the winter tourism season is about to end while the building season hasn’t quite started we’ll probably seeing a small uptic in unemployment to

  23. 5%) which is in a much better situation that was manly due to smart government spending – e.g we paid part of the salary of people who went on reduced hours. as a consequence many people (especially the critically under-supplied tradesmen and engineers) were still in their jobs when the recovery began – the companies could take immediate advantage of that while companies in the US have to be certain that the recovery is for real before investing money in training / retraining laid-off workers.

  24. Josh: My understanding of the stimulus money was that much went to the states and there it was used to maintain the salaries of teachers and other public employees. So the states were able to use the printed/borrowed (depending on whether the bonds were then bought by the Fed) money to keep the number of public workers and their salaries the same as if the Collapse of 2008 had not occurred (often with pay and pension increases). 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. This cannot be compared to the construction of the Interstate Highway System or the Hoover Dam.

  25. Interesting that there is no analysis of how that money is spent, as though priorities didn’t ever figure into the calculus. When suggesting cuts, the small priority of cable television is held up. It might be worthwhile to consider that this family is spending $6,851 on supporting it’s local militia, including $2833 in guns and ammo at their 3 shooting ranges. It might also be worthwhile to note that about 40% of their $38,200 ($15,800) in expenses is the interest on the huge debt they were carrying since 2001. Finally, this oversimplified analogy overlooks the most simple solution to their problem. The family needs to increase earnings if it ever hopes to reduce it’s deficit. Why is that not an option?

  26. Steven: I love the shooting range analogy! Thank you. Can the family increase earnings? The family has tried since the 1970s to increase individual per-hour earnings, but has not succeeded due to its poor educational performance and competition from well-educated hard-working people in foreign countries. The family has thus been forced to send its women into the workforce and work longer hours in order to increase its wealth. The family will advocate for liberalized immigration rules and will accept a more crowded home soon as it hosts immigrants and children of immigrants in an effort to increase overall income while individual wages remain stagnant or fall.

  27. @Cynic
    Simpler analogy:
    1 year of Obama = 80% of 8 years of Reagan,
    minus the benefit of bankrupting the Soviet Union.
    You must clarify “bankrupting the Soviet Union.” The USSR collapsed in spite of Reagan, in fact, the USSR may have collapsed at least 2-3 years sooner, had he not been taken such a reckless hard line in his first term. If anything, Gorbachev’s combination of “glasnost'” and “perestroika” overloaded the Soviet political and economic system, fueling the regionalism and nationalism that led to disintegration.

    It is convenient to state all of the current deficits are attributable only to Obama. With Reagan’s spending spree you then had in place an enormous system of legal graft, in the form of the benefits to rural congressional districts that house military bases, contractors, etc. which is incredibly difficult to remove. That must also be taken into consideration.

  28. I like the analogy, very helpful.

    I’d like to warn against philg’s immigrant objection to Pedro’s Scandinavian example. Many immigrants to Sweden do not speak the language (far more often so than in the US) and do not have training matching Swedish employment needs. In addition, children of large groups of immigrants tend to do poorly in school, further lowering their chances, and job applicants will face discrimination. I don’t know whether refugees are counted among the unemployed, but refugees are typically denied employment for years on end while awaiting their residence status (speaking about Europe more generally here, not sure about Sweden specifically). To propose that immigrant unemployment suggests low unemployment rates have something to do with “swedishness” (or finnishness etc.) is therefore hardly fair.

  29. @heroineworshiper That is not the same – borrowing for a home is secured debt (ie there is something of real value that the bank can go an repossess). The US govt. is making unsecured debt. HUGE difference.

  30. Also add that if the creditors come to collect, the “family” will shoot or bomb them, or simply shoot or bomb another family to steal their assets.

    Your analogy is cute, but misses the central point that this “family” has a world class arsenal of awe-inspiring weapons and pathological and completely amoral eagerness to use them.

  31. Dan: Thank God we didn’t issue secured debt; the Chinese would be over here repossessing Yellowstone National Park, putting toll booths on I-80, etc. I think the bigger difference is that the house will last for 50-100 years. If we build a house today, it will cost a lot, but our maintenance expense will be very low next year. Borrowing to pay for this year’s health care expenses (Medicare) doesn’t make sense because next year our health care expenses will be about the same if not higher. Borrowing to pay for 2007’s war (Iraq?) doesn’t make sense because 2008’s war (Afghanistan?) was just as expensive (maybe the Libyan war will be cheaper, but of course we’re still running the previous two wars as well).

  32. @Phil:

    In response to Josh’s point that “borrowed money is being spent on Medicare, Medicaid, and defense,” you replied that “My understanding of the stimulus money was that much went to the states and there it was used to maintain the salaries of teachers and other public employees.”

    First of all, please direct me to the section of this website that supports that claim:

    Second, I don’t think that Josh was just talking only about the stimulus, and neither were you in the original post. That was about the entire federal budget, paid for by tax revenues and by borrowing. And indeed most (63%) of the federal budget does go to pay for Social Security, Medicare/Medicaid, and defense. Is it the case that money that is borrowed to pay for the federal budget can only be used to pay for certain things?

    I’m also wondering why you mentioned the salaries of public employees in the first place? Are they really so high that we have to borrow trillions of dollars to pay for them? According to the Heritage Foundation, the nation would save a whopping $47B “if federal workers were paid at the same rate as private sector employees.”
    (Source: http://www.npr.org/2010/11/11/131250179/gop-eyes-cutting-federal-bureaucracy-to-save-money)
    In the context of your original post, how could that amount of money matter? Even if we fired all 2M federal employees at an average salary of 100k, we save 200B.

  33. jg: How can it be that public employee compensation will have a significant effect on the nation’s finances? It might well be the case that we could save just $47B per year by paying federal workers what private companies would pay similarly qualified people. However, the market clearing wage for a federal worker might well be substantially lower, given the job security, short working hours, lack of pressure, etc. Perhaps the real number is $100B per year and it still wouldn’t make a huge dent in a $1.7T deficit, just as you say (though I’m not sure that is a justification for throwing away $100 billion every year).

    http://www.institutionalinvestor.com/pensions_and_endowments/Articles/2766229/State-Pension-Plans-Scramble-to-Avoid-Bankruptcy.html points out that estimates of the funding shortfall for state pension plans is between $500 billion and $3 trillion. That doesn’t account for the cost of unfunded retiree health care guarantees. Nor should we forget that this is an estimate. If those state workers who retire today at age 41 (bus driver here in Massachusetts) or 50 (many workers in many states) end up living longer than projected, the shortfall could be much larger. If investment returns are disappointing, the shortfall could be much larger as well.

    Between pensions and payment of government workers, both federal and state, at higher than market-clearing wages, we’re probably talking about $2-7 trillion over the next decade.

  34. This family also has also spent an ungodly amount on ammunition and body armor, which is why this family can keep borrowing money as long as it wants.

  35. Your analogy makes the situation easier to grasp, but the phrase “stealing from our grandchildren” is overused, and is a common misconception. In fact, dept can take the from of investment which will increase productivity, capital, and resources in the future. The amount we spend is irrelevant as long as it is going to the right services, industries, and innovators.

    At a time when the nation is demanding higher wages and new jobs,government spending is our most powerful tool. Dollar for dollar, a change in government spending has a greater impact on economic growth than a change in taxation. Government spending increases overall spending, while some money from tax cuts becomes stuck in savings accounts. Saved money is a comfort to the individual but it’s better for the country as a whole if that money is in circulation, doing what it does best: wealth creation!

  36. Charlotte: Thanks for the perspective that “government spending is our most powerful tool”. Certainly there seem to be a lot of folks in Washington who agree with you! Your point that “The amount we spend is irrelevant as long as it is going to the right services, industries, and innovators” has me a little worried. I don’t associate unionized public workers and government contractors with innovation.

    If deficit spending and debt have all of the benefits that you set forth, I can’t figure out why Iceland, Ireland, Greece, Argentina, and Portugal have had any difficulties. In fact, it would seem that with a sufficiently wise government (i.e., one that borrowed and spent a lot), a country could achieve wealth independent of how educated, skilled, and hard-working its population was.

  37. The family spends $38,200 per year and earns $21,700 per year, for a deficit of $16,500 per year. It cut $380/year in cable expenses. It could cut a further $550/year in interest payments it pays to its children for loans against their allowance.

    In the past, the family has been able to earn as much as $51,300 per year, but the bread-earners prefer to accumulate debt against their impressive credit score and earning potential. This isn’t to mention the accumulated assets of the family, which include everything from enormous expanses of land and natural resource rights to cutting-edge military hardware and technology patents, not to mention the accumulated debts of dozens of other families in the neighborhood.

    (I think the analogy needs added complexity to give an accurate picture, frankly.)

  38. The family has a total income (GDP) of more like $150,000 ; the $38,200 is consensually arrived at to cover some of the common expenses. Some family members have a markedly disproportionate share of the family income and assets, and though they are loathe to be assessed more for the protection the family affords them and their wealth, they are more than glad to lend the family money to cover the deficits, so most of the interest represents transfer of wealth from poorer to wealthier family members. Other families lend them money too, though our family spends $6,000 a year for home invasions and preparing against having their home invaded. They had a big home invasion event 70 years ago equal to their total annual income, and never paid that debt off, but their income grew and they inflated some of it away, so nobody cares. They all like to listen to their own radios, but the serious advocates of debt reduction frame the problem as the purchase of a $4 public radio/tv, although the problem might be that one cousin who selfishly demands food and a place to live in exchange for teaching the children.

    So, about as fouled up as my actual family; I don’t want to go to Thanksgiving dinner with either of them.

  39. Proportions, on the other hand, have a lot less bias to provide information. You could say that spending is 1.7x the income and that the borrowing was reduced by 2%.

  40. My favorite part of this whole discussion is “free market” and “socialism” as regards the US, because US economic governance isn’t like marxism at all, nor is it a free market (at all, as has beenpointed out)

    It’s a centrally regulated (or maybe “guided?” or “hedged”?) economy that at this point is largely organized around consolidating wealth for the elite, since most of the “socialism” the right wing whines about constantly is money being funneled directly to military contractors, the healthcare industry, agribusiness, and who ever else is the answer to “qui bono?” (hint: if you don’t know who the are, here’s some signs– billions in earnings, yet they pay no taxes, bitch about how unions are breaking them, but they give millions in bonuses to jack-offs that crash the company, or even the whole economy (if they didn’t, how would they get top talent like that?)).

    The only term I can come up with is Totalitarian Slapstick (they eat the pie after they smash your face with it), because they don’t seem to have the talent for true fascism that the euro-axis governments had.

  41. There is a problem with your analogy since the US government is the monopoly issuer of the currency which non-convertible.

    How the economy works with a fiat currency is more like this:

    Parent issues coupons (dollars) to his children in return for doing chores around the house (government spending) which they will use to pay rent (taxes). The kids want to take a break once in a while so they would like some savings so the parent decides to issue more coupons than are necessary for the rent (deficit spending) which the kids can put in their savings account (treasury bonds).

    The national debt is just the equivalent of the accumulation of these savings coupons. So in actual fact the national debt just represents the accumulated savings of the private sector. So when a government creates a surplus it is actually reducing the amount of savings in the private sector.

    Of course the government needs to control inflation so that the savings are worth something when the private sector decides to spend the savings (eg. during retirement) and it does this by removing currency in form of taxes

    This is all very clearly explained here
    which covers the domestic situation and here for imports and exports

  42. @philg-
    Which doesn’t take GDP into account. Clearly the breadwinner’s “employer” (US economy?) is willing to pay larger chunks of its total sales revenue. The highest total federal receipts as a percentage of GDP in history was roughly 35% (give or take a few points). Current GDP is $14 trillion and change, landing us somewhere in the neighborhood of $50k per year (using your Greenspun’s Number). Play with the numbers and percentages a bit, and you get a range that includes my original number.

    (Just to kind of take a side-swipe at the current Capitalism/Socialism debate here, why is it that the wealthy are wealthier now than they were ten years ago, yet we have higher unemployment than we did ten years ago, but still we get further insistence that we must make the wealthy wealthier in order to make unemployment go down? Is this an argument that is entirely divorced from empirical analysis?)

  43. A 2% unemployment rate is actually bad for the economy. Various sources will disagree with the specific rate that is optimal, but it’s around 3-4%. Sub-3% (or whatever you agree is optimal) unemployment makes it impossible to grow, as there aren’t enough competent employees available for new or expanding businesses. Think about the last time you were hiring (for those of you who have done so) – you’d much rather hire in a time of higher unemployment, as you can find plenty of good candidates; on the other hand, in a time of low unemployment you often will have to hire a suboptimal candidate as there aren’t enough really good candidates, on top of the fact that you have to pay them more than you would in a weaker economy.

  44. And if this family goes bankrupt it can’t order Chinese take-out or fill up the Hummer at Abdul’s gas station, so the other families in the town have little choice but to keep borrowing money to our main family, in order to stay in business themselves.

    Pedro/sweden: I understand that you can’t blindly copy one countries solutions to another one. But America often seems irrationally devoted to “the American Way”, trying to re-invent hot water (it’s a saying here in Belgium) and often ending up with something lukewarm, faced with very comparable problems, poor people getting sick, other countries, new zealand, germany, belgium are doing a better job for less money. Their systems have flaws aswell. So compare everyone’s flaws and benefits, extract the best practices, and apply them to your specific situation. Offcourse, policy is ruled by only those facts and figures that fit with ideology and funding, and while we’re all still living in democracies, it would be foolish to assume the masses wouldn’t vote accordingly.

    Socialism?: I understand that there are mechanisms at work in corporations that make then more effective then government in handling things. But there’s also mechanisms at work in corporations that make make them money guzzlers, like beeing legally obliged to their shareholders to make as much money as possible.. A corporation that makes all or most of it’s money by charging the government seems like a very complicated way of avoiding beeing called a socialist. The military seems to run ok, why can’t it build it’s own weapons? If teachers can be on a governemtn payroll, why can’t doctors? Or pill makers.Turn Buraucracy into Meritocracy, connect governemts workers compesations to the goals of policy and separate public funding from profit chasing. Don’t tax the rich, but tax dead money, there must be mechanisms concievable that turn the ‘trickle down’ into a waterfall.. Don’t take money to throw it into the bottomless pit of dept, but stear money by encouraging investment that generate employment and innovation and punishing immobility. Ow and get some transatlantic trade agreements going that dissolve tax havens, and insure that how much taxes a company pays is based on it’s income and not the size of it’s legal/tax department.

    sorry for opening the ‘president of the world’ floodgates there.

  45. philg: In the business world, the thing that Charlotte’s discussing- borrowing in order to fund investment, on the basis that the return on that investment is greater than the costs of investment, is known as leveraging, and it’s extremely common practice.

    And, frankly, this disconnect starts to cut to some of the problems with how you’re framing this topic- even besides the fact that the government is not a household and really shouldn’t be expected to behave like a household*, there’s that bit about talking about presenting the budget cuts as “cable television”. Some of the cuts, such as the cuts to IRS enforcement, are actually a great deal more like trying to save money on gas or transit budgets by deciding to skip work days (and thus damaging your wages far in excess of the savings)

    *This is always a point of contention, and the notion’s mostly associated with the more Keynsian policies coming from the left, but let’s put a finer point on it regards to the right: the argument for the Bush tax cuts, and part of the basis for the Ryan/Heritage numbers now, has always been that our “household” will end up bringing home more money by taking pay cuts at work. That’s not how actual households work, any more than the argument that the government should engage in deficit spending in a recession, *because* the rest of the economy is contracting and it needs to counteract this effect corresponds to something that real households would ever do, either.

  46. Heroineworshiper, You are confusing debt vs. deficit. I borrowed the money to buy my house _once_. I don’t borrow that much money every. single. year. And after buying the house, my total debt started going down because I started paying off that loan. Constantly borrowing money for short-term gains isn’t analogous to buying a house. It’s analogous to running up the credit cards for video games and toys.

    Go talk to your financial planner about the advisability of running up about half your income as unsecured debt _every_ _year_.

  47. 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.

  48. 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?

  49. 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/

  50. @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.

  51. 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!

  52. “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.

  53. 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.

  54. 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.

  55. 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.

  56. 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.

  57. 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.

  58. 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).

  59. 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.

  60. 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.

  61. 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://philip.greenspun.com/blog/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).

  62. 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!

  63. 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).

  64. 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.

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

  66. 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).

  67. 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.

  68. 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.

  69. 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.

    And behold, our wildly progressive tax scheme.
    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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