When it comes to highly charged and complex issues, the budget deficit is at the top of the list. As a society, we certainly need to have this debate; after all, a $16 trillion federal budget deficit is a big issue. However, as pundits and politicians poke, prod and excoriate each other on this topic, the level of discourse would be improved, and the public’s understanding of the issue would be increased, if we could all get beyond a few widely circulated myths—-
Myth 1: The Federal Government Should Stick to a Budget like Normal families Do!
Even President Obama has compared the decisions about the federal deficit to the decisions that a family must make in only spending what they have. In reality, the government is actually a bit more responsible in managing its finances in that the proportion of total outstanding household debt relative to total household income (90%) is greater than the share of outstanding federal debt to GDP (70%). Further, among 35-54 year olds, fully half of households have debts greater than their family income. This debt has allowed families to purchase homes, send their children to college, and be able to respond to emergencies. In a similar way government borrowing has allowed us to build and maintain investments such as the interstate highway system and federal support for higher education. Debt has also been used to respond to emergencies such as wars and disasters.
Myth 2: The Federal Government Should Produce a Balanced Budget like all State Governments Do!
It is quite common to hear some version of the statement—“if States can balance their budgets, why can’t the federal government do the same.” Actually, up until the last run-up of large federal deficits in response to the current recession, the use of debt at the federal and state level was quite comparable. States balance their “operating budget” but take on large amounts of debt in their “transportation and capital budgets.” In terms of the share of interest paid as a proportion of the budget, the states are only slightly lower than the federal level (and they get about 20 percent of their budgets from the federal government).
Myth 3: Federal Deficits Debase the Currency and Cause Inflation!
The historical evidence shows that the relationship between federal deficits and inflation is not direct as most deficits do not lead to out of control inflation. The United States has yet to experience anything resembling the sort of hyper-inflations that have occurred in other countries where inflation rates have reached 100% a year. Since World War II, inflation has mostly been kept in track. The run-up of prices in the 1970s was sparked by rising oil prices and a wage-price spiral. There was some increase in federal debt in the middle of this decade, but deficits exploded in the 1980s as inflation declined. Finally, in the last five years, as debts have soared, many pundits have predicted rising inflation. Yet here we are ten years after high deficits in every year but no sign of high inflation.
Myth 4: The Federal Government Should Act like Business Leaders and Meet Payrolls Without Resorting to Debt!
Modern corporations use debt financing for most long-term construction and equipment. In 2007, Non-financial corporations paid $649 Billion in interest payments while the Federal government paid less than half that amount ($313 billion). In particular, private equity companies rely very heavily on debt financing to “leverage” their profits when they make acquisitions. And since corporations (like the government) can, in theory, live forever, they can go on carrying debt forever. All that matters for corporations and governments is that their incomes never fall so far behind their spending that their debt grows faster than their income over some long period of time. We are in danger of that now and something needs to be done once the economy strengthens. While one rating agency has downgraded US debt, the others haven’t and the interest rates on US bond of various lengths show that investors are very confident in the government’s ability to meet its obligations.
Myth 5: The Federal Government Has a Spending Problem!
No, we have a disconnect between what we “want” to pay in taxes and what we “want” in services. We ask a lot from our national government: e.g. national defense, care for the elderly, support for states and localities, regulation of commerce, environment, and finance, and support for the less fortunate. The federal government, through the Medicare and Medicaid account for fully one half of all health care spending. Since the growth of health care spending has been so great, federal spending has risen accordingly. Many falsely believe that there is a great deal of waste in the Federal budget that could be easily cut. But administration after administration has combed the budget for savings. What is left may seems wasteful to some, but what is still there has its defenders and political backers. Finally, while the public sector is not the most efficient work environment, it is not that different from private large, bureaucratic organizations. For example, the administrative costs to run Medicare are a fraction of the comparable costs of private insurance companies.
Most efforts to solve the deficit flounder on the inability to come to agreements on the size of tax increases and specific program reductions. There are many websites that show the combination of spending cuts and tax rises that are necessary to move to a smaller deficit in the future. It is doable if the political will for compromise is there. But plans that promise tax cuts without saying what programs will be cut or how additional revenue will be raised continue the impression that we can have lower taxes without the pain of big cuts in popular programs.
Conclusion: Debt is pervasive throughout the economy and is mostly used for good purposes such as houses, cars, education, and capital improvements. Federal debt can also be a good thing when we use it to allow the government to function during times when the economy is temporarily depressed. But we should make sure that over the long haul the amount of debt doesn’t grow faster than the economy. If we don’t, eventually others will want higher and higher interest rates to get them to hold our debt and ultimately we would be forced to either inflate our debt away or default. To make sure that doesn’t happen we have to be realistic about what we can afford and how much it costs to have the government services we need.
In theory, a functioning national political system should be able to deal with the need for government action during a time of high unemployment and low interest rates. As the economy recovers, tax revenues will automatically rise and reduce the deficit from its $1 trillion a year level. But this is not enough: Ultimately the overarching myth inherent in the entire budget debate is the myth that the public can have the government services they want without having to pay the price for those. No one is going to be entirely happy with the final compromise, but a compromise is inevitable and the sooner the better.