Understand Federal Budget In Terms Of Deficit, Debt, Interest
Sunday, October 6, 2013, 1:00 AM | Leave Comment
The federal budget has three characteristics attached to it: deficit (or surplus though rarely), debt, and interest. Come to think of it, that’s exactly how family finances behave as well. There will always be debt and interest. Budget of any government in the world has these two characteristics attached to it.
You can say that the budget was born with the twins. Deficit, however, can turn into surplus through some prescribed austerity programs to tighten expenses and increase revenues somehow.
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Deficit vs. Surplus
Governments have income – taxes are the biggest portion – and expenses. When the expenses, in a given year, are more than the income, then it’s a budget deficit. Conversely, when expenses are less than the income, it’s budget surplus.
Since moving to the States in the 70s and trying to understand the issues related to the budget, in recent memory, there was budget surplus in President Clinton’s last couple of years in the White House.
When the economy is weak like for the last couple of years, more and more folks are jobless. Less and less money goes into the government treasury through IRS in the form of taxes. This is one reason why the deficit often grows during recessions.
However, when the economy is strong and more tax revenue goes into the Treasury, the budget deficit shrinks. If it keeps shrinking year after year, a time comes that budget goes into surplus.
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National Debt
Debt is different than deficit. The latter is measured in a given year. Let’s say, since the birth of the nation, government has borrowed money and has not been able to pay it in a given year. It keeps adding up year after year.
The basic thing to remember is: “Each time the government runs a deficit – spend more than earn, it increases the national debt; each time the government runs a surplus – spend less than earn, it shrinks the debt.
The U.S. National Debt has two distinct types:
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Net debt
It measures the government’s borrowing from private sector – banks, investors and then of course foreign governments. High net debt can also cause part of the profits from economic growth to flow overseas. Foreigners owned fully half the United States’ $16 trillion plus in net debt as of August 2013, mostly in the form of U.S. Bonds, Treasury Notes, etc.
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Gross debt
The U.S. government has trust funds in its name. The Treasury borrows against that. So Gross debt is net debt plus the debts the Treasury owes to U.S. government trust funds. An example can be that of the Social Security (SS) trust fund. So far, SS has taken in more money in payroll taxes than it has distributed.
The surplus money is invested in Treasury bonds and the Treasury in turn uses the proceeds to help pay for government operations. As a result, the Treasury owes money to the SS trust fund that will be repaid when SS needs it to pay future benefits.
So which of the two types is a better measure of the effect of debt on the economy? Experts say that Net debt is better measure because it is a direct relationship between the government and the private sector. More money the government borrows, less capital available for private sector to borrow. Over the long term, it leads to less investment and slower economic growth.
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Interest
Interest or the cost of capital is the fee a lender charges a borrower for the use of the lender’s money. The borrower never owns the money and must return it to its proper owner within a mutually agreed upon period. This is the true cost of government borrowing and can be a considerable sum.
Interest Expense on the Debt Outstanding is ridiculously high – more than $370 billion in the 4 months between July and October (estimate) 2013. In 2008, these interest payments claimed $253 billion, or a little more than 8 percent of the budget and was nearly the amount that it spent on education, transportation, and veterans’ programs combined. That’s how big the total interest amount can be in a given year.
One thing else to remember about interest is what we pay now is for benefits received in the past.
In a Nutshell
My friend from the 60s says: “People who understand the federal budget and know how to reduce the deficit are sitting on the sideline. They are not playing the game. People who don’t understand the federal budget and don’t know how to reduce the deficit are working on it.” Go figure.
