Debt and Deficits

Douglas J. YoungProfessor Emeritus

Montana State UniversityJanuary, 2011

Debt and Deficits

1. How Big is the Federal Government Debt? The Deficit?

2. How Much is “Too Much?”3. The Long Term Outlook 4. What Can be Done

Definitions• Deficit = Expenditure – Revenue

– Usually, per year– “The Federal Government’s deficit in

2010 was approximately $1.4 trillion.”• Debt = Accumulation of prior deficits

less surpluses – At a point in time, e.g. end of year– “The Federal Government’s Debt on

September 30, 2010 was $13.6 trillion.”

Federal Deficits 1939-2011

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009

Perc

ent o

f GD

P

ERP 2010 and earlier, Tbl B-78

Federal Receipts and Outlays

10%

15%

20%

25%

30%

1970 1975 1980 1985 1990 1995 2000 2005 2010

Perc

ento

fGD

P

Receipts Outlays

ERP, 2010

The Debt – How Big is It?• Federal Government Debt =

$13.6 Trillion, or $44,000 per person• Non-Financial Corporate Business

– Debt = $13.6 Trillion– Assets = $26.2 Trillion

• Household + Nonprofit Sector– Debt = $13.9 Trillion– Assets = $68.8 Trillion

http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf

Ownership of Federal DebtBillions of Dollars – September 30, 2010

Total $13,586 100%

Agencies and Trusts $4,534 33%

Federal Reserve $965 7%

Domestic $3,887 29%

Foreign $4,200 31%US Treasury http://www.fms.treas.gov/bulletin/b2010_4fd.doc

Federal Debt in the Long Run

Federal Government Debt

Taylor, “Getting Back on Track,” St. Louis Review, May-June, 2010

Per

cent

of G

DP

Gross Federal Debt

0%

20%

40%

60%

80%

100%

120%

140%

1940 1950 1960 1970 1980 1990 2000 2010

Perc

ento

fGD

P

ERP 2010 and earlier, Table B-78

Federal Debt

0%

20%

40%

60%

80%

100%

120%

140%

1940 1950 1960 1970 1980 1990 2000 2010

Perc

ento

fGD

P

ERP 2010 and earlier, Table B-78

Gross

Held by Public

How Much Debt is “Too Much?”

• When lenders worry that the country won’t be willing and/or able to pay it back =>

• Interest rates rise (dramatically) to compensate lenders for:– Default Risk and/or– Inflation Risk

When Lenders Lose Faith …

Publicly Held Debt

0

20

40

60

80

100

120

140

1997 1999 2001 2003 2005 2007 2009

Perc

ent o

f GD

P

GreeceItalyBelgiumPortugalUSASpainIrelandGermany

OECD

Would you loan Ireland money?

The Exchange Rate Effect

• If lenders distrust a country’s debt …– Sell their bonds (as we have said)– More generally, sell assets denominated

in that currency in favor of others, because the whole economy is likely to be affected

– That is, sell that country’s currency

Thailand: 1998

Malaysia: 1998

Korea: 1998

Argentina: 2002

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20Ja

n-00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

$US

per P

eso

The Effect on the Euro• Not happening (much) in Europe,

because – Greece, Ireland, Spain, Portugal are a

small part of the Euro– “Rescue” package from European

Central Bank– Can sell Irish bonds and buy German

bonds

Could a Run on the Dollar Occur?

• Yes, the US Dollar is the mostly widely held currency in the world

• But, China and other holders of US dollar-denominated assets would be harmed – As the dollar fell– If economic collapse ensued

• No evidence to suggest it (so far)

The US Dollar is Stable (so far)

As of January, 2011 …

• The US Government Debt is NOT “Too Much” in the sense that it threatens the economic and financial system

• But Neither Debt nor Deficits, as Conventionally Measured, Include “Promises” Made to Future Generations

The Long Term Outlook

National Commission on Fiscal Responsibility and Reform

http://www.fiscalcommission.gov/

• Not necessarily THE ANSWER• Good discussion of the issues• You decide what to do

Debt Scenarios

December Tax Deal

Flat Revenues; Growing Spending

What Can be Done?

• Cut Spending (from what it would otherwise be)– Health Care– Social Security– Other (Discretionary) Spending

• Raise Revenues– Tax Reform

Deficits with and without Reform

What the Commission recommends

• Do not implement the 23% cut in physician payments in current law

• But Freeze physician payments from 2012 to 2020

• Direct the CMS to “develop an improved physician payment formula that encourages care coordination … and pays based on quality … not quantity”

Recommendations - 2

• Reduce Fraud• Malpractice (Legal) Reform • Require minimum deductibles and

cost-sharing in Medicare supplements • 3.6 Establish a long-term global

budget for total health care spending and limit the growth to GDP + 1%

Social Security

Social Security

• Make the benefit formula more “progressive,” ie reduce benefits for high-earners and increase them for the lowest earners, those older than 85, and long-term disability recipients

Social Security - 2• Gradually increase early and full

retirement ages by 2 years based on increases in life expectancy– Hardship exemption at age 62

• Increase taxable earnings to cover 90% (versus 86% today)

• Use the “chained” CPI for inflation• Cover all new S&L workers

“Discretionary” Spending

• Includes defense, education, courts, unemployment, agriculture, spending on Congress and the Executive Branch, etc.

• Does not include “formula” programs like health spending, social security or legal obligations like interest

Discretionary Spending - 2

• Enact “tough” spending caps with “real teeth” to bind Congress

• Make significant cuts in both security and non-security spending

• Cut agriculture spending• Reform civil service and military

retirement• Pay freeze (including Congress!)

Tax Reform(Doug’s translation in italics)

• Lower tax rates and broaden base (Eliminate or limit deductions)

• Reduce the deficit (Raise taxes)• Increase progressivity (Raise taxes

on the rich)• Make America the best place to start

a business and create jobs (Cut the corporate tax rate)

Individual Income Tax - 1

• Reduce the top personal rate from 35% to 23-29%

• Increase taxes $80 billion in 2015 and $180 billion in 2020

• Repeal the AMT and phase out of deductions and exemptions

Individual Income Tax - 2

• Tax capital gains & dividends as ordinary income

• Eliminate itemized deductions (!)• 12% tax credit for mortgage interest

on principal residence (capped)• 12% tax credit on charitable

donations > 2% of AGI

Individual Income Tax - 3

• Cap exclusion of employer-provided health insurance

• Tax interest on new S&L bonds• Cap exclusion for contributions to

retirement accounts at $20,000 or 20% of income

• Eliminate 150 other tax expenditures

Corporate Tax

• Lower top rate from 35% to 23-29%• Eliminate subsidies for particular

businesses (Drilling expenses. Ethanol? Green energy?)

• Change taxation of foreign source income

Summary• The US government debt is not now

at dangerous levels• However, a continuation of current

policies for 25 years would be problematic at best

• The Deficit Commission laid out a (mostly) coherent solution

• Does the political will exist?

Questions?

This presentation is available at:http://www.montana.edu/djyoung

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