by Jurgen Brauer, October 2003
Copyright: J. Brauer. No reproduction without permission.

In the 1980s and early 1990s, the Reagan and Bush administrations, in conjunction with Congress, ran up annual federal government budget deficits running into the hundreds of billions of dollars. These accumulated to form a national debt equivalent to several trillion dollars.

Annual budget deficits fell in each of the eight Clinton years, eventually resulting in budget surpluses for a couple of years. Falling deficits still means deficits. If instead of running a $300 billion deficit, you run a $200 billion deficit, you are still adding to our overall debt. Thus, national debt grew even during the Clinton years but at least the trend was slowed.

Now, however, annual budget surpluses have vanished. Deficits are in fashion once more, and the pace of adding to the national debt is picking up. The meekness of the economy is partly responsible – fewer revenues, more outlays – but so are the President and Congress. The President wants tax cuts which means less revenue and a bigger budget hole; and Congress wants more spending which implies an even larger hole in the federal pocket book.

Predictably, the deficit and debt debate of the 1980s will be reopened and it might be useful to offer some caution. The number one caution is not to be afraid of big numbers. Six, seven, or eight trillion dollars worth of accumulated debt is a very big number indeed. But economists rarely deal with absolute numbers. We like our numbers relative, relative that is to other numbers. For instance, if you have an annual $100,000 income, a mortgage banker is unlikely to deny you a $200,000 mortgage. Your debt/income ratio is 2-to-1 and no one raises an eyebrow. Your annual income is sufficient to pay interest and to repay the debt over time.

Similarly, at the national level our national income is well over $10 trillion dollar. A seven trillion dollar debt implies a 7-to-10 debt/income ratio – or 0.7-to-1, far better than in our mortgage example.

The substantive issues therefore do not revolve around the trillions of dollars of debt. The debt is large but trivial. Instead the substantive issues revolve around other issues, one of which appears particularly important to me. The overall US national debt is generally divided into so-called "debt held by the public" and "other debt." Here is what happens. When the federal government runs a budget deficit that needs to be financed, it needs to borrow the money from somewhere. What are the sources of borrowing? We can borrow from overseas – and many foreigners are happy to loan to us because we are good credit risk – or we can borrow from ourselves. In addition to paying taxes, I also each month buy US treasury bonds, meaning that I am helping to finance the budget deficit. In return, the US government promises to pay interest and eventually to repay the principal also. The US government is a good credit risk not only for foreigners but for its own citizens as well. Such debt is "debt held by the public."

But government has another source to borrow from. It is the Social Security Trust Fund. It is still the case that active workers annually pay more into the social security fund than needs to be withdrawn to pay to current retirees. Thus, the federal government borrows the surplus from the trust fund. Because of semantic shenanigans, this is not called "debt held by the public," even though debt held by the Social Security Trust Fund is money promised to future retirees – who surely are part of the public.

In a few years from now, the Social Security Trust Fund will be in trouble. Fewer active workers will annually pay less into the fund than retirees will require to be withdrawn. The Trust Fund's accounts will be in deficit and will need to be supplemented from the coffers of the federal government. Government will have to pay up its debt to the Fund. But government can do so only if it has revenue from which to pay the debt to the Fund. Yet revenue already is short, or else government wouldn't run a budget deficit to begin with. In a word, the federal government's annual budget deficit will spiral drastically out of control in order to service the Trust Fund debt.

This means that government will either require higher taxation from the working generation to service the debt so that retirees can receive their promised retirement benefits or it will introduce legislation to reduce the promised benefits to the generation of retirees. Most likely, Congress will do both. This is such a dicey situation that no politician will touch the topic in earnest. Everyone hopes to finish out his or her political career before then.

The math is not fuzzy at all. In fact, it is not even math. It is arithmetic. If you and I each pay one dollar into the Trust Fund and three retirees draw one dollar each out of the Trust Fund, then there is a deficit of one dollar. This one dollar deficit will be financed by calling in the debt, almost all of which is held by the federal government. How is it going to pay for it?

As we gear up for yet another presidential campaign cycle, I will measure candidate's honesty by how they address this question.