YOU DECIDE: What are the basics of the debt debate?

Media Contact: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

By Dr. Mike Walden
North Carolina Cooperative Extension

Few economic issues are bigger or more controversial than the national debt, as we’ve seen by the recent negotiations in Washington. By the time you read this a deal on the debt may have been struck. Even so, questions about the debt will likely linger and be debated.

Here I provide some answers to basic questions about the debt. Unfortunately, economists can’t always provide “the” answer, so in these cases I’ll give alternatives — alternatives that provide plenty of thinking and deciding by you!

What Is the Difference Between the Debt and the Deficit? Debt and deficit are often used interchangeably, but they are different. The deficit is what the federal government borrows in a year — similar to what a person might put on his credit card in a year. The debt is the current total amount of borrowing by the federal government that hasn’t been repaid — comparable to a person’s outstanding balance on a credit card.

How Big Is the Debt? The total national debt owed to non-government agencies and government agencies (such as Social Security) alike is $14.5 trillion. But just as a person with more income can afford to carry more debt, so too can a country. Therefore, economists like to express the size of the national debt as a percentage of total national income (technically called “gross domestic product”). This amount is now 96 percent, second-highest to the rate during World War II. Eleven other countries, including Japan and several in Europe, have higher debt to income percentages.

Can We Afford the Debt? When we ask if a person can afford their debt, we look at the periodic payments — like a monthly mortgage or car payment — and see what chunk (percentage) they take of the person’s income. We can do the same for the national debt. Interest owed on the national debt now takes about 2 percent of national income. Part of the reason for the relatively low percentage is the very low level of interest rates today. If interest rates rise down the road, then so too will this percentage.

Why Has the Debt Increased? This is one of the most contentious questions about the national debt because it pits those who focus on spending against those who emphasize taxes. An examination of the data show both spending and taxes have contributed to the rising borrowing. In 2007, the last year before the recession, federal spending as a percent of national income was 19.6 percent, slightly lower than the 20.7 percent average of the 1990s. Federal revenue as a percent of national income was 18.5 percent, exactly the same as the average for the 1990s. So there was a deficit of 1.1 percent of national income.

Then the Great Recession hit. Typically during recessions, relative government revenues fall as businesses and households earn less. Also, relative government spending increases as more people qualify for public assistance (food stamps, Medicaid, etc.) and the government tries to spur the economy with new spending (examples are the TARP — Troubled Asset Recovery Program — of 2008 and the stimulus plan of 2009). In 2009, federal revenue as a percent of national income had dropped to 14.9 percent, while federal spending as a percent of national income had risen to 25 percent, thereby jumping the deficit to 10.1 percent of national income. And a bigger deficit adds more to the national debt.

So, Should Spending Be Cut or Taxes Increased to Deal with the Debt? This is the big question and is the one that groups in Washington have been arguing about for years. It’s also one that economists can’t give a clear answer on, either because we disagree among ourselves on the impacts of tax and spending changes or because part of the answer is based on subjective valuations of what is most important.

Let me try to stake out the different positions and their reasoning. One group wants to increase federal revenues to between 20 percent and 22 percent of national income. They believe federal spending will naturally rise over time, primarily due to the growing retirement population and its impacts on Social Security, Medicare and Medicaid. This group is not against some paring of federal spending, but they don’t think balancing the budget can be done all on the spending side due to the roles they see for the government in areas like health care, education and income assistance.

Another group wants to tackle the problem entirely on the spending side and not increase federal taxes. Indeed, this group thinks the current uncertainty about possible tax increases may be motivating businesses not to invest and hire. So they believe the economy will be helped if taxes are not increased. They also think future federal spending can be restricted through a combination of adding incentives to motivate frugality, privatizing some federal functions and reducing programs or benefits for some targeted groups.

Virtually everyone agrees on one thing: doing nothing about the national debt is not an option. Indeed, if left alone, some projections suggest the national debt as a percentage of national income could double to 200 percent in 25 years. Of course, the big question is, what to do? Hopefully, we will decide, and soon!

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The College of Agriculture and Life Sciences communications unit provides his You Decide column every two weeks. Previous columns are available at http://www.cals.ncsu.edu/agcomm/news-center/tag/you-decide

Related audio files are at http://www.cals.ncsu.edu/agcomm/news-center/category/economic-perspective/