Deficit: Why Should I Care?

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Most U. The federal government does not have that restriction. Many situations can cause spending to exceed revenue. An involuntary job loss can eliminate revenue. Sudden medical expenses can quickly send spending skyward. Spending can easily outpace revenue if the consequences of debt aren't too painful. That occurs in the early stages of credit card debt.

The debtor keeps charging, and only paying the minimum payment. It's only when interest charges become excessive that overspending becomes too painful.

Why Should I Care About the Federal Deficit? | Pocketsense

Like families, governments also lose revenue during recessions. As workers lose jobs, there aren't enough taxes coming in. Unlike families, the federal government can keep adding each year's deficit to the debt for a long time. As long as interest rates remain low, the interest on the national debt is reasonable. The federal budget deficit is not an accident.

That's because government spending drives economic growth.

Don’t Panic Over the Budget Deficit

It's a result of expansionary fiscal policy. Job creation gives more people money to spend, which further boosts growth. Tax cuts also expand the economy. There are immediate penalties for most organizations that run persistent deficits. If an individual or family does so, their creditors come calling. That makes new credit more expensive.

Eventually, they may declare bankruptcy. The same applies to companies who have ongoing budget deficits. Their bond ratings fall. When that happens, they have to pay higher interest rates to get any loans at all. These are called junk bonds. Governments are different. They receive income from taxes. Their expenses benefit the people who pay the taxes.

Government leaders retain popular support by providing services. Most voters don't care about the impact of the debt. As a result, deficit spending has increased the U. There are only two ways to reduce a budget deficit.

You must either increase revenue or decrease spending. On a personal level, you can increase revenue by getting a raise, finding a better job, or working two jobs. You can also start a business on the side, draw down investment income, or rent out real estate. Decreasing spending is easier in the short-term. Many experts recommend cutting out non-essentials, like Starbucks coffees and cable subscriptions. It also works for someone with a spending addiction, if they get help.

But increasing revenue is more sustainable in the long run. Constantly evaluate and improve your skills to maximize your revenue from the job market. Governments can only increase revenue by raising taxes or increasing economic growth. Tax increases are tricky. If they are too excessive, they will slow growth. Politically, they often end a politician's career. Increasing growth can only be done moderately. If growth is faster than the ideal range of percent, it will create a boom, which leads to a bust.

Cutting spending also has pitfalls. Government spending is a component of GDP. If the government cuts spending too much, economic growth will slow. That leads to lower revenues and potentially a larger deficit. The best solution is to cut spending on areas that do not create many jobs. Most governments prefer to finance their deficits instead of balancing the budget. Government bonds finance the deficit. Most creditors think that the government is highly likely to repay its creditors. That makes government bonds more attractive than riskier corporate bonds.

As a result, government interest rates remain relatively low. That allows governments to keep running deficits for years. The United States finances its deficit with Treasury bills, notes, and bonds.

That does not mean, however, that we should put aside all policy changes designed to reduce deficits over time. Indeed, implementing a credible long-term strategy to bring deficits down to a more sustainable level would likely enhance near-term assistance to the economy. The cyclical component can be attributed to the weak economy.

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A recession drives down government revenue because many workers and businesses are no longer earning as much taxable income. At the same time, government spending rises because more people need assistance through programs such as Medicaid, unemployment benefits and food stamps.

The result is a temporary, or cyclical, increase in the deficit. Once the economy recovers, tax revenue and government spending on assistance programs should return to normal levels. The most effective policy changes are those affecting permanent law, such as entitlement programs and tax provisions that run on autopilot.

With structural deficits, one-time spending cuts or temporary tax increases may help to relieve the pressure but cannot solve the problem. The United States currently faces both a cyclical and a structural deficit. The cyclical deficit is caused by the financial crisis and severe recession from which the country is still recovering.

The structural deficit reflects a chronic mismatch between government revenue and spending that under current policies will dramatically worsen as health care costs rise and the population ages. Meanwhile, debt held by the public rose from A number of non-cyclical factors have contributed to the high deficits of recent years. Some of these are related to but not caused by the economic downturn. For example, a combination of temporary spending increases and tax cuts intended to stimulate the economy have been enacted since Another factor that is temporarily expanding the deficit is the cost of operations in Iraq and Afghanistan.

Significant as these factors have been in pumping up near-term deficits, they are not the most problematic aspect of the structural deficit. Of more concern is the projected growth of the three largest entitlement programs: Social Security, Medicare and Medicaid. The basic facts are a matter of arithmetic, not ideology. Two factors stand out: demographics and health care costs. Over the next 25 years, the number of Americans aged 65 and up is expected to jump from 13 percent of the population to 20 percent.

This alone will drive up the cost of the big three entitlement programs, which already comprise 42 percent of all federal spending. Demographic change, however, is only part of the problem. For several decades, health care costs have consistently outpaced economic growth. If this phenomenon persists, it will greatly compound the growing fiscal pressure. In short, there will be many more seniors consuming a product health care that tends to grow faster on a per-beneficiary basis than economic growth.

According to CBO, 64 percent of the cost growth for these three programs through is attributable to population aging and the remaining 36 percent to rising health care costs. Borrowing our way through this is not a viable option because the rising cost of Social Security, Medicare and Medicaid is not a temporary blip. It gets bigger with time. Incurring permanently rising debt would result in staggering interest costs and ultimately a total debt burden that would crush the economy. The best way to view the problem is to look at spending, revenues, deficits and debt as a share of the gross domestic product GDP over time.

Doing so provides context by showing the timing and magnitude of the problem measured against the size of the economy.

10 Myths About Government Debt

This contrasts with where we are headed under current law. Adding 5. Consider that in defense spending including war costs was 4. That means the projected cost increase of the major entitlement programs could not be fully offset even if all defense spending were eliminated. The same is true for all non-defense appropriations, which totaled 4.

Covering the added cost with new revenue would require the equivalent of an 80 percent hike in individual income taxes over the year average. Even this, however, would not stop the debt from growing as a percentage of the economy because it would not cover the cost of rising interest payments on the debt. Deficits add to spending by increasing interest costs. If all this sounds like a daunting challenge, it is.

Don’t hold your breath for a house-price crash

But it is far from a worst-case scenario. In fact, it is quite optimistic because it is based on a series of assumptions about current law that range from questionable to extremely unlikely. For example, current-law projections assume that major tax cuts first enacted in and on a temporary basis will expire on schedule at the end of and that no further relief will be granted from the Alternative Minimum Tax AMT.

These assumptions produce a revenue windfall that neither political party seems prepared to accept. On the spending side, the current-law baseline assumes that appropriations, including defense, will grow no faster than inflation; that Medicare physician reimbursements will be cut by about 30 percent in the coming years; and that the provisions of the health care reform bill Affordable Care Act, or ACA will be fully implemented and effective.

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Altering these assumptions to better reflect continuation of current policy rather than strict application of current law reveals an even more troubling outlook. Because spending is higher and revenues are lower in this scenario, the impact of interest costs on the debt is even more devastating, adding 7. In other words, absent change, the structural deficit under current policies produces a vicious cycle of higher deficits, debt and interest costs that spirals upward in perpetuity.

No plausible level of economic growth can change this dynamic. It requires a legislated solution. The most basic reason to be concerned about the structural deficit is that it is projected to grow faster than the economy.

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Even assuming a strong economy i. Eventually, the debt burden would become too great to bear. Although it is impossible to say exactly when that would happen, it would be foolish to risk finding out. For one thing, deficits tend to divert savings away from more productive investments in the growth capacity of the economy.

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