Does The Deficit Matter?

“Number one, we inherited a $1.3 trillion deficit. …That wasn’t me.”

-President Barack Obama 

For almost a decade, one of the most impactful economic and fiscal issues of our time has simply been ignored. At best, it has been the elephant in the room that nobody wants to acknowledge, but everybody knows is there: By the end of this year, the United States government will have an estimated $1.84 trillion budget deficit. That forecast, released Monday by the White House, represents nearly 13% of GDP. Simply put, as a nation we owe more than we have–substantially more. This debt is damaging the economy, increasing U.S. risk abroad, and placing a great burden on future generations. Leaders from both parties are complicit, and President Obama’s newly proposed budget shows little regard for the weight of the deficit.

The foundation for the present deficit was forged during the Bush Administration. When President Bush took office in 2001, he inherited a $128 billion budget surplus, one of the shining achievements of the Clinton Administration (or at least of the Congress he led). At the end of the federal budget year for 2008, the Congressional Budget Office reported a deficit of $438 billion, representing the fastest eight year deficit growth in the history of the country. The Bush Administration was hurt by the post-9/11 recession, which greatly impacted tax revenues, as well as massive spending on the Iraq War. However, a huge portion of the deficit was controllable, as a small majority came from costly congressional spending. Expensive programs like No Child Left Behind and Medicare drug supplementation, combined with President Bush’s reluctance to veto Republican earmarks on social programs, created an environment of spending far from fiscal conservatism.

President Bush’s successor, Barack Obama, has decided to double down on that debt.  He recently pushed through the $787 billion spending stimulus and signed a $410 billion omnibus spending bill.  His bailouts of the auto, financial, and housing industries are yet to have a final price tag, but most analysts expect it to be upwards of $250 billion. Finally, his recently proposed $3 trillion budget widens non-wartime government spending to levels not seen since Lyndon Johnson’s Great Society.  Many analysts now expect the deficit to double by 2010. Obama has responded to critics of his wild spending by saying he will gain $17 billion in savings from his budget by cutting waste in weapons systems and education. The cuts in those 121 programs, however, amount to less than one-half of 1 percent of the total budget for 2010.

The question then arises, if both administrations have simply embraced the deficit, does it really matter? Unquestionably. When a government has a deficit, it must raise money to pay for its spending initiatives, and each step in that process has potentially devastating results. There are three ways that the U.S. government funds its debt and spending initiatives: 1. Increased debt to foreign countries; 2. Higher taxes; 3. Printing of money.

First, one of the most commonly used revenue generators is the sale of U.S. debt to foreign nations. The current national debt stands at $10.6 trillion, meaning the U.S. owes close to 75% of its current GDP to foreign nations. This should be worrisome. When a foreign nation holds a substantial amount of U.S. debt, it increases its economic and financial leverage over the U.S., especially when so deeply entrenched in treasury bonds. This gives a nation like China (which now holds close to $1 trillion in U.S. debt) tremendous leverage in the U.S. financial system, as a massive sell-off of government debt would lead to hyper-inflation, immediate  revenue loss, and wide-spread instability in the market. This financial weapon may be the most potent in future questions of national security.

Second, the government can generate revenue through increased taxation on its citizens. Raising taxes pulls money from the private sector into the government revenue stream, and temporarily provides funding for a variety of spending initiatives. The problem here, however, is that a higher tax rate pulls more money out of the economy, where it can be consumed, saved, or invested, and into the government, where a true marketplace does not exist. The more money the government charges businesses and consumers to invest, the less they will invest. The more money the government takes from consumers’ earned income, the less those consumers have to spend. As a result, consumers have less money to pour into businesses, which create jobs and quality products, and businesses have less money to invest in their own development.

The final option to finance government debt is for the treasury to print money.  This is a unique power reserved by the federal government (local governments and states cannot print money, and therefore must declare bankruptcy when they cannot pay back their debt), and is perhaps the most frequently used of all the options. In small doses, printing money can provide a healthy level of monetary supply for an economy. However, as this process accelerates to meet the demands of increased debt and spending, hyper-inflation results. The more money circulating in the economy, the less each dollar is worth. As this imbalance grows, the value of the money taxpayers worked so hard to earn falls rapidly, and consumption again stalls.

The bottom line is that the budget deficit matters both in the present and the future. A balanced budget is indicative of a prudent government and a healthy economy. A deficit damages economic growth and threatens national security.

The solution to the deficit problem is simple: fiscal responsibility. This means reigning in spending, aggressively eliminating earmarks and pork, and shrinking government bureaucracy. We have gone nearly a decade without fiscal responsibility, and past Administrations, from Reagan to Clinton, proved that economic prosperity comes with fiscal conservatism. Our current exposure will only lead to greater economic deceleration, increased leverage from foreign nations, and market instability. We can no longer ignore the elephant in the room.

-Matt Benchener from TruPolitics.net