Hello again! For today’s installment we will look at a theory that is popular among Liberals, and that is to tax the rich more. I will need to do some more estimates on this one because like with the corporate tax data, I do not have access to the detailed 2010 income tax figures as they have not yet been published by the IRS yet (the most recent year published for income taxes was 2008). But income taxes were a little simpler to figure out as deduction and tax credit rates do not change much from year to year and the tax rates did not change from 2008 to 2010. So assuming the break down of percentages of who paid income taxes in 2008 did not change much, here is the breakdown of the $898 billion received in income taxes in 2010:
Those who made less than $49,999 a year paid on average 11.7% of their taxable income, which amounted to 109.5 billion or 12.2% of all income tax revenue.
Those who made between $50,000 and $199,999 a year paid on average 16.2% of their taxable income, which amounted to 373.5 billion or 41.6% of all income tax revenue.
Those who made more than $200,000 a year paid on average 25.7% of their taxable income, which amounted to 419.3 billion or 46.7% of all income tax revenue.
For my analysis I am going to consider anyone who makes more that $200,000 a year “rich” because these returns only made up about 5% of all tax returns in 2008, so I figured that if you made more money that 95% of the tax payers that was a good indication of being pretty well off.
To cover the national deficit in 2010 we would of had to raise income taxes on the top 5% of wealthiest Americans by 400% or in other words we would have to increase the top three tax brackets from 28%, 33% and 35%* to 112%, 132% and 140%. Since it is mathematically impossible to tax someone at a rate higher than 100% that means that we cannot balance the budget based on purely raising tax rates on the rich. Even if we rewrote the tax laws to eliminate all deductions and tax credits for those who made more that $199,999 a year it would be impossible because you would need to tax the income of the rich at a rate of 102%.
So balancing the budget by taxing the rich was not possible in 2010 but what would a tax hike on those who make more than $200,000 accomplish? A substantial tax increase of 33%, or other words about 34.1% of their taxable income after tax credits would decrease the federal deficit by $136.8 billion or 10.5 percent.
So what is the verdict? Without a major over hall of the tax code, a tax hike for the rich cannot balance the federal budget and even a higher tax increase of 33% would only make minor gains on balancing the budget.
By the numbers:
Percentage this idea could reduce the federal budget deficit by: 10.5%
Total dollar amount this idea could cut the deficit by: $136.8 billion
*There is an interesting discrepancy to note here. How is it that the rich pay on average 25.7% of their taxable income but the top tax brackets are 28%, 33% and 35%? There are two reasons and they both have to do with current tax law. First is partly because the way tax brackets work and secondly it is mostly because how capital gains (money made from stocks, bonds and interest-bearing accounts) are taxed. I will go into this in more detail in my “flat tax” section.
Tuesday, April 26, 2011
Wednesday, April 20, 2011
Part VI
Balancing the budget by eliminating government waste.
This idea is a popular one that gets a lot of attention in the news and gets traction among Conservative, Moderate, and Liberal politicians alike (the major difference is which government functions each group wants to put under the microscope). We have all heard news stories about people defrauding the government, wasted government money on foolish projects, or government workers abusing privileges. When you hear these stories it can seem like an astronomical amount of money is being wasted. But if we could end (or even severely curtail) government waste, fraud, and abuse what effect would it actually have on the budget?
Before we can crack open the books we have to set some ground rules. Government budgets are open to the public but no program or agency has a budget category called “wasteful spending” (please no jokes from Libertarians). So we have to define what is wasteful spending? For my purposes I am not going to consider whether money that is spent on a program that I deem worthwhile a determination of whether or not it was wasted because that is subjective. The definition I will use for waste will be whether the money was spent on something other than what it was intended for. Even with that definition, the exact amount is a matter of debate. But I did a little research and found a government website called http://www.paymentaccuracy.gov/. It is a public information site that shows, based on internal government review, how much money federal agencies and programs improperly pay out to contractors, businesses, and individuals. These improper payments are due to clerical errors, administrative mistakes, and fraud. The statistics published for 2010 showed that the federal government over paid contractors, businesses and individuals by 5.49%, but not all of this money is wasted. It is possible for the government to reclaim overpayments (by prosecution in case of fraud or people voluntarily paying it back in cases of clerical error) the government has averaged an 80.6% reclaim rate since 2004. So if we figure the government reclaimed 80% of overpaid funds in 2010, that means that in the end, the government overpaid contractors, businesses, and individuals by 1.09 % (plus the administrative cost to get the money back).
Now these statistics are interesting, but they do not accurately tell us how much money the government actually wastes. This is because these statistics are only dealing with agencies and programs that directly pay money out, and do not reflect any poorly spent funds or inefficiencies. But I do think these numbers give us a ballpark figure of what percentage of funding is difficult to track in a large organization like the federal government. So let's assume for a moment that 5.5% of government funding across the board is lost due to waste, fraud, and abuse. Now let's assume that in 2010 Congress and the Presidency instituted sweeping regulations and policy reform that reduced waste, fraud, and abuse and increased efficiency to the point that the federal government was able to reduce their costs by 5.5% without losing any functionality (with the exception of the interest on the national debt because that amount can’t be reduced by efficiency). If that were the case the cost of government spending would have been reduced by $167 billion dollars and that would have in turn, reduced the deficit to $1,126 billion a year.
So what is the verdict? Well the fact of the matter is, waste and inefficiency are part of human nature. There will always be some degree of human error, incompetence, or people trying to cheat the system. So I think it is fair to say that even if we could set up perfect policies and regulations, we could only reduce waste, fraud, and abuse by so much, because human beings run the programs. But hypothetically speaking if we could achieve the extremely optimistic goal to reduce costs by 5.5% (or the total amount of money the government is willing to acknowledge was miss spent in 2010) through increased efficiency, the lion’s share of the deficit would stay intact. To put things in perspective if we go back to our "federal government as a household" budget (see Part II), that family would have trimmed their bills by $334 a month. Now this sounds great, but this family still has $2,254 in bills each month that they cannot pay.
So what does this mean? The budget cannot be balanced by relying on cutting government waste as its primary focus. The reason is, that even if the government were wildly successful at rooting out waste it would only reduce the defect by 12.9%. But even more problematic with the idea of reducing government waste is how do we even do it in the first place and how can we predict how effective our efforts will be? The question is a bit like how do we reduce crime or poverty? There are lots of ideas out there to deal with these types of problems, but it is difficult to quantify how effective a program will be. For example a police department can propose a plan to reduce crime, but it cannot propose a plan to reduce household robberies by 23%. It gets even more complex with cutting waste because if you are spending $1 on additional oversight for every $5 you cut in waste your net gain is only 80% of the waste you cut. So true savings are very hard to calculate until after the fact.
Ultimately it is important to push our government to be more efficient because it can only help and it would be a step in the right direction when it comes to balancing the budget. However, I think that the important thing to take away here is that if a politician is telling you that they will balance the budget without cutting a single program or raising any taxes, they are trying to sell you snake oil.
So by the numbers:
Percentage this idea could reduce the federal budget deficit by: N/A (My guess is no more than 12.9%)*
Total dollar amount this idea could cut the deficit by: N/A (My guess is no more than $167 billion)*
*Since there is no official number on the amount of government waste and there is no way to know how effective reform would be at eliminating waste it is hard to quantify how effective this strategy would be at cutting the deficit. But it seems it would be unlikely that it would be more than $167 billion total waste according to the available evidence (and a little bit of estimation on my part) and even if all this waste could be eliminated it would only take care of 12.9% of the deficit. But since my analysis relied a little more estimation than I am comfortable with, I am not going to consider these numbers as certain.
This idea is a popular one that gets a lot of attention in the news and gets traction among Conservative, Moderate, and Liberal politicians alike (the major difference is which government functions each group wants to put under the microscope). We have all heard news stories about people defrauding the government, wasted government money on foolish projects, or government workers abusing privileges. When you hear these stories it can seem like an astronomical amount of money is being wasted. But if we could end (or even severely curtail) government waste, fraud, and abuse what effect would it actually have on the budget?
Before we can crack open the books we have to set some ground rules. Government budgets are open to the public but no program or agency has a budget category called “wasteful spending” (please no jokes from Libertarians). So we have to define what is wasteful spending? For my purposes I am not going to consider whether money that is spent on a program that I deem worthwhile a determination of whether or not it was wasted because that is subjective. The definition I will use for waste will be whether the money was spent on something other than what it was intended for. Even with that definition, the exact amount is a matter of debate. But I did a little research and found a government website called http://www.paymentaccuracy.gov/. It is a public information site that shows, based on internal government review, how much money federal agencies and programs improperly pay out to contractors, businesses, and individuals. These improper payments are due to clerical errors, administrative mistakes, and fraud. The statistics published for 2010 showed that the federal government over paid contractors, businesses and individuals by 5.49%, but not all of this money is wasted. It is possible for the government to reclaim overpayments (by prosecution in case of fraud or people voluntarily paying it back in cases of clerical error) the government has averaged an 80.6% reclaim rate since 2004. So if we figure the government reclaimed 80% of overpaid funds in 2010, that means that in the end, the government overpaid contractors, businesses, and individuals by 1.09 % (plus the administrative cost to get the money back).
Now these statistics are interesting, but they do not accurately tell us how much money the government actually wastes. This is because these statistics are only dealing with agencies and programs that directly pay money out, and do not reflect any poorly spent funds or inefficiencies. But I do think these numbers give us a ballpark figure of what percentage of funding is difficult to track in a large organization like the federal government. So let's assume for a moment that 5.5% of government funding across the board is lost due to waste, fraud, and abuse. Now let's assume that in 2010 Congress and the Presidency instituted sweeping regulations and policy reform that reduced waste, fraud, and abuse and increased efficiency to the point that the federal government was able to reduce their costs by 5.5% without losing any functionality (with the exception of the interest on the national debt because that amount can’t be reduced by efficiency). If that were the case the cost of government spending would have been reduced by $167 billion dollars and that would have in turn, reduced the deficit to $1,126 billion a year.
So what is the verdict? Well the fact of the matter is, waste and inefficiency are part of human nature. There will always be some degree of human error, incompetence, or people trying to cheat the system. So I think it is fair to say that even if we could set up perfect policies and regulations, we could only reduce waste, fraud, and abuse by so much, because human beings run the programs. But hypothetically speaking if we could achieve the extremely optimistic goal to reduce costs by 5.5% (or the total amount of money the government is willing to acknowledge was miss spent in 2010) through increased efficiency, the lion’s share of the deficit would stay intact. To put things in perspective if we go back to our "federal government as a household" budget (see Part II), that family would have trimmed their bills by $334 a month. Now this sounds great, but this family still has $2,254 in bills each month that they cannot pay.
So what does this mean? The budget cannot be balanced by relying on cutting government waste as its primary focus. The reason is, that even if the government were wildly successful at rooting out waste it would only reduce the defect by 12.9%. But even more problematic with the idea of reducing government waste is how do we even do it in the first place and how can we predict how effective our efforts will be? The question is a bit like how do we reduce crime or poverty? There are lots of ideas out there to deal with these types of problems, but it is difficult to quantify how effective a program will be. For example a police department can propose a plan to reduce crime, but it cannot propose a plan to reduce household robberies by 23%. It gets even more complex with cutting waste because if you are spending $1 on additional oversight for every $5 you cut in waste your net gain is only 80% of the waste you cut. So true savings are very hard to calculate until after the fact.
Ultimately it is important to push our government to be more efficient because it can only help and it would be a step in the right direction when it comes to balancing the budget. However, I think that the important thing to take away here is that if a politician is telling you that they will balance the budget without cutting a single program or raising any taxes, they are trying to sell you snake oil.
So by the numbers:
Percentage this idea could reduce the federal budget deficit by: N/A (My guess is no more than 12.9%)*
Total dollar amount this idea could cut the deficit by: N/A (My guess is no more than $167 billion)*
*Since there is no official number on the amount of government waste and there is no way to know how effective reform would be at eliminating waste it is hard to quantify how effective this strategy would be at cutting the deficit. But it seems it would be unlikely that it would be more than $167 billion total waste according to the available evidence (and a little bit of estimation on my part) and even if all this waste could be eliminated it would only take care of 12.9% of the deficit. But since my analysis relied a little more estimation than I am comfortable with, I am not going to consider these numbers as certain.
Monday, April 18, 2011
Part V
Welcome back! I had a few hiccups in the data on this one but I think we can run with it, I thought would explain the problem before we start. The IRS has not released their data on corporate tax receipts for 2010 (I have the total amount from the Government Printing Office, but not the details) so we have to get a little creative to approximate the specifics. I looked at the most recent available year which was 2007, to work out the percentages (I figured they would be similar since overall corporate tax rates have not changed since 2007), but as it turns out even though the tax rate has not changed in a while the tax credits and deductions change quite a bit from year to year so I extended my data set to get a more accurate picture. Based on the averages, over the past five years, US corporations have been able to deduct 49 percent of their total profits. Of the non-deducted profits, corporations pay 35 percent in taxes. Out of what they pay in taxes, 24.2 percent is refunded back to the corporation in the form of tax credits.
To break down how this works let's say that that I ran a lemonade stand that was taxed the same way that US corporations are. Over the course of the summer I earned $100. When I look at my expenses at the end of the summer I see that I paid $40 for materials to make my stand and for the ingredients and $9 for a city permit to sell lemonade. These expenses are deductable under federal law so I can subtract them from my overall profits and report that I made $51 (Notice I did not deduct the $20 I spent at the arcade because that would be tax fraud). So now I owe 35% of $51, which is $17.85. But I am a clever accountant and I filed for a small business tax credit which is $3 and the sustainable resources tax credit because all my lemonade cups were made from recycled paper, which is $1.31. So when it is all said and done I will owe $16.54 to the IRS (of lemonade stands) at the end of the summer.
So moving from the world of lemonade stands to our corporate world, in 2010 the total amount of tax revenue from corporate taxes was $191 billion (this number is official and is from the Government Printing Office, who publishes the historical annual budgets). Assuming this number is consistent with the average of the past five years, that means there were about $255 billion in owed taxes before tax credits were taken into account, $729 billion in taxable income (the difference between taxable and untaxable profits is very similar to individual income taxes after untaxable income and deductions are factored in) and $1,487 billion in total profits.
Based on these numbers, to cover the deficit we would have to tax corporations doing business in the US 7 times the amount we do now. Not only would this be politically impossible to do it would be mathematically impossible as well. It is impossible to raise the necessary amount of money as there was only $729 billion in corporate taxable income in 2010. Even an impossible 100% tax rate would only cover 55.3% of the deficit.
So a corporate tax hike could not have balanced the budget in 2010 as the deficit was still higher than all the taxable income of America’s corporations combined. To gain any more revenue from corporate taxes it would require that the tax code be rewritten to be able to tax the necessary 88.5% of total corporate profits and this would most likely be a political and economic disaster.
But that being said, what could realistically be accomplished by an increase in corporate taxes? I am not an economist so I cannot factor in what a raise in taxes would do to economic growth, but assuming we could change the tax rate without substantially effecting corporate incomes. I will look at three options.
1. Eliminating all corporate tax credits.
2. Increase federal tax rates to be comparable with the highest corporate tax rates of other industrialized nations.
3. Increase federal tax rates to be comparable with the highest corporate tax rates of other industrialized nations and eliminate all corporate tax credits.
1. Eliminating all corporate tax credits.
By my loose estimates about $64 billion in tax credits were handed out in 2010 (It was $65 billion in 2007 which is the most recent year I can confirm). Corporate tax credits are a heavily debated issue, some people call these tax credits corporate welfare, some say they give unfair advantages to certain industries, and some say they encourage economic growth and give businesses incentives to expand and hire new employees. I cannot say whether tax credits are good or bad but I can say that eliminating them would do little to balance the budget. Cutting $64 billion in spending would only reduce the deficit by 5.6%.
2. Increase federal tax rates to be comparable with the highest taxes rates of other industrialized nations.
The US corporate tax rate is 35% of taxable income for corporations that make more than $18,333,333 . There is a graduated tax scale for businesses that make less that than that amount in a year but their taxes make up less than 5% of corporate tax revenue. After tax credits and deductions are figured in, the amount in taxes the average US corporations pays is 34.9 percent. So for simplicity sake I am going to say the tax rate is 35%.
Now you may have often heard that the US has the highest corporate tax rate in the world. This is mostly true. We have the highest overall tax rate when you factor in federal, state, and local corporate taxes (in some areas it is over 50%). When it comes to just the national rates we are the second highest. Japan is the highest with 40% (local taxes add about 0.6%*). So if we were to tax US companies at 40% we would raise an additional $27 billion (2.3 percent of the deficit), even less than if we cut corporate tax credits.
3. Increase federal tax rates to be comparable with the highest taxes rates of other industrialized nations and eliminate all corporate tax credits.
This would raise corporate tax revenue from the current $191 billion to $282 billion and reduces the current deficit by 7%.
So what is the verdict? What would happen if we hike corporate taxes and eliminated all corporate tax credits?
By the numbers:
Percentage this idea could reduce the federal budget deficit by: 7%
Total dollar amount this idea could cut the deficit by: $91 billion
* I pulled this number from a New York Times article (http://www.nytimes.com/2010/12/14/business/global/14yen.html) and Wikipedia supports this figure. I tried to verify it independently but oddly enough Japan’s National Tax Agency publishes all their statistics in Japanese, which I cannot read.
To break down how this works let's say that that I ran a lemonade stand that was taxed the same way that US corporations are. Over the course of the summer I earned $100. When I look at my expenses at the end of the summer I see that I paid $40 for materials to make my stand and for the ingredients and $9 for a city permit to sell lemonade. These expenses are deductable under federal law so I can subtract them from my overall profits and report that I made $51 (Notice I did not deduct the $20 I spent at the arcade because that would be tax fraud). So now I owe 35% of $51, which is $17.85. But I am a clever accountant and I filed for a small business tax credit which is $3 and the sustainable resources tax credit because all my lemonade cups were made from recycled paper, which is $1.31. So when it is all said and done I will owe $16.54 to the IRS (of lemonade stands) at the end of the summer.
So moving from the world of lemonade stands to our corporate world, in 2010 the total amount of tax revenue from corporate taxes was $191 billion (this number is official and is from the Government Printing Office, who publishes the historical annual budgets). Assuming this number is consistent with the average of the past five years, that means there were about $255 billion in owed taxes before tax credits were taken into account, $729 billion in taxable income (the difference between taxable and untaxable profits is very similar to individual income taxes after untaxable income and deductions are factored in) and $1,487 billion in total profits.
Based on these numbers, to cover the deficit we would have to tax corporations doing business in the US 7 times the amount we do now. Not only would this be politically impossible to do it would be mathematically impossible as well. It is impossible to raise the necessary amount of money as there was only $729 billion in corporate taxable income in 2010. Even an impossible 100% tax rate would only cover 55.3% of the deficit.
So a corporate tax hike could not have balanced the budget in 2010 as the deficit was still higher than all the taxable income of America’s corporations combined. To gain any more revenue from corporate taxes it would require that the tax code be rewritten to be able to tax the necessary 88.5% of total corporate profits and this would most likely be a political and economic disaster.
But that being said, what could realistically be accomplished by an increase in corporate taxes? I am not an economist so I cannot factor in what a raise in taxes would do to economic growth, but assuming we could change the tax rate without substantially effecting corporate incomes. I will look at three options.
1. Eliminating all corporate tax credits.
2. Increase federal tax rates to be comparable with the highest corporate tax rates of other industrialized nations.
3. Increase federal tax rates to be comparable with the highest corporate tax rates of other industrialized nations and eliminate all corporate tax credits.
1. Eliminating all corporate tax credits.
By my loose estimates about $64 billion in tax credits were handed out in 2010 (It was $65 billion in 2007 which is the most recent year I can confirm). Corporate tax credits are a heavily debated issue, some people call these tax credits corporate welfare, some say they give unfair advantages to certain industries, and some say they encourage economic growth and give businesses incentives to expand and hire new employees. I cannot say whether tax credits are good or bad but I can say that eliminating them would do little to balance the budget. Cutting $64 billion in spending would only reduce the deficit by 5.6%.
2. Increase federal tax rates to be comparable with the highest taxes rates of other industrialized nations.
The US corporate tax rate is 35% of taxable income for corporations that make more than $18,333,333 . There is a graduated tax scale for businesses that make less that than that amount in a year but their taxes make up less than 5% of corporate tax revenue. After tax credits and deductions are figured in, the amount in taxes the average US corporations pays is 34.9 percent. So for simplicity sake I am going to say the tax rate is 35%.
Now you may have often heard that the US has the highest corporate tax rate in the world. This is mostly true. We have the highest overall tax rate when you factor in federal, state, and local corporate taxes (in some areas it is over 50%). When it comes to just the national rates we are the second highest. Japan is the highest with 40% (local taxes add about 0.6%*). So if we were to tax US companies at 40% we would raise an additional $27 billion (2.3 percent of the deficit), even less than if we cut corporate tax credits.
3. Increase federal tax rates to be comparable with the highest taxes rates of other industrialized nations and eliminate all corporate tax credits.
This would raise corporate tax revenue from the current $191 billion to $282 billion and reduces the current deficit by 7%.
So what is the verdict? What would happen if we hike corporate taxes and eliminated all corporate tax credits?
By the numbers:
Percentage this idea could reduce the federal budget deficit by: 7%
Total dollar amount this idea could cut the deficit by: $91 billion
* I pulled this number from a New York Times article (http://www.nytimes.com/2010/12/14/business/global/14yen.html) and Wikipedia supports this figure. I tried to verify it independently but oddly enough Japan’s National Tax Agency publishes all their statistics in Japanese, which I cannot read.
Saturday, April 16, 2011
Part IV
Before I dive into my budget analyses, there is some explaining I should do first. The Federal budget is a complex beast with lots of different kinds of programs that are funded in different ways. But broadly speaking there are three types of government spending: “Discretionary,” “Mandatory” and “Debt." You may have heard about these in the news, and if you have ever wondered what they mean than today is your lucky day.
Discretionary is the most straightforward. This is the amount that Congress gives Federal Agencies and programs to run them for that year. It is a fixed amount and the agency must make the funds last until the next year (unless the agency petitions Congress for more money). Think of this as your grocery bill when you budget. You set aside amount of money each month for groceries, you decided the amount based on your needs and if the end of the month rolls around and the amount money you set aside wasn’t enough you have to decide whether to live on peanut butter and jelly sandwiches until your next pay day or spend more than you planned on, but in either case the decision is up to you. This is the simplest part of the budget for Congress to control. If Congress wanted to increase or decrease an agency’s or program's budget one year, they can, when they draw up a budget to submit to the President to sign. This type of spending made up about 38 percent of the national budget in 2010.
Mandatory is a little more complex. Mandatory spending is spending that is based on expenses that the government is obligated to pay based on laws it has already passed. Congress cannot change these amounts without changing laws that are already on the books. Think of this as your phone bill. You don’t “decide” how much your phone bill is or the rates you pay, the amount is based on the phone plan you signed up for and how much you use it and once the bill comes at the end of the month your cannot “decide” that you do not want to pay it, you could change your plan at the end of the month, but you would still have to pay your bill that you received under the old plan. An example of this kind of spending is Social Security retirement benefits or the child income tax credit. Congress does not decide how much it will spend on Social Security or a child income tax credit each year. Congress passed laws that set out how much Social Security will pay or how much tax credit will be given for each child. After that, the amount is calculated though out the year based on the criteria set forth by Congress. This type of spending is harder to change because it requires a change of law so it is not as simple to alter. This type of spending made up about 56 percent of the national budget in 2010.
The last type is national debt interest. This is pretty simple, this is the amount that the government has to pay on securities that have matured and the amount with interest that was borrowed from government trusts. This amount is not decided by Congress it is simply the amount that needs to be paid to keep the US in good standing as a debtor and keep government trust solvent. Think of this as the minimum payment on a credit card, if you do not make the payment they will close your account. This type of spending made up about 5 percent of the national budget in 2010. Now it is worth noting that the Federal government has a lot interest bearing trust of its own, for example, when you pay taxes throughout the year the government invests part of it in securities, then before you get your tax refund the government cashes out the security, pays you back the amount of the original overpayment but keeps the interest (clever huh?). The government uses the interest it receives on the securities it owns to pay its own debts. If the government did not do this debt interests would require more than twice the amount of tax dollars that it needs now (the actual percentage of the overall budget that goes to debt interest is about 12 percent, but tax revenue only needs to cover about 5 percent. The rest is covered by government investment profits).
These are the three types of spending. Many times when you read about the budget, or hear about it in the news they only talk about discretionary because that is all that the congress has direct control over. This can be a little deceptive because the majority of spending is not discretionary but is mandatory. For my analysis of the budget I will be considering the budget as a whole as it is impossible to balance the budget unless you consider the whole budget. This can be a little tricky to calculate at times because many agencies received both discretionary and mandatory funding. For example, the Department of Defense gets a fixed amount each year to run operations (i.e. discretionary funds) but it also receives funds to pay retired members of the military (i.e. mandatory funds). My goal is to analyze various ways to balance the budget and in each case I want to stay in the realms of what is realistic and legally possible (in other words real solutions and not catch phrases and slogans). So I will be drawing a distinction between discretionary and mandatory spending at times because it would require different action to change each one. Hopefully with this explanation it will help it make sense.
My next post will be the start of my analysis of plans to balance the budget. As I go through, there is a magic number to keep in mind, 1,293 billion, that is how big the deficit was in 2010. So each idea will be measured in how effective it would be at reducing this number.
Discretionary is the most straightforward. This is the amount that Congress gives Federal Agencies and programs to run them for that year. It is a fixed amount and the agency must make the funds last until the next year (unless the agency petitions Congress for more money). Think of this as your grocery bill when you budget. You set aside amount of money each month for groceries, you decided the amount based on your needs and if the end of the month rolls around and the amount money you set aside wasn’t enough you have to decide whether to live on peanut butter and jelly sandwiches until your next pay day or spend more than you planned on, but in either case the decision is up to you. This is the simplest part of the budget for Congress to control. If Congress wanted to increase or decrease an agency’s or program's budget one year, they can, when they draw up a budget to submit to the President to sign. This type of spending made up about 38 percent of the national budget in 2010.
Mandatory is a little more complex. Mandatory spending is spending that is based on expenses that the government is obligated to pay based on laws it has already passed. Congress cannot change these amounts without changing laws that are already on the books. Think of this as your phone bill. You don’t “decide” how much your phone bill is or the rates you pay, the amount is based on the phone plan you signed up for and how much you use it and once the bill comes at the end of the month your cannot “decide” that you do not want to pay it, you could change your plan at the end of the month, but you would still have to pay your bill that you received under the old plan. An example of this kind of spending is Social Security retirement benefits or the child income tax credit. Congress does not decide how much it will spend on Social Security or a child income tax credit each year. Congress passed laws that set out how much Social Security will pay or how much tax credit will be given for each child. After that, the amount is calculated though out the year based on the criteria set forth by Congress. This type of spending is harder to change because it requires a change of law so it is not as simple to alter. This type of spending made up about 56 percent of the national budget in 2010.
The last type is national debt interest. This is pretty simple, this is the amount that the government has to pay on securities that have matured and the amount with interest that was borrowed from government trusts. This amount is not decided by Congress it is simply the amount that needs to be paid to keep the US in good standing as a debtor and keep government trust solvent. Think of this as the minimum payment on a credit card, if you do not make the payment they will close your account. This type of spending made up about 5 percent of the national budget in 2010. Now it is worth noting that the Federal government has a lot interest bearing trust of its own, for example, when you pay taxes throughout the year the government invests part of it in securities, then before you get your tax refund the government cashes out the security, pays you back the amount of the original overpayment but keeps the interest (clever huh?). The government uses the interest it receives on the securities it owns to pay its own debts. If the government did not do this debt interests would require more than twice the amount of tax dollars that it needs now (the actual percentage of the overall budget that goes to debt interest is about 12 percent, but tax revenue only needs to cover about 5 percent. The rest is covered by government investment profits).
These are the three types of spending. Many times when you read about the budget, or hear about it in the news they only talk about discretionary because that is all that the congress has direct control over. This can be a little deceptive because the majority of spending is not discretionary but is mandatory. For my analysis of the budget I will be considering the budget as a whole as it is impossible to balance the budget unless you consider the whole budget. This can be a little tricky to calculate at times because many agencies received both discretionary and mandatory funding. For example, the Department of Defense gets a fixed amount each year to run operations (i.e. discretionary funds) but it also receives funds to pay retired members of the military (i.e. mandatory funds). My goal is to analyze various ways to balance the budget and in each case I want to stay in the realms of what is realistic and legally possible (in other words real solutions and not catch phrases and slogans). So I will be drawing a distinction between discretionary and mandatory spending at times because it would require different action to change each one. Hopefully with this explanation it will help it make sense.
My next post will be the start of my analysis of plans to balance the budget. As I go through, there is a magic number to keep in mind, 1,293 billion, that is how big the deficit was in 2010. So each idea will be measured in how effective it would be at reducing this number.
Thursday, April 14, 2011
Part III
How is that for suspense? Well, it really is not that exciting but it is a serious issue. A problem with having a large debt is that we have to keep up the interest payments so we remain a profitable investment and people will keep buying securities. It is like making the minimum payment on a credit card so they won't close the account. This is really expensive. Every dollar we spend on paying the interest on a matured security is a dollar that could have been spent on something we need. In 2010 the US government paid 413 billion dollars in interest. To put that in perspective that amount that is the same amount of money that it took to run The Department of Education, The Department of Energy, NASA, Homeland Security, The Department of Veterans Affairs, The Department of Transportation, The State Department, The Small Business Administration, and The National Science Foundation all combined. Another way of looking at it is that if we did not have to pay this interest every person who played income taxes in 2010 could have cut their tax bill by 45.9%.
So, as you can see it is both costly and dangerous for our nation to have a large and growing debt. But odds are you knew that before you started reading this blog. The bigger question is how do we fix this, how do we pay down the debt? Simply put it is the same way any of us pay down our own debts, the government simply needs to balance the budget, or in other words generate as much revenue as it spends each year. This is easier said than done and there are a lot of strong opinions about how it should be done and chances are you have your own thoughts on the topic. Well, this is the meat and potatoes of this blog. There are a lot of theories out there about how to balance the budget and what I want to do is look at some of these theories and run the numbers and see how they add up.
Here is a list of some popular ideas on how to balance the budget. I am going to examine each scenario to see how effective they are and to what extent they would need to be implemented to have any real impact. My goal here is to remain apolitical and stick to what I can back with numbers. Over the next several blog posts I will look at these scenarios and see what the numbers say.
Plans to balance the budget:
Tax corporations more
Reduce government waste
Raise taxes on the rich
Grow the economy
Cut government (non-military) spending
Cut the military’s budget
Introduce a “flat tax”
Reform Social Security
Reform Health Care
These are the theories I am going to deconstruct. If there are any you would like me to add to the list feel free to leave a comment and I will do my best.
So, as you can see it is both costly and dangerous for our nation to have a large and growing debt. But odds are you knew that before you started reading this blog. The bigger question is how do we fix this, how do we pay down the debt? Simply put it is the same way any of us pay down our own debts, the government simply needs to balance the budget, or in other words generate as much revenue as it spends each year. This is easier said than done and there are a lot of strong opinions about how it should be done and chances are you have your own thoughts on the topic. Well, this is the meat and potatoes of this blog. There are a lot of theories out there about how to balance the budget and what I want to do is look at some of these theories and run the numbers and see how they add up.
Here is a list of some popular ideas on how to balance the budget. I am going to examine each scenario to see how effective they are and to what extent they would need to be implemented to have any real impact. My goal here is to remain apolitical and stick to what I can back with numbers. Over the next several blog posts I will look at these scenarios and see what the numbers say.
Plans to balance the budget:
Tax corporations more
Reduce government waste
Raise taxes on the rich
Grow the economy
Cut government (non-military) spending
Cut the military’s budget
Introduce a “flat tax”
Reform Social Security
Reform Health Care
These are the theories I am going to deconstruct. If there are any you would like me to add to the list feel free to leave a comment and I will do my best.
Wednesday, April 13, 2011
Part II
In my last post I explained how the Federal government borrows money. In this post I will explain the dangers of excessive borrowing. It is important to note that the danger is not from a government that goes into debt. It would be extremely foolish to have a government that never borrowed. All nations have cycles in their economies, even before the industrial era, nations had years of plenty and years of famine. Inevitably even the most vigilant governments with the most robust economies will have an economic down turn and thus receive less money than it spent in a given year. As I said in my last post if the government was confined to annual revenue for spending, things would be very unstable for example, imagine if one year the government had to fire 20 percent of the Army because they could not afford it, only to rehire them the next year when the economy bounced back, assuming firing 20 percent of the army did not make the problem even worse and the government cannot save the necessary amount to ride out the bad years because the amounts are so massive it would hurt the economy because it would cause deflation.
So borrowing is the way to go. But the problem with borrowing year after year is that you risk a dangerously high level of debt. So how much debt is dangerous debt? There is no solid number or percentage you can give to answer that question. But a good way to look at it is the same way we look at blood pressure. If you have elevated blood pressure you could feel more or less healthy and live a normal life, though you are at a higher risk for a heart attack or stroke, and as your blood pressure goes up so do the odds that you will have a heart attack. For many people the first time they realize they have high blood pressure is after a heart attack. Debt is very similar, as your debt goes up so does the risk for catastrophe, though there may not be many outward signs of trouble.
So are we close to a catastrophe? Well National debt is like private debt, when it comes to how much is too much. It will vary from person to person. But let's look at the US government as a household and bring down the numbers to levels that are a little easier to wrap our heads around. If the US government were a middle class household it would have a combined income of $52,888 annually with $341,064 in debt and $62,040 in a retirement account. Each month this household makes $4,324 and has $6,912 in bills including the minimum payments on their debt. As you can see this family is not living on a sustainable budget and inevitably living on this budget will have extremely negative consequences.
So what are the catastrophes our nation could face? What is the debt equivalent of a heart attack? For an individual with private debt the risks are foreclosures, bankruptcy and repossession. Fortunately this is not a possibility (China can’t just take Wyoming if we defaulted), but there are some possibilities that are very scary. Here are two heart attack scenarios.
1. Undue influence by lender nations.
This example has an interesting history lesson from when the shoe was on the other foot. During World War II the US bought a lot of securities from the UK because they were spending at huge rates due to the war. After the war the UK started paying its securities back gradually as they matured but even in the 1950’s the US still held a massive amount of British securities. In 1956 the Egyptian Government seized control of the Suez Canal, which had belonged to the British. The UK, France and Israel launched a military operation against Egypt to regain control of the Canal and overthrow the Egyptian Government. The US disapproved of this action because we were worried that the Soviets might get involved. But the US was unable to diplomatically convince the British to halt the operation. So the US took action informed the UK that if it did not halt the operation the US would sell much of its British securities (debt) on the open market under value. This would have flooded the world market with the British Pound, which would have caused massive inflation in the UK that would have made British currency worth so little that it was estimated that UK would not able to import food, oil, or coal within a week of the sell off and the UK’s economy would be in shambles. Needless to say the UK called off the invasion and without the UK’s support the French and Israeli governments followed suit.
What we did to the UK sixty years ago could happen to us today. China owns over a trillion dollars in US securities. It would be financially difficult for China, but not impossible, for them to sell off large amounts of their US securities. If they were to do this, we could see massive inflation in a matter of days. Now truth be told, it is unlikely that there would be a massive sell off any time soon, because China relies on us economically just as much on us as we rely on them. But it does not mean that they would never do it, as hard as it would be for them, if tensions ran high, it would be cheaper and easier than a war. Who would have thought in 1945 that the UK’s closest ally would threaten to destroy their entire economy 11 years later?
2. We lose our good credit rating.
As I stated in a previous post, we need to be able to sell securities (IOUs) to pay our bills as a nation, and other nations, companies and individual are willing to buy our securities because it is good and safe investment. But if it ever got the point where we were not a good or safe investment we would not be able to sell securities (or enough securities) to cover our costs. The way this would happen would be if our debt got so large that we could not keep up with the interest rate and we started defaulting on securities or even if investors perceived that we might start defaulting on securities in the future (a bad sign would be if we started selling securities to pay off other securities, that would scare off investors because eventually someone will get the short end of the stick). The effect that this would have on our nation is that without being able to run a deficit, government would have to suspend all programs it could not afford. Given the rate we borrow that would mean shutting down 37.4 percent of government functions (at current deficit levels). This would make the cuts that State Governments have had to do during the recession look small and could result in the economy crashing in a way that we have not seen since the Great Depression.
So these are pretty scary possibilities and like a heart attack we like to tell ourselves that that will never happen to us. But each year the debt grows it becomes more and more likely. There is one more consequence though and this is one is not theoretical, this one is happening right now. I will cover it in my next post.
So borrowing is the way to go. But the problem with borrowing year after year is that you risk a dangerously high level of debt. So how much debt is dangerous debt? There is no solid number or percentage you can give to answer that question. But a good way to look at it is the same way we look at blood pressure. If you have elevated blood pressure you could feel more or less healthy and live a normal life, though you are at a higher risk for a heart attack or stroke, and as your blood pressure goes up so do the odds that you will have a heart attack. For many people the first time they realize they have high blood pressure is after a heart attack. Debt is very similar, as your debt goes up so does the risk for catastrophe, though there may not be many outward signs of trouble.
So are we close to a catastrophe? Well National debt is like private debt, when it comes to how much is too much. It will vary from person to person. But let's look at the US government as a household and bring down the numbers to levels that are a little easier to wrap our heads around. If the US government were a middle class household it would have a combined income of $52,888 annually with $341,064 in debt and $62,040 in a retirement account. Each month this household makes $4,324 and has $6,912 in bills including the minimum payments on their debt. As you can see this family is not living on a sustainable budget and inevitably living on this budget will have extremely negative consequences.
So what are the catastrophes our nation could face? What is the debt equivalent of a heart attack? For an individual with private debt the risks are foreclosures, bankruptcy and repossession. Fortunately this is not a possibility (China can’t just take Wyoming if we defaulted), but there are some possibilities that are very scary. Here are two heart attack scenarios.
1. Undue influence by lender nations.
This example has an interesting history lesson from when the shoe was on the other foot. During World War II the US bought a lot of securities from the UK because they were spending at huge rates due to the war. After the war the UK started paying its securities back gradually as they matured but even in the 1950’s the US still held a massive amount of British securities. In 1956 the Egyptian Government seized control of the Suez Canal, which had belonged to the British. The UK, France and Israel launched a military operation against Egypt to regain control of the Canal and overthrow the Egyptian Government. The US disapproved of this action because we were worried that the Soviets might get involved. But the US was unable to diplomatically convince the British to halt the operation. So the US took action informed the UK that if it did not halt the operation the US would sell much of its British securities (debt) on the open market under value. This would have flooded the world market with the British Pound, which would have caused massive inflation in the UK that would have made British currency worth so little that it was estimated that UK would not able to import food, oil, or coal within a week of the sell off and the UK’s economy would be in shambles. Needless to say the UK called off the invasion and without the UK’s support the French and Israeli governments followed suit.
What we did to the UK sixty years ago could happen to us today. China owns over a trillion dollars in US securities. It would be financially difficult for China, but not impossible, for them to sell off large amounts of their US securities. If they were to do this, we could see massive inflation in a matter of days. Now truth be told, it is unlikely that there would be a massive sell off any time soon, because China relies on us economically just as much on us as we rely on them. But it does not mean that they would never do it, as hard as it would be for them, if tensions ran high, it would be cheaper and easier than a war. Who would have thought in 1945 that the UK’s closest ally would threaten to destroy their entire economy 11 years later?
2. We lose our good credit rating.
As I stated in a previous post, we need to be able to sell securities (IOUs) to pay our bills as a nation, and other nations, companies and individual are willing to buy our securities because it is good and safe investment. But if it ever got the point where we were not a good or safe investment we would not be able to sell securities (or enough securities) to cover our costs. The way this would happen would be if our debt got so large that we could not keep up with the interest rate and we started defaulting on securities or even if investors perceived that we might start defaulting on securities in the future (a bad sign would be if we started selling securities to pay off other securities, that would scare off investors because eventually someone will get the short end of the stick). The effect that this would have on our nation is that without being able to run a deficit, government would have to suspend all programs it could not afford. Given the rate we borrow that would mean shutting down 37.4 percent of government functions (at current deficit levels). This would make the cuts that State Governments have had to do during the recession look small and could result in the economy crashing in a way that we have not seen since the Great Depression.
So these are pretty scary possibilities and like a heart attack we like to tell ourselves that that will never happen to us. But each year the debt grows it becomes more and more likely. There is one more consequence though and this is one is not theoretical, this one is happening right now. I will cover it in my next post.
Tuesday, April 12, 2011
Part I
Hello again thanks for coming back. The blog is about my attempts to evaluate the problem of our nation's high national debt in the hopes that I will become a more informed voter in the process. My secondary goal is to be informative to whoever reads this and hopefully encourage them to take an interest in government and the welfare of our nation. If you follow this blog to the end (and I hope you will!) I would encourage people to post comments or ask questions but I would ask that we try to keep this politically neutral. I want to stress that I want to talk about facts and ideas, not who you should or should not vote for, or who is or who is not at fault for current difficulties. When I comes to voting I strongly encourage everyone to do it. As for who you should vote for, I do not want any advice that goes beyond: be informed, do your homework, and vote your conscience.
With that said lets dive right into it. The issues this blog is about it the national deficit and the debt that that leads to. So let's start with basics before we look at any problems or solutions.
What is the national debt?
This is the money and that the Federal government has had to borrow over the years to run government functions that they did not have revenue to cover at the time.
Why does the Federal government need to borrow money?
When the government spends more money that it has on hand it is called deficit spending. When the government does this it has to borrow to cover the expenses it cannot afford.
Why does the Federal government just not spend more than it collects in taxes?
The main reason is that the government does not really know how much it will collect in taxes until the taxes actually come in. It is a little like owning your own business. You can estimate how much money you might make in a year but you will not know the actual amount until the year is over. So the government could write up a budget that it is sure it could afford at the beginning of the year, then a recession could hit and it turns out that the tax revenue collected thought the year was not enough by the end of the year. Also it would be very hard for the government to function reliably if it had to cut and reinstate programs on annual bases depending on whether the money was there or not.
Why doesn’t the Federal government just save money in good years and draw on in bad years?
Well it does do this to a certain extent but it is actually not good for the government to save too much money. It is because of the huge amount of money the government deals with. If the government were to save the hundreds of billions, if not trillions of dollars, it would need be able to ride out a slump in the economy, let alone a major recessions, it would have a harmful effect on the economy. The reason is if the Government pulled that amount money out of the economy, through taxes, and did not return to the economy through government spending or tax refunds it would severely reduce the national money supply and lead to deflating value of the dollar with would cause wages to drop and general economic instability.
How big is the federal debt?
Last I check (April 7th 2011) the debt was $14,264,245,526,311.58
Is that a lot of money?
Yes.
How does that Federal government borrow money?
The Federal debt is not like a mortgage or credit card debt like an individual might have. With government debt the interest rate and the terms are not set by the lender, but by the borrower. This is done by selling securities, now there are lots of different kinds of securities but they all work roughly like this. Let's say the US government needs $1000 that they do not have. To raise the money the government authorizes the Treasury Department to sell IOUs (securities) on the open market to earn that amount. So the Treasury makes 10 IOUs with the following terms: If you buy this IOU for $100 the US Government will pay you back $105 after two years (These terms are not the actual terms, just examples. The actual terms vary depending a number of factors. Some have to be paid back in 3 months and some after 30 years). Then the Treasury puts these IOUs on the market and ten people buy one each then bingo, the US government has the $1000 it needed, but they will owe ten people $105 in two years. It is also worth noting that after the two years is up the government does not automatically have to pay that back., it is paid back any time after when the agreed period of two years is over and the owner redeems those securities (so it is worth noting that the government cannot pay off the debt any faster than people want to cash in).
Who buys these IOUs (securities)?
Lots and lots of different people, countries, banks, companies and state and local governments, in fact it is very possible the you or someone you know owns some of that debt. Have you ever owned a federal savings bond or a Treasury bill? These are securities, and if you owned one you owned part of national debt.
Is this the only way the government borrows money?
No, the government also borrows money from itself, but I will cover that later.
Who owns the debt right now?
Again lots and lots people, countries, banks, companies and state and local governments. But broadly speaking $9,652,195,544,012.12 (about 68 percent of the national debt) are outstanding securities (so IOUs we have sold and not paid back yet) and $4,612,049,982,299.46 (about 32 percent) is money that the government has borrowed from itself (again more on that later)
I thought that we borrow a lot of money from China is that true?
Well yes and no. The US government does not “borrow” money directly, it sells securities (IOUs) that it has to pay back, but yes China does own a lot of these securities but not the majority (though they are the single biggest owner of securities). Here are the top 5 foreign Governments that own US security:
1. China $1,154.7 billion
2. Japan $885.9 billion
3. United Kingdom $278.4 billion
4. OPEC (Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.) $215.5 billion
5. Brazil $197.6 billion.
All together the US government owes 4,453.4 billion to foreign governments.
Who do we owe the remaining 5,135 billion to?
Private individuals, banks, and companies, maybe even you.
Some of those countries do not like us very much why would they, or anyone else for that matter, buy our securities and finance our debt?
Because it is a good investment. The US government has never defaulted on a security. It is a safe way to invest because the US economy is rather stable and America is a reliable debtor. Whether you own $100 or $100 billion of Treasury bills that is almost as good a gold when it comes to keeping its value (and it is a lot easier to get and there is a lot more of it than there is gold).
You mentioned that the Government can borrow money from itself how is that possible?
Shakespeare’s Polonius said “Neither a borrower nor a lender be.” Well we are guilty of both here. The other chunk on the national debt is intergovernmental loans ($4,612,049,982,299.46). The way this works is a little less straightforward than securities. The government has a lot of trust funds. The most famous is the Social Security Trust fund. The Social Security Trust fund is an interest bearing trust of money that has been saved from when the Government collects more in Social Security payroll taxes than pays out in Social Security benefits. The trust is there to help in the event of a down turn in the economy (like the current recession) and Social Security payroll taxes cannot cover Social Security benefits. In these cases the trust will provide the money to cover the short fall until the economy picks back up. So how do we borrow from ourselves? Now let's say the government needs $1000 and it does not want to sell any more securities (like any commodity there is only so much demand and you do not want to flood your market). So it looks at its own accounts and sees billions of dollars in the Social Security Trust fund (which is in the form of securities just like the debt except this time the government is the buyer and not the seller). So the government cashes out the $1000 it needs and spends it. Of course the government has to pay that back to the Social Security Trust so it can buy new securities to replace the old ones and a little extra to make up for the loss in interest that would have occurred if that money had just stayed in the trust. This method of borrowing has some upsides in that it can happen quickly and the time that it has to be paid back is a little more flexible than a security that will cashed out by the owner when it matures.
Well that is quite the system, but it seems to work, then why should we be worried?
You are right, it is quite the system, and for all intents and purposes it works, and works well, but in excess it has its dangers. I will cover it in my next post.
With that said lets dive right into it. The issues this blog is about it the national deficit and the debt that that leads to. So let's start with basics before we look at any problems or solutions.
What is the national debt?
This is the money and that the Federal government has had to borrow over the years to run government functions that they did not have revenue to cover at the time.
Why does the Federal government need to borrow money?
When the government spends more money that it has on hand it is called deficit spending. When the government does this it has to borrow to cover the expenses it cannot afford.
Why does the Federal government just not spend more than it collects in taxes?
The main reason is that the government does not really know how much it will collect in taxes until the taxes actually come in. It is a little like owning your own business. You can estimate how much money you might make in a year but you will not know the actual amount until the year is over. So the government could write up a budget that it is sure it could afford at the beginning of the year, then a recession could hit and it turns out that the tax revenue collected thought the year was not enough by the end of the year. Also it would be very hard for the government to function reliably if it had to cut and reinstate programs on annual bases depending on whether the money was there or not.
Why doesn’t the Federal government just save money in good years and draw on in bad years?
Well it does do this to a certain extent but it is actually not good for the government to save too much money. It is because of the huge amount of money the government deals with. If the government were to save the hundreds of billions, if not trillions of dollars, it would need be able to ride out a slump in the economy, let alone a major recessions, it would have a harmful effect on the economy. The reason is if the Government pulled that amount money out of the economy, through taxes, and did not return to the economy through government spending or tax refunds it would severely reduce the national money supply and lead to deflating value of the dollar with would cause wages to drop and general economic instability.
How big is the federal debt?
Last I check (April 7th 2011) the debt was $14,264,245,526,311.58
Is that a lot of money?
Yes.
How does that Federal government borrow money?
The Federal debt is not like a mortgage or credit card debt like an individual might have. With government debt the interest rate and the terms are not set by the lender, but by the borrower. This is done by selling securities, now there are lots of different kinds of securities but they all work roughly like this. Let's say the US government needs $1000 that they do not have. To raise the money the government authorizes the Treasury Department to sell IOUs (securities) on the open market to earn that amount. So the Treasury makes 10 IOUs with the following terms: If you buy this IOU for $100 the US Government will pay you back $105 after two years (These terms are not the actual terms, just examples. The actual terms vary depending a number of factors. Some have to be paid back in 3 months and some after 30 years). Then the Treasury puts these IOUs on the market and ten people buy one each then bingo, the US government has the $1000 it needed, but they will owe ten people $105 in two years. It is also worth noting that after the two years is up the government does not automatically have to pay that back., it is paid back any time after when the agreed period of two years is over and the owner redeems those securities (so it is worth noting that the government cannot pay off the debt any faster than people want to cash in).
Who buys these IOUs (securities)?
Lots and lots of different people, countries, banks, companies and state and local governments, in fact it is very possible the you or someone you know owns some of that debt. Have you ever owned a federal savings bond or a Treasury bill? These are securities, and if you owned one you owned part of national debt.
Is this the only way the government borrows money?
No, the government also borrows money from itself, but I will cover that later.
Who owns the debt right now?
Again lots and lots people, countries, banks, companies and state and local governments. But broadly speaking $9,652,195,544,012.12 (about 68 percent of the national debt) are outstanding securities (so IOUs we have sold and not paid back yet) and $4,612,049,982,299.46 (about 32 percent) is money that the government has borrowed from itself (again more on that later)
I thought that we borrow a lot of money from China is that true?
Well yes and no. The US government does not “borrow” money directly, it sells securities (IOUs) that it has to pay back, but yes China does own a lot of these securities but not the majority (though they are the single biggest owner of securities). Here are the top 5 foreign Governments that own US security:
1. China $1,154.7 billion
2. Japan $885.9 billion
3. United Kingdom $278.4 billion
4. OPEC (Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.) $215.5 billion
5. Brazil $197.6 billion.
All together the US government owes 4,453.4 billion to foreign governments.
Who do we owe the remaining 5,135 billion to?
Private individuals, banks, and companies, maybe even you.
Some of those countries do not like us very much why would they, or anyone else for that matter, buy our securities and finance our debt?
Because it is a good investment. The US government has never defaulted on a security. It is a safe way to invest because the US economy is rather stable and America is a reliable debtor. Whether you own $100 or $100 billion of Treasury bills that is almost as good a gold when it comes to keeping its value (and it is a lot easier to get and there is a lot more of it than there is gold).
You mentioned that the Government can borrow money from itself how is that possible?
Shakespeare’s Polonius said “Neither a borrower nor a lender be.” Well we are guilty of both here. The other chunk on the national debt is intergovernmental loans ($4,612,049,982,299.46). The way this works is a little less straightforward than securities. The government has a lot of trust funds. The most famous is the Social Security Trust fund. The Social Security Trust fund is an interest bearing trust of money that has been saved from when the Government collects more in Social Security payroll taxes than pays out in Social Security benefits. The trust is there to help in the event of a down turn in the economy (like the current recession) and Social Security payroll taxes cannot cover Social Security benefits. In these cases the trust will provide the money to cover the short fall until the economy picks back up. So how do we borrow from ourselves? Now let's say the government needs $1000 and it does not want to sell any more securities (like any commodity there is only so much demand and you do not want to flood your market). So it looks at its own accounts and sees billions of dollars in the Social Security Trust fund (which is in the form of securities just like the debt except this time the government is the buyer and not the seller). So the government cashes out the $1000 it needs and spends it. Of course the government has to pay that back to the Social Security Trust so it can buy new securities to replace the old ones and a little extra to make up for the loss in interest that would have occurred if that money had just stayed in the trust. This method of borrowing has some upsides in that it can happen quickly and the time that it has to be paid back is a little more flexible than a security that will cashed out by the owner when it matures.
Well that is quite the system, but it seems to work, then why should we be worried?
You are right, it is quite the system, and for all intents and purposes it works, and works well, but in excess it has its dangers. I will cover it in my next post.
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