The comparison of the U.S. federal budget to a household or family budget is a bad analogy. Cutting expenses will help to pay off you personal debt, but In times of recession, severe budget cuts or tax hikes will worsen the economy. Unlike individual consumers with limited lifetimes, the government cannot go out of business anytime soon. Borrowing is necessary to finance economic growth. Deficit as a dollar amount doesn't tell you much about the health of our economy, so deficit as a percentage of Gross Domestic Product (GDP) is the standard metric. The U.S. is not deeply in debt to other nations, in fact the percentage of the national debt held by foreigners because we actually earn more from our assets abroad than we pay to foreign investors.
These days I often hear people drawing parallels between a family budget and our national budget. The speaker is usually attempting to justify steep spending cuts by pointing to the size of the federal deficit. It’s a bad analogy. Personal budgets really don’t have much in common with a national budget and it’s not just a question of scale. They are fundamentally different.
Slash v. Tax
If you or I have too much debt, we can reduce it by cutting expenses. The same strategy will not reduce a national deficit. In fact, excessive spending cuts or tax increases applied to a weak economy will make a recession worse. Because of political deadlock in Washington, we have not significantly cut spending OR raised taxes. The U.S. may be recovering too slowly from recession, but at least we are recovering. The same cannot be said for many European countries. You may have heard about the Greek riots in reaction to deep cuts in government programs. Economists believe the economy of the eurozone is still tanking because of the severe austerity programs.
If You Could Live For 225 Years Your Credit Limit Would Be Higher.
Two hundred and twenty-five years is the length of time since the U.S. constitution was adopted and the budget was enacted. Since you and I cannot live that long, we have to consider how to avoid bankruptcy and pay debts before we die. The same cannot be said of our government. No one expects the U.S. to be overthrown any time soon; creditors don’t fear it will go out of business. In fact, the U.S. government has been in debt every year since 1776, (with one exception in 1835). Even during the surplus years of the Clinton administration we borrowed to finance further growth (Wray, R.).
Some people will even try to tell you that we have high unemployment because of government spending. The reverse is true: When the economy slows, increased costs of government programs (like unemployment benefits) and falling tax revenues drive the deficit higher. Economic insecurity causes people to spend less, reinforcing that trend. If the government reacts by raising taxes and slashing social programs, people spend even less, possibly pushing recession into depression. The job of good government is to counterbalance swings in the economy (Craighead, B.). The Congressional Budget Office estimates unemployment would be .07-1.7 % higher without the tax cuts and stimulus spending of 2009. It will be time to put the brakes on borrowing when the economy starts to recover faster.
What exactly is The Federal Deficit and how is it Different from Personal Debt?
The General Accounting Office defines deficit as follows: “The amount by which the government’s outlays exceeds the sum of its receipts for a given period, usually a fiscal year.” When you think of your personal or family budget, your debt is the amount of money it would take to pay off the bills till you no longer owe anyone. The target is zero dollars owed. The federal budget deficit is more like a ratio of borrowed money to revenues. You absolutely don’t want to pay off the federal deficit because without borrowing, there would be no way to finance growth. Imagine you are the chief financial officer of a big corporation and you tell the Board that the organization owes nothing. You will be fired immediately because no investment means no growth. In other words, you are going out of business very soon.
One valid comparison of the national budget to a personal budget is that the dollar amount people owe doesn’t tell you much about their financial health unless you also know their income. If Warren Buffet and I both owe a million bucks, only one of us is going bankrupt (and you know it’s not Buffet). Deficit as a percentage of Gross Domestic Product is a better measure of a nation’s economic health than a dollar amount. InvestorWords.com defines GDP as “The total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports”. The GDP tells you how productive we are as a nation, so it’s a good comparison for debt. In 2011 our deficit was $1.3 trillion, or 9% of GDP.
Another very significant difference between personal and national borrowing is that we own a big piece of our own debt. Economist Paul Krugman reminds us that our national debt as a share of GDP was larger after World War II than it is now, and that did not prevent the postwar generation from achieving the biggest increase in income and living standards in history. The tax base grew and those bonds paid out. Nowadays foreigners may hold a greater percentage of our debt, but the comparison still holds because America earns more on its assets abroad than it pays to foreign investors (Krugman, 2012).
In summary, the next time you hear someone going on about how the federal budget deficit is going to make the U.S. bankrupt and burden our children with everlasting debt, you can be sure that person is not an economic scholar.
CIA World Fact Book. Retrieved April 27, 2012 from https://www.cia.gov/library/publications/the-world-factbook/geos/us.html
Craighead, B. (2011). The Wrong Budget Analogy. Retrieved from http://articles.latimes.com/2011/aug/24/opinion/la-oe-craighead- spending-20110824
Krugman, P.(2012). Nobody Understands Debt. Retrieved from http://www.nytimes.com/2012/01/02/opinion/krugman-nobody-understands-debt.html
Wray, R. (2010).. The Federal Budget is NOT like a Household Budget: Here’s Why. Retrieved from http://www.nextnewdeal.net/federal-budget-not-household-budget-heres-why