The deficit is real and dangerous
I read the editorials about the fiscal cliff from both Senator Sanders and the Ethan Allen Institute. I think some facts would help to inform the debate. How big is the deficit? The 2012 Federal Budget (source: OMB) as enacted calls for $2.469 trillion in receipts and $3.796 trillion in expenditures with a deficit of $1.3 trillion. The actual deficit was about $1.1 trillion (the fiscal year ends in September). The October 2012 deficit was $120 billion; at $20 billion increase over 2011. To put this in perspective, median family income in the US is about $50,000. This deficit is like earning $50,000, spending $75,000 and putting $25,000 on your credit card.
That is not sustainable.
How can the deficit be eliminated? Total Federal income tax receipts are $1.165 billion (OMB 2012 budget data). You could double all the income taxes in the country and barely close the deficit. While increasing taxes on the rich may or may not be a good idea for many reasons, the proposition that it significantly reduces the deficit is demonstrably false. The Federal government spends $716 billion on defense, $846 billion on health and Medicare and $778 billion on Social Security.
How much is the debt? The official estimate of US Federal debt is slightly over 100 percent of GDP (Dept. of Commerce, Bureau of Economic Analysis). This is about $15 trillion. The current US debt ceiling established by Congress is $16.3 trillion. Spain, which is currently seen as potentially unable to pay its debts and needing a bailout from the European Union and/or International Monetary Fund has a debt to GDP ratio lower than that U.S., at about 90 percent.
What about interest on the debt? The Federal government currently spends about $225 billion on net national interest, or about 1.5 percent of GDP. The US national debt is very short in maturity as well, with an average of about 5 years compared with the U.K. whose national debt has an average maturity greater than 13 years. This means that if interest rates rise, the U.S. interest payments will rise quickly (like a floating rate mortgage). If 5 year Treasury interest rates (now 0. 62 percent) were where they were in April, 2011 (over 2 percent), interest payments would skyrocket to over $700 billion - which is similar to each of current defense spending or Social Security spending.
This fact should be extremely frightening.
Have countries gotten in this kind of debt trouble before? Absolutely.
Sovereign debt crises and debt defaults are quite common, most recently by Greece, Iceland and Argentina.
How do countries with 100 percent debt to GDP get through? There are only two alternative outcomes: First, a very aggressive program (e.g., Sweden's debt crisis of 1992 and Germany post-reunification) to bring down the debt, or second, default. How to countries default? Countries default in one of three ways. First, they simply fail to pay debts when due (Greece and Argentina). Second, they allow inflation to rise that reduces the real value of the debts they owe (the U.S. in the 1970s-80s). Debasing the coin of the realm is a time-honored practice of governments including the Emperor Nero and Henry VIII. Third, is financial repression. Financial repression is when the government pursues policies that result in a large transfer of wealth from one segment of the economy to another. Today, for example, the Fed is keeping interest rates far below the rate of inflation. CPI increased 2.2 percent year over year to October 2012 (Bureau of Labor Statistics). A 2 year CD from Berkshire Bank pays 0. 6 percent. If you invest in that CD, you are losing 1. 6 percent per year in real terms. That is effectively a wealth transfer from all savings to consumers in the economy. Financial repression is a hidden form of taxation.
The U.S. is in a situation that is quite simple. We have more debts than we can pay unless significant changes are made. Each day that goes buy accumulates more and more debt, making solving the problem ever more difficult. The Obama Administration's 2013 budget submission proposed a 2013 Federal deficit of $900 billion. Both parties are posturing in an unrealistic manner. The idea that we can solve this problem without both tax increases and cuts in entitlement is, in fact, simply untrue. I will close by sharing a comment of Jean-Claude Juncker, a former Luxembourg Prime Minister, on economic reform: "We all know what to do, we just don't know how to get re-elected after we've done it."
Mike Schozer is a Visiting Lecturer at Middlebury College where he teaches on financial market and financial crises.
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