March 22, 2011
Revenues come from individual income taxes, Social Security and Medicare (FICA) taxes, corporate taxes, excise taxes, estate and gift taxes, and other special collections as well as from borrowing. Revenues are categorized as either “Trust Funds” or “Federal Funds.” Trust Funds generated from FICA taxes, for example, are earmarked revenues for particular purposes (i.e., Social Security, SS Disability Insurance, Railroad Retirement). For the purposes of understanding how a tax dollar is spent, we only focus on Federal Funds (not Trust Funds) – money available for general spending. In FY2010, the federal government financed over half – 53.2 cents of each dollar of the $2.8 trillion Federal Fund outlays for FY2010 – through borrowing. Collected revenues accounted for only 46.8 cents of each dollar of Federal Fund outlays.
What is a deficit?
Simply stated, in FY2010 the government spent more than the revenues it collected and therefore incurred a deficit. To finance its spending in FY2010, the government had to borrow funds, similar to when individuals use credit cards to finance purchases that exceed their budget.
“Debt” vs. “Deficit”
These two terms are often used interchangeably, but they mean two very different things. “Deficit” is an annual figure that represents the difference between what the government brings in as revenues and what it spends in years when it spends more than it brings in (as opposed to “surplus”). “Debt” is the accumulated total of all annual deficits and surpluses.
Where is the money borrowed from?
The “borrowed” 53.2 cents of each dollar spent in FY2010 largely comes from two sources. Money can be borrowed from trust funds within the budget, such as when the government borrows from Social Security surplus to pay for other programs. Money can also be borrowed from sources external to the budget, such as by issuing bonds and federal securities which are purchased, for example, by the governments of Japan and China and by U.S. residents.
Why is money borrowed?
Fifty-three cents may seem like a large amount of each dollar to borrow, and depending on circumstances, this amount has varied from 73 cents in 1943 to 0 cents in 2000. Why is the government borrowing a relatively large amount in FY2010? The federal response to the collapse of financial institutions, the global economic downturn and the domestic housing crisis resulted in a large deficit and high level of borrowing. In 2009 this response took the form of the Troubled Asset Relief Program (TARP), the American Recovery and Reinvestment (stimulus) Act and more funding for unemployment benefits.
How is the borrowing paid for?
The national debt, currently approaching $14 trillion, is the total of annual deficits and surpluses (when there have been surpluses) dating back to 1940. The national debt is similar to the revolving balance on a credit card where every month a new purchase is added to the account. When evaluating the size of deficits and the debt, we should consider what the funds have been spent on as well as the current costs and potential future benefits. For example, an assessment of our credit card balance would be quite different if the balance represents a shopping spree vs. payment for a needed medical procedure.
Regardless of whether debt is considered “good” or “bad,” it's important to know avenues to debt reduction. There are really only two: (1) decreased spending and (2) increased revenues. Decreased spending can mean the loss of federally supported programs. Increased revenues can mean higher taxes.