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If federal revenues and government spending are equal in a given fiscal year, then the government has a balanced budget. If revenues are greater than spending, the result is a surplus. But if government spending is greater than tax collections, the result is a deficit. The federal government then must borrow money to fund its deficit spending.
While a deficit describes the relationship between spending and revenues in a single year, the federal debt - also referred to as the national debt - is the sum of all past deficits, minus the amount the federal government has since repaid. Every year in which the government runs a deficit, the money it borrows is added to the federal debt. If the government runs a surplus, it can use the extra money to pay down some of its debt. And each year, the government pays interest on the national debt as part of its overall spending.
As of June 4, 2015, total U.S. debt stood at $18.153 trillion.
The federal government has run a deficit in 45 out of the last 50 years. Usually that deficit is around three percent of the economy, as measured by Gross Domestic Product (GDP).
The size of a budget deficit in any given year is determined by two factors: the amount of money the government spends that year and the amount of revenues the government collects in taxes. Both of these factors are affected by the state of the economy, as well as by the tax and spending policies enacted by Congress.
For example, during tough economic times like the Great Recession, many types of government spending automatically increase because more people become eligible for need-based programs like food stamps and unemployment benefits. At the same time, tax revenues tend to decrease for a couple of reasons: people are working less, and paying less in taxes; and corporations also earn less profit, and they too pay less in taxes. What's more, lawmakers may intentionally increase government spending during a recession in order to stimulate the economy, even though they know that one short-term result will be a deficit. During the Great Recession, the federal deficit in 2009 reached 9.8 percent of the economy, but in 2015 is about average again, at 3.2 percent of the economy.
The deficit can also reflect temporary spikes in spending that are not matched by equal spikes in revenue (through increasing taxes, for instance). For example, the deficit in 1943 at the height of war spending on World War II reached nearly 30 percent of the economy.
Finally, tax policy plays a major role in determining whether we run surpluses or deficits. Many factors probably contributed to the budget surpluses of the 1990s, but one of them was tax increases, which took the form of tax rate increases for the highest income taxpayers (although rates stayed well below what they had been prior to the 1980s). Likewise, major tax cuts in 2001 and 2003 were a major contributor to deficits over the last decade, and to today's debt - by some measures, even more so than the economic downturn.
To finance the debt, the U.S. Treasury sells bonds and other types of securities (Securities is a term for a variety of financial assets). Anyone can buy a bond or other Treasury security directly from the Treasury through its website, treasurydirect.gov, or from banks or brokers. When a person buys a Treasury bond, she effectively loans money to the federal government in exchange for repayment with interest at a later date.
Most Treasury bonds give the investor - the person who buys the bond - a pre-determined fixed interest rate. Generally, if you buy a bond, the price you pay is less than what the bond is worth. That means you hold onto the bond until it "matures." A bond is mature on the date at which it is worth its face value. For example, you may buy a five-year $100 bond today and pay only $90. Then you hold it for five years, at which time it is worth $100. You also can sell the bond before it matures.
There are actually many different kinds of Treasury bonds, but the common thread between them is that they represent a loan to the Treasury, and therefore to the U.S. government.
The federal debt is the sum of the debt held by the public - that's the money borrowed from regular people like you and from foreign countries - plus the debt held by federal accounts.
Debt held by federal accounts is the amount of money that the Treasury has borrowed from itself. That may sound funny, but recall from Where the Money Comes From that trust funds are federal tax revenues that can only be used for certain programs. When trust fund accounts run a surplus, the Treasury takes some of that surplus and uses it to pay for other kinds of federal spending. But that means the Treasury must pay that borrowed money back to the trust fund at a later date. That borrowed money is called "debt held by federal accounts;" that's the money the Treasury effectively lends between different federal government accounts. Almost one-third of the federal debt is held by federal accounts, while the remaining two-thirds of the federal debt is held by the public.
Debt held by the public is the total amount the government owes to all of its creditors in the general public, not including its own federal government accounts. It includes debt held by American citizens, banks and financial institutions as well as people in foreign countries, foreign institutions and foreign governments.
As you can see in the pie chart above, about one third of the total federal debt, and nearly half of debt held by the public, is held internationally by foreign investors and central banks of other countries who buy our Treasury bonds as investments. These countries include China ($1.3 trillion), Japan ($1.2 trillion) and Brazil ($262 billion), the three countries that currently hold the most U.S. debt. Treasury also groups foreign holders of national debt by oil exporting nations (including Iran, Iraq, Kuwait, Ecuador, Nigeria and others, $297 billion) and Caribbean banking centers (Bermuda, Cayman Islands, and others, $293 billion).3
The next largest portion of debt held by the public is held by private domestic investors, which includes regular Americans as well as institutions like private banks.
The U.S. Federal Reserve Bank and state and local governments also hold substantial shares of federal debt held by the public. The Federal Reserve's share of the federal debt is not counted as debt held by federal accounts, because the Federal Reserve is considered independent of the federal government. The Federal Reserve buys and sells Treasury bonds as part of its work to control the money supply and set interest rates in the U.S. economy.
The debt ceiling is the legal limit set by Congress on the total amount that the U.S. Treasury can borrow. If the level of federal debt hits the debt ceiling, the government cannot legally borrow additional funds until Congress raising the debt ceiling, and could be left with no way to pay its bills. If this happens, it could result in sudden interruptions of government services and unintended consequences.
Congress has the legal authority to raise the debt ceiling as needed. Doing so does not authorize new spending, but rather allows the Treasury to pay the bills for spending that has already been authorized by Congress.
The debt ceiling evolved from restrictions that Congress placed on federal debt nearly from the founding of the country. Legislation that laid the groundwork for the current debt ceiling was passed in 1917, and the first overall debt ceiling was passed in 1939. Since then, the debt ceiling has been raised or otherwise amended more than 140 times, including more than a dozen times since 2000.
On February 10, 2014, the debt limit was suspended until March 15, 2015. The national debt is expected to reach the current debt ceiling in the summer or fall of 2015 unless Congress acts to raise it.
Often, the decision by Congress to raise the debt ceiling has not been controversial. Since 2011, however, due to political partisanship as well as debates about the size of the federal budget and deficit spending, the debt ceiling has become a highly contentious issue. Some members of Congress have pledged to allow the federal government to default on its debt payments rather than raise the debt ceiling again.
There is an ongoing debate as to whether the government should limit its ability to borrow. Some consider deficit spending to be a hindrance to the government and the economy, arguing that a deficit only shifts the burden to future generations because it must be paid for eventually, just like any other loan.
Others see deficits as a crucial way for the government to stimulate the economy during an economic downturn. Proponents of this view believe that the role of government is not only to provide services that the private sector won't, but also to stimulate the economy during economic crises. They argue that deficits are necessary in times of economic hardship, but that during economic booms, budget surpluses should be used to pay down the debt.
In some ways, deficits and debt are actually less controversial than you would think from listening to the rhetoric - with deficits in 45 out of the last 50 years, our government has chosen policies that lead to slight deficits more often than not, regardless of who controls Congress or the White House. And in times of surplus, lawmakers across the political spectrum have argued to use some of the surplus not just to pay down the debt, but for other priorities like government services or tax cuts.