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How the U.S. Debt and Deficit Differ and How They Affect Each Other

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debt.jpg

Unlike the rest of us, the Federal government doesn't have to pay off its debt...it just prints more money.

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U.S. Debt

The deficit adds to the nation's debt.

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How the U.S. Debt and Deficit Differ and How They Affect Each Other

National Debt Clock in 1992

Photo: Chris Hondros/Hulton Archive/Getty Images

How the Federal Debt and Deficit Are Different:

The U.S. budget deficit is when Federal spending is greater than the tax revenue received for that year. In Fiscal Year 2014, the budget deficit was projected to be $744 billion. This is much lower than the all-time high of $1.4 trillion reached in FY 2009.

The U.S. Debt exceeded $17 trillion on October 17, 2013. This is nearly three times the debt in 2000, which was $6 trillion.

How Does the Deficit Affect the Debt?:

Each year, the deficit is added to the debt. The Treasury must sell Treasury bonds to raise the money to cover the deficit. This is known as the public debt, since these bonds are sold to the public.

In addition to the public debt, there is the money that the government loans to itself each year. This money is in the form of Government Account Securities, and it comes primarily from the Social Security Trust Fund. These loans are not counted as part of the deficit, since they are all within the government. However, as the Baby Boomers retire, they will begin to draw down more Social Security funds than are replaced with payroll taxes. These benefits will need to be paid out of the general fund. This means that either other programs must be cut, taxes must be raised or benefits must be lowered. Unfortunately, legislators have not yet agreed on an effective plan to meet Social Security obligations.

How Does the Debt Affect the Deficit?:

The debt affects the deficit in three ways. First, the debt actually gives a better indication of the true deficit each year. You can more accurately gauge the deficit by comparing each year's debt to last year's debt. That's because the budget deficit, as reported in each year's budget, does not include the amount owed to the Social Security Trust Fund. However, this is a debt that will need to be repaid one day, and so the amount borrowed from it is a more accurate description of each year's government liabilities than the reported budget deficit. (Source: St. Louis Federal Reserve, Deficit, Debts and Trust Funds, August 2006)

Second, the interest on the debt is added to the deficit each year. About 5% of the budget is allocated to debt interest payments. Interest on the debt hit a record in FY 2011, reaching $454 billion. This beat its prior record of $451 billion in FY 2008 -- despite lower interest rates. By the FY 2013 budget, the interest payment dropped to $248 billion, as interest rates fell to a 200-year low. However, as the economy improved, interest rates rose starting in May 2013. As a result, interest on the debt is projected to quadruple to $850 billion by FY 2021, making it the fourth largest budget item. (See Budget Spending)

Third, the debt can decrease tax revenue in the long run. This would further increasing the deficit. As the debt continues to grow, creditors can become concerned about how the U.S. government plans to repay it. Over time, these creditors will expect higher interest payments to provide a greater return for their increased perceived risk. Higher interest costs dampen economic growth.

How Does the Deficit and Debt Affect the Economy?:

Initially, deficit spending and the resultant debt boosts economic growth. This is especially true in a recession. That's because deficit spending pumps liquidity into the economy. Whether the money goes to jet fighters, bridges or education, it ramps up production and creates jobs.

However, not every dollar creates the same number of jobs. In fact, military spending creates 8,555 jobs for every billion dollars spent. This is less than half the jobs created by that same billion spent on construction. For more, see Unemployment Solutions.

In the long run, the resultant debt is very damaging to the economy, and not only because of higher interest rates. The U.S. government may be tempted to let the value of the dollar fall so that the debt repayment will be in cheaper dollars, and less expensive. As this happens, foreign governments and investors will be less willing to buy Treasury bonds, forcing interest rates even higher.

The greatest danger comes from the debt to Social Security. As this debt comes due when Baby Boomers retire, funds will need to found to pay them. Not only could taxes be raised, which would slow the economy, but the loan from the Social Security Trust Fund will stop. More and more of the government's spending will need to be devoted to pay this mandatory cost. This would provide less stimulation, and could further slow the economy. Article updated October 22, 2013

More on the Deficit and the Debt:

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  3. US Economy
  4. Definitions
  5. Fiscal Policy Definitions
  6. How the U.S. Debt and Deficit Differ and How They Affect Each Other

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