How the Federal Debt and Deficit Are Different:
The
U.S. Federal Deficit is when government spending is greater than revenue received for that year. In
Fiscal Year 2009, the budget deficit will be $1.75 trillion. The FY 2010 deficit will be $1.17 trillion.
The U.S. Federal Debt is over $11 trillion. This is nearly double 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 from the Social Security Trust Fund. These loans are not counted as part of the deficit, since it is all within the government. However, as the Baby Boomers retire, it will need to be paid back. Unfortunately, there is not yet an effective plan to do so.
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 by comparing each year's debt to last year's debt.That is because the amount owed to the Social Security Fund is a debt that will need to be repaid one day, and so the amount borrowed from it is a more accurate description of the government's liabilities than the reported budget deficit. (Source: St. Louise 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. In FY2010, this was $164 billion. By 2019, the interest payment will be about $622 billion, or 12% of total spending. (Source: OMB, Table S-4)
Third, the debt can decrease tax revenue thereby increasing the deficit. As the debt continues to increase, 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 can increase economic growth. This is especially true in a recession.
However, 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 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.
