Friday, July 22, 2011

Why is there a debt ceiling?

As I watch the circus in Washington with regard to the Federal government’s so-called “debt ceiling”, I‘m now thinking that this issue is strange in one very fundamental, basic way.

We see various high ranking government officials and other supposedly smart people running around like Keystone Cops and hyperventilating about why we must, absolutely must, raise the Federal government’s debt limit on August 2 (not August 3), and that if we don’t, then the economy as we know it will cease to exist. We’ll drop off a cliff. The worldwide economy will implode, and we’ll never recover. It’ll be over, the end, fini, sayonara, the fat lady will sing, Armageddon will happen, etc. So we’re told by all of those people who are so much smarter than us.

Now here is the strange part. Ponder this: Why does the federal government have a debt limit, if once we reach it, we have no choice but to raise it? Why is the “debt ceiling” there in the first place if it’s not a ceiling at all?

“Debt” is, of course, borrowed money. That means it will have to be paid back some day. Think about buying a new truck. If you don’t have the cash to buy it, you can usually get a loan, and then you pay monthly payments, often for a long time, to pay the loan back.

Suppose you also buy a nice, new boat with another loan. Now, you have more monthly loan payments.

How about a house? Nobody has enough cash to buy a house, so you get a mortgage. More monthly payments.

And then there are those credit cards. Still more monthly payments.

If this keeps up, a person may reach a point where they just can’t make all of those monthly payments, and that’s a real problem. Foreclosure, repossession, nasty debt collectors calling, and other such unpleasantness will most likely ensue.

So the concept of limiting one’s debt seems like a good idea. Depending on the household income level, some specific number representing the total debt that a person or family can carry is established, and then they know not to go above that number in their total borrowing. This “debt ceiling” serves as a restraint on their borrowing, which is a good thing. It keeps them from getting “over extended”.

In concept, that is what a debt ceiling or limit is. It’s a tool for exercising basic, sound financial management by making sure that one doesn’t borrow too much money.

Currently, the federal government borrows about thirty-two cents out of every dollar it spends, so the debt is piling up. Right now, the total national debt is about fourteen trillion dollars, a lot of money to have to pay back to the lenders.

Let’s put that number in perspective.

The federal government currently is spending $3.8 trillion a year; of that, $1.2 trillion is borrowed. Percentage wise, thirty-two percent of the federal budget is borrowed.

The $14 trillion total national debt represents 3.6 years of the total federal government spending. In other words, if Uncle Sam did nothing but pay down the national debt, it would take 3.6 years to do it. Of course, that scenario is very hypothetical, since it means that all spending on the military, Congress, government agencies, Social Security and other entitlements, and everything else the federal government does would have to stop, which they won’t. In fact, because the government is borrowing money as described above, that total national debt figure isn’t going down at all; it’s going up.

Congress apparently realized that unlimited borrowing and spending on their part would lead to some very bad financial consequences. So Congress set a national debt limit, meaning that Congress couldn’t borrow more than that amount of money. I guess the intent was to force some self-restraint in borrowing and spending. But here we are, up against the $14 trillion debt limit and rising.

The big money sinks in the federal budget are Social Security and Medicare. The Social Security trustees estimate that, left on it’s current course, Social Security alone will run a deficit of $3.76 trillion in 2075. Add in Medicare, and you have a one-year deficit of $4.80 trillion, for just two entitlement programs. Those estimates are under an “intermediate” scenario, not a worst-case or best-case scenario.

Gross Domestic Product (GDP) is the total value of all goods and services produced in the entire country. That $4.80 trillion deficit will be somewhere between 24% and 50% of 2075 GDP, depending on the assumptions made.

Think about that. On the current trajectory, in 2075 we will spend between 24% and 50% of the value of everything produced in the country on two entitlement programs.

For you “sustainability” advocates, that is not sustainable.

Here are two conclusions we can draw from all of this.

First, since debt is caused by spending more money than is coming in, when a pre-defined debt limit is reached, shouldn’t spending be reduced?

Second, the only way to have any significant impact on federal spending is to make structural reforms to Social Security and Medicare.

No, raising taxes on the "rich" won’t solve the federal debt problem, especially something as meaningless as closing a tax loophole for corporate jets or some other such silliness. In previous columns, I have discussed who pays the most federal taxes, and space doesn’t allow me to repeat all of that here. But consider two factoids. One: In 2008, the last year for which IRS data is available, the top 50% of income earners paid 97% of all federal income tax. Two: If the feds took all of the taxable income of all people earning over $200,00, it would only pay the Social Security – Medicare - Medicaid bill for 2012, but not for any one year in the future since the costs of those programs are expected to rise rapidly. So increased taxes won’t do it.

Now we know the answer to the question. The debt ceiling is there to keep the Federal government from borrowing excessively, and once the limit is hit, spending needs to be cut.

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