The Truth About Deficits and the Debt

America needs to cut spending now.

Editor’s Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth 1: Debt and deficits are a disease that can only be cured by raising taxes.

Fact 1: Debt and deficits are only a symptom. The disease is overspending. And tax increases are no cure. Besides, even if we could balance the budget by raising taxes it wouldn’t stay balanced so long as programs like Social Security, Medicare, and Medicaid remain unreformed.

Polls reveal that debt and deficits have become defining issues in American politics. While these issues are indeed important and the American people are justifiably concerned about the level of debt our nation is racking up, they are only symptoms of the real problem: overspending. America is living beyond its means and is projected to continue doing so into the foreseeable future.

The above chart compares tax revenues and government spending as a percentage of GDP from 1930 to the year 2084, using Congressional Budget Office (CBO) projections for the years 2011 to 2084.  

As you can see, in the past, tax revenues have averaged 15.9 percent of GDP. During recent years, revenue collection has slightly increased, averaging 18.5 percent of GDP during the 1990s, and averaging 17.5 percent of GDP during the first decade of the new millennium. Notably, the federal government has never been able to collect 21 percent of GDP in tax revenues. It defies reality to think that it will be able to do so now. That’s why the CBO estimates that revenues will remain fixed at 19.3 percent of GDP into the future.

Yet the CBO anticipates that from 2012 through 2021, the federal government will spend, on average, 23.3 percent of GDP—a higher level of spending as a percentage of GDP than the government has ever been able to collect.

Myth 2: There is no relationship between high interest rates and deficits. And even if there was, interest rates remain at all-time lows.

Fact 2: That may have been true once, but the data now shows that investors anticipate an increase in both interest rates and deficits.

For the last 20 years, economists have looked for evidence that deficits lead to higher interest rates. In 1993, for instance, North Carolina State University economist John Seater surveyed the literature on deficits and interest rates and concluded that the evidence is “inconsistent with the traditional view that government debt is positively related to interest rates.” But George Mason University economist Arnold Kling argues that economists haven’t seen a correlation between budget deficits and interest rates because foreign investment in U.S. assets has increased over the years, dulling the impact of fiscal policy. The real question is what happens if that investment slows or stops.

Moreover, deficits have reached a level that economists haven’t really studied before. Current circumstances remind Kling of “a guy jumping out of a building from the 10th floor, passing the third floor, and saying, ‘It’s all fine so far.’” Deficits do not matter up to a certain level. But at what level do we hit the ground with a resounding splat?

Here is what we do know: To get deficits under control the federal government could cut spending, increase taxes, or do some combination of both. Neither of these policies is popular; hence the temptation to print money (or “monetize the debt”) to pay the bills. The resulting inflation would reduce the value of each dollar, and it would introduce high levels of uncertainty into the economy. Imagine what it would be like to try to calculate the net present value of your investment in an environment where you can’t predict what your dollars will be worth tomorrow. Such circumstances mean less innovation and less entrepreneurship, and therefore less economic growth and more hardship.

The Federal Reserve may be reluctant to take the inflationary route. But investors know that other central banks have done so in the past and that such a scenario could happen again. In exchange for extending more loans to a federal government that has become a riskier borrower, lenders will ask for an inflation premium.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Fist of Etiquette||

    When doing her reality check, Veronique should stand in front of her charts like a meteorologist in front of a weather map. Tell me that wouldn't be aces.

  • BrophyWorld||

    Does any libertarian believe that Democrats and Republicans will significantly cut the budget? The debt cannot be repaid, a huge penalty that will income earners for at least the next 40 years. Alternatively, imagine living with a responsible government like Hong Kong, in a Mediterranean climate like California. Voting with your feet is more effective than voting in a ballot booth. Chile offers a combination of pleasant climate and fewer government burdens than many others. If you’re ready to shed the debt your government has imposed upon you, it is a good destination to consider:
    http://brophyworld.com/move-to-santiago-chile/

  • Jesus Rundgren and The Cheese||

    "In about 20 years...
    When this country disappears...
    You and I will stay...
    And watch this sucker...fade away...

    Fade away...ooohhh..."

  • Sudden||

    I like how, if you take the first graph showing tax revenue vs. spending as % of GDP, and flip it 90 degrees clockwise, it looks like a stick figure zombie or sleepwalker...

  • ||

    Hey, Veronique stole my hockey stick!

  • Coincidence?||

    I think not, since the economy is a dead man walking.

  • Old Mexican||

    Myth 1: Debt and deficits are a disease that can only be cured by raising taxes.


    Lefty: You just want to starve children!

  • Jim||

    I frequently ask leftists if there was mass starvation in the streets before FDR. A startling number of them claim that yes, yes there was.

  • Tony||

    A child from a family in the top income quintile who does not get a college degree is more likely to wind up in the top income quintile himself than a child from a family in the bottom income quintile who does get a college degree.

    Libertarian: fuck children. Fuck everyone! I've got mine!

  • Red Rocks Rockin||

    I guess pushing the "Everyone should go to college" meme isn't as productive as the do-gooders claim it to be.

  • Red Rocks Rockin||

    Progressive: Fuck the rich! They have what I want!

  • JoshINHB||

    A child from a family in the top income quintile who does not get a college degree is more likely to wind up in the top income quintile himself than a child from a family in the bottom income quintile who does get a college degree.

    Disfunctional families, how don't they work?

  • Ink guy||

    Notice Tony doesn't say that people brought up in the bottom quintile stay in the bottom quintile, just that they are less likely to cross the income threshold required to make it to the top 20% - which is probably something like 50k. In other words, it's more valuable to be brought up in the middle class than it is to go to college for 4 years. Ok, so what?

  • Mr. FIFY||

    Wealth-envy solves nothing, Tony. We've tried to tell you, but you just don't listen.

  • Bill||

    Oh my God!! MORE likely? We must act now. I'm sure that we can pass legislation that will address this horrible situation.

    And this time it will really, really work. (Really!)

  • APJ||

    Please spend less time focusing on inequality and more time focusing on elevating the bottom. Inequality hardly means shit.

  • Tony||

    That would be true if it weren't so egregious in this country.

  • sevo||

    Tony|4.2.11 @ 1:30PM|#
    "That would be true if it weren't so egregious in this country."

    Translation from brain-dead:
    "I don't like it!"

  • ||

    A child from a family in the top income quintile who does not get a college degree is more likely to wind up in the top income quintile himself than a child from a family in the bottom income quintile who does get a college degree.

    Yup Obama's America and 60 years of statist policy and rule has destroyed social mobility.

    Why again are you blaming libertarians for the problems your ideology created?

  • APJ||

    And old people!

  • dulcis||

    Veronique de Rugy is attuning into the most apposite gift to America since the Statue Of Liberty

  • ||

    What i want to know is why a statue made out of probably one of the 3 most pretty metals on the periodic table is allowed to stay a sickly green even after it has repeatedly been repaired and cleaned?

  • dulcis||

    I'm sentimental about that patina

  • Bill||

    It's on the ocean. They would have to have teams of people cleaning it constantly to remove the patina which is copper oxide. Each time the copper would get thinner and thinner. So you'd have to reskin the statue much more often.

  • Bill||

    and I assume copper chloride, etc. from being on the sea ......... is even more corrosive than just air.

  • Tony||

    So stupid misleading charts is Veronique's signature thing right?

  • which||

    part?

  • Tony||

    That curve that extends 20 years beyond first contact with the Vulcans...

  • Do you mean I can't trust the||

    CBO?

  • Red Rocks Rockin||

    I know you can't do math, but please try to do some research on exponential equations.

  • Bill||

    It's produced by the CBO which is fairly non-partisan and only involves a few dozen variables and you don't believe it?

    But if it is global warming curves even further into the future involving thousands of variables (essentially trying to model the entire planet and parts of the solar system)
    then how do you feel about it?

  • Tony||

    Global warming isn't subject to radically change with each new government. The graph assumes no revenue increases for all those decades, for example.

  • ||

    There's a shitload of assumptions in Global Warmer graphs and they are far, far more complex extrapolations of things that we frankly don't understand compared to calculating an off-book loan coming due.

    C'mon man.

  • ||

    Lets see, listen to somebody with clear and reasoned arguments who backs it up with actual facts, somebody that appears on Bloomberg a much respected business channel all over the world. Or listen to a thick brick whose ramblings use the "its for the children" argument. Its a tough choice to decide between the two.

  • ||

    Tony,
    How many posts do you have to bait us with before you, um, get off?

  • Barney Frank||

    MMF! MMMFFFF!!!

  • ||

    Tony, Obama was supposedly brought up poor, college educated (but won't release his records) and was mentored. How did he pay for college? It just proves that getting rich and successful is partly "who you know."

  • Tony||

    Yeah. Especially if the people you know are rich. The point is the role of luck in success.

  • Red Rocks Rockin||

    The problem, Tony, is that you believe luck is the primary factor. You're like a goonish nerd who thinks a good physique and charming personality is the result of genetics, and if only he had been born to the right parents, he'd have mad game and chicks kneeling at his feet instead of being a socially dysfunctional, physically repulsive, passive-aggressive misfit.

  • sevo||

    Tony|4.2.11 @ 1:40PM|#
    "Yeah. Especially if the people you know are rich."

    Define "rich".

  • air max france||

    good luck

  • JE||

    I guess it's wishful thinking to hope people might realize that government debt obligations are illegitimate and should simply be defaulted on.

  • Sith||

    I don't kneel in worship
    I don't believe in a ghost
    I don't take kindly to judgment
    death follows me underground

    Thunder and lightning protect me from god
    I won't be skull fucked by faith
    I am the upside down cross

  • ConfederalRepublicBy2030||

    Hey, all you retarded libertarians and constitutionalists just don't get it, because Barack Obama and the disciples of the Comintern will feed your children for you.

    There is an easy explanation for this. You see, if Mr. Rich has $1000, we tax $500, and give it to Mr. Poor, both of them now have $1,000,000, because we went and printed shiploads of bills.

    And you don't get a say in this, either, since we've disarmed the population, and there's no longer an incentive not to fuck you senseless with taxation and governmental detachment from the populace. :) Tough shit, freedom-loving rational people. Tough shit.

  • ConfederalRepublicBy2030||

    Guys, when will the NFA of 34 and the GCA of 68 and the FOPA of 86 get repealed? Any ideas?

  • Ekim||

    Debt will never be brought under control until the printing press is. As long as the bank keeps printing more credit, there will be more debt. In effect, the bank confiscates goods from citizens by printing credit, and lends the goods back to citizens. Better to just let citizens buy the goods they make for cash (let CPI prices go down as productivity improves over time). Then the total public/private debt to GDP ratio won't keep changing over time. Too much debt is a bad thing, which means that printing too much credit (debt) is a bad thing.

  • ||

    Who are you trying to fool with the "Long Term Spending Unsustainable" chart? You must think your readers are the type of idiots who don't know that the CBO only models spending policy, not tax policy. Tax revenue is projected to increase right along with spending; it's just that the CBO doesn't score tax policy so their numbers falsely assume constant tax revenue. But tax revenues won't be constant, obviously. Your own chart proves it.

  • ||

    The chart projects spending and revenue as a percentage of GDP (not spending and revenue dollars). The missing component is GDP. CBO is merely assuming tax revenue isn't going to increase significantly as a percentage of GDP, and that's likely a sound assumption (there is a practical limit to how much you can squeeze out of the tax base). Spending growth is built into the programs and entitlements that are on the books (Congress has promised a sky of unfunded liabilities). The take home of the chart is the gap between spending and revenue (not in dollar terms, but as a percentage of GDP). The difference is a deficit, the accumulation of which is a debt.

    The current debt is 97% of the current GDP. As we continue to run deficits that number will continue to grow.

    "If something cannot go on forever, it will stop," (Herbert Stein)

    What is of concern is not if the debt will be extinguished, but how. Decrease spending? Not likely as long as there is the AARP, wars to be fought, and children of whom to be thought. Increase taxes? Not likely as long as who ever at the wheel is unwilling to drive the bus over an economic cliff. Monetize the debt? Bingo! Of course that means inflation, a devalued dollar, an end to foreign debt servicing, and therefore, ultimately, spending cuts imposed rather than choosen.

    Wouldn't it just be better to curb the spending now? It's better to happen now, easier, than hard later.

  • sevo||

    "Wouldn't it just be better to curb the spending now? It's better to happen now, easier, than hard later."

    I'd like to agree, but this presumes two circumstances not in evidence:
    1) The Tonys of the world finally realize you can't keep taking money from others to line your own pockets.
    2) That our elected servants have a event-horizon longer than the next election, where they can claim saint-hood for handing out money and let the blame fall on those who follow.

    Given that ignoramuses qualifying under the first condition represent a seeming majority of voters, the hope for either is slim.

  • Marian Kechlibar||

    The short event horizon of electoral democracies is becoming a serious problem all over the world.

    I, for one, am not sure whether any reasonable solution exists - now when so many special interests are already in play.

  • ||

    It's all academic at this point. America will not cut spending. Democrats and Republicans will not cut spending. People who demand spending cuts will also demand that their favorite gummint cheeze be preserved and "enhanced."

    At this point, we're just discussing how it will feel when the car crashes into the brick wall.

  • LifeStrategies||

    Yes indeed. Few people seem to understand, as insightful British politician Dan Hannan says, “You cannot spend your way out of recession or borrow your way out of debt.”

  • ||

    I doubt that we will significantly cut spending. The pro-government types see moral virtue in government and see evil where ever the government hasn't reached yet. Therefore, they see building the fed as a moral crusade. The cutters see cutting spending as a moral crusade, but the media is on the side of the government and will never give a balanced view of these spending choices. Every time the CPB gets threatened, they trot out Sesame Street. Never once, do we see mainstream media expressing cynicism about this or commenting that the CPB could be free standing now if they hadn't given away the store on product licensing rights. The big PBS producers make serious bank off Elmo, etal as well as the other shows. No mention of this ever gets made.

    Whenever any program gets threatened, the hysteria from the pro-govt people just gets pumped out to the masses. No one ever takes the other side's arguments as gospel and just pumps them to the masses.

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