Government Spending and America’s Future

Some Statistics Regarding Government Spending

In Fiscal Year 2007, the U.S. federal government’s revenue was $2.57 trillion, but it spent $2.73 trillion.  This means that the federal government had to go into a debt of $160 billion just for 2007.  Now, spending more than taking in is not a new phenomenon with our federal government, this has been going on for many, many years.  If we look at the Gross Federal Debt (or National Debt), we see that except for a few minor exceptions, it has continued to grow every year since 1940.[1]  The exception years were 1947, 1948, 1951, 1956, 1957, and 1969. 

Taking on more debt every year is not necessarily a problem if the U.S.’s economy is growing faster than the rate of rise of the debt, because a rapidly growing economy can absorb or pay back the debt as long as the debt is not growing too fast.  Therefore, a better measure is the Gross Federal Debt as a percentage of the Gross Domestic Product (GDP).  Indeed, the problem is not necessarily that bad.  Since 1940, there were 35 years (about half of the time) in which the ratio of (Debt/GDP) actually decreased.  Unfortunately, most of those years occurred before 1980.  As a matter of fact, only six of those 35 years occurred since 1980.  They were 1981, 1997, 1998, 1999, 2000, and 2001.  There was none after 2001.  The ratio (Debt/GDP) reached a low of 32.6% in 1981, and gradually rose to about 65-70% in recent years.

How significant are these numbers?  In absolute terms, the U.S. government’s National Debt today is around $9.3 trillion.  With a population of about 304 million, each person’s share is about $30,600!  The National Debt is increasing an average of $1.46 billion per day since September 29, 2006!  In Fiscal Year 2007, the federal government spent $2.73 trillion.  More than 52% (or $1.427 trillion) of this spending was for mandatory spending, primarily Social Security, Medicare, and Medicaid payments.  Almost nine percent (or $238 billion) of this spending was to pay for the interest associated with the National Debt!  This means that only about 39% (or $1.065 trillion) remained for discretionary spending.  Of this $1.065 trillion of discretionary spending, about 53.5% (or $570 billion) was directed to defense spending.  That left only $495 billion for non-defense discretionary spending.  This means that our interest payment of $238 billion was almost half of the total federal government’s non-defense discretionary spending!

If the above trend (rising debt and huge defense spending) continues, there surely will not be enough to fund all the necessary domestic programs.  Before we continue to discuss the implications of this rising huge National Debt on America’s future, I want to sidetrack and point out that a similar situation is also occurring with many state governments.  In March 2008, the Asbury Park Press (APP) ran a series of four weekly articles on the New Jersey state government spending.  The APP pointed out that the state debt increased from $13 Billion in 1997 to $38 billion in 2007.  The debt as a percentage of personal income doubled in 10 years, from 3.8% in 1997 to 7.6% in 2007.  Compounding the problem was two additional major unfunded or under-funded obligations.  From fiscal 1997 to 2005, no state money was put into the state’s Public Employees’ Retirement System, and from fiscal 2000 through 2005, no state money were provided to the Teachers’ Pension and Annuity Fund, which is the second-largest pension system in NJ.  This means that when more and more public employees and teachers retire, more and more money will be needed from the state budget to pay for these under-funded obligations, and therefore less and less money will be available to pay for all the other needed state programs.  Taking these two under-funded programs into account, the APP estimated that the long-term obligations of NJ is about $121 billion, or more than three times larger than the state debt of $38 billion as of 2007!

How did this happen and how could this happen?  Politicians are notoriously short-sighted.  They are short-sighted not because they cannot see the long-term consequences, but because it is good near-term politics.  Politicians prefer to take the easy way out and protect or enhance their near-term political positions by over-promising or over-giving.  For over a decade, NJ’s government from both sides of the political aisle has borrowed money to boost pensions, pay for tax cuts, and in at least one instance, balance the state budget, all without asking voters to pay higher taxes.  One could also argue that President Bush’s tax rebate in 2008 is also an action to gain near-term political advantage for his party, but has long-term adverse consequences since it just adds to the debt of the federal government.  That was why Mayor Bloomberg of New York criticized this action with the remark “that is like giving an alcoholic another drink.”

Implications for America’s Future

We will now return to discuss the economic implications for America’s future from the huge and rising National Debt of the federal government (actually most of the implications are also applicable for the state government).  There are at least four major economic implications.

  1. Continued rising interest payments:  As the debt rises, the interest of course also rises.  As previously mentioned, in 2007 the federal government was already spending $238 billion (or almost nine percent) of its 2007 revenue of $2.73 trillion to pay for the interest from the National Debt.  As also previously mentioned, the ratio (Debt/GDP) has also continued to increase.  This means that the amount of adverse economic impact from the rising interest payments will continue to increase.

    The problem of rising National Debt is compounded when the federal government creates programs that are under-funded and sometimes even worse when they are unfunded.  In the discussion of the NJ government, we already mentioned some NJ state programs in this category.  For the federal government, I think the War in Iraq can be considered to be such an example, in the sense that money to support the war is taken from money to support other foreign and domestic programs.

  2. Poorer credit:  When the federal government is borrowing more and more money at a rate that is increasing faster than the GDP, it means that it will take longer and be much more difficult for the government to pay back the debt.  When this continues for a while, the financial credit of the U.S. will decrease.  This means that the lenders will charge higher and higher interest rates, thus making a bad problem even worse.
  3. Devaluation of the U.S. dollar:  For the same reason that the financial credit of the U.S. government decreases as its (Debt/GDP) continues to rise, the value of the U.S. dollar will continue to devaluate, because the U.S. no longer has enough produced products or precious commodities (such as gold) to pay back the lenders.

    An analogy is that if A borrows money from B.  At first B is willing to lend the money to A because A owns a house, one or more cars, furniture and appliances in the house, some money or equity investments, and perhaps even a business, i.e., A has collaterals that B can take if A forfeits the loan.  If A borrows more and more money from B, after a while, when the amount of money owed is larger than A’s collaterals, then B will not want to continue lending money to A. 

    In the case of federal governments, another way of saying this is that the U.S. is just printing more and more paper money when it issues more and more IOUs.  When the U.S. economy is strong and there are enough collaterals to back up the loans, the paper money is worth its face value.  When there are no longer sufficient collaterals to back up the paper money, the U.S. dollar will be devaluated.  This is because if our collaterals are only worth x dollar bills, and now we have 2x dollar bills because we printed more dollar bills, then each dollar now is equivalent in worth to the previous 50 cents.  The consequence is that lenders will not be willing to lend the U.S. more money, unless the interest rate is very large.

  4. No more lenders and existent lenders dumping the U.S. dollars:  When the excessive money-borrowing trend continues, lenders will no longer be willing to purchase newly-issued IOUs from the U.S. government, existing lenders may terminate current loans, and foreign countries may just dump their holdings in U.S. dollars.  This will force further devaluation of the dollar and the U.S. economy may just collapse.

Additional Comments

The just discussed adverse economic impacts on the U.S. will of course have adverse political and social impacts.  America as a political power will diminish.  Many domestic programs will have to be curtailed or eliminated, leading to public dissatisfaction and social unrest.  There may be a brain drain to more prosperous foreign countries, resulting in a further deterioration of America’s creativity, productivity, and competitiveness.

This is not such a far-fetched scenario./span>  As a matter of fact, one could say that the handwriting is already on the wall.  To overcome this decline of America as an economic and political power, the mind set of the American political leaders and its citizens must make significant changes and sacrifices.  We must responsibly manage our budgets.  We must not ignore the long-term consequences and mortgage our future by taking actions that result in only short-term political advantages.[2]  We must be courageous to be willing to make the tough and perhaps even unpopular decisions.  We must get rid of corruption and political patronages.  Our political and business leaders must not allow big businesses and their executives from getting filthy rich on the backs of the ordinary workers.  Our labor union leaders must not make unreasonable demands that could bring down the whole company or industry.  We must figure out ways to increase our competitive productivity and decrease our trade deficits.  In increasing our competitive productivity, it is not sufficient to increase it only on the creative phase, but also on the product development or manufacturing phase.  WWe must pay more attention to “we-ism” and less attention to “me-ism.”

Summary

For many years our government (both federal and state) has been spending beyond its means./span>  The debt that is being accumulated is getting too large and increasing at a rate faster than the growth of our GDP.  We are already at a point where almost half of our non-defense discretionary spending is spent on paying interest on our National Debt.  If such a trend continues, our debt will increase to an unmanageable level, our financial credit will decrease leading to higher interest rate for our loans, our U.S. dollar will get devaluated, resulting in a vicious cycle and ultimately no one being willing to lend us any more money and countries dumping the U.S. dollar.  This will lead to dire economic, political, and social consequences for our country as a whole.& 

Americans are smart and hard-working people./span>  We must attack the problems at their roots, and not try to divert people’s attention by creating scapegoats, or take actions that result in only short-term gains, while mortgaging our future.  WWe must act courageously and unselfishly, and we must act quickly.

I am not an economist, and I am not an expert on the subject of this article./span>  If the explanation can be made clearer or if there are inaccuracies in this article, I would appreciate getting that feedback.


[1]  “Historical Tables of Budget of the United States Government – Fiscal Year 2006,” from the Office of Management and Budget.

[2]  For a discussion of a slightly different nature of the need for long-term focus, see the article “Need for the Establishment of a Center for Future Studies” in the “Archived-P/S Commentary” page of this website.

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