Deficits as far as the eye can see

The federal deficit has swollen to record levels, with no end in sight. Is there a solution?

National debt is at an all-time high.
(Image credit: Corbis)

Are deficits a recent problem?

In Washington, they are a long-standing habit. Except for the four-year period from 1998 to 2001, the federal government has spent more money than it took in every year since 1970. But the scale of deficit spending has changed dramatically. This year, the deficit is projected to hit $1.56 trillion—an all-time high—pushing the cumulative national debt burden to a staggering $11.4 trillion. (Last year, the government spent $187 billion on interest payments alone.) The 2009 deficit, $1.4 trillion, was equal to 10 percent of the country’s gross domestic product, or the total output of goods and services—the highest ratio since World War II. And the Obama administration projects that massive deficits may persist until 2020 or beyond. The country’s continuing accumulation of massive debt, says financial guru and investor Warren Buffett, is a problem “as ominous as that posed by the financial crisis itself.”

How did the deficit get so big?

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When George Bush took office in 2001, the U.S. had an annual budget surplus of $236 billion, thanks largely to a flood of tax receipts generated by the dot-com boom. Bush swiftly enacted tax cuts aimed mostly at high earners, which transformed the surplus into a $150 billion deficit in just one year; there hasn’t been a surplus since. Then came 9/11 and the wars in Afghanistan and Iraq, which were fought on credit, and have cost close to a trillion dollars so far. The Medicare drug benefit, which Bush and Congress enacted in 2003, will add another $1 trillion to the deficit by 2015. But the greatest damage was inflicted by the 2007–08 Great Recession, which drove down employment, profits, and tax receipts. In one year, the government’s tax revenues fell $400 billion—17 percent. At the same time, Washington laid out $154 billion to bail out troubled financial institutions and $202 billion on economic stimulus. The deficit soared.

Why do deficits matter?

Not everyone agrees that they do, at least in the short term. Liberal economists such as Joseph Stiglitz and Paul Krugman favor more stimulus spending now, arguing that the U.S. can tackle the deficit once prosperity is restored. But even they agree that deficits eventually make it more costly for America to borrow, because worried creditors will demand that the U.S. pay higher interest rates. Higher Treasury bond rates, in turn, translate to higher rates for everything from mortgages to business loans, creating “drag” on economic growth. And the bigger the interest tab, the less government has to invest in infrastructure, education, and other cornerstones of a healthy economy. “As we accumulate more and more debt,” says Harvard economist Kenneth Rogoff, “we leave ourselves very vulnerable.”

How hard is it to cut the deficit?

Politically, it’s nearly impossible. At this stage, the U.S. can’t simply grow its way out of the deficit, which leaves the options of a major tax increase, massive cuts in spending, or some combination of the two. Tax increases have become an act of suicide for politicians—just ask the first President Bush, whose tax hikes helped make him a one-term president. Spending cuts aren’t any more popular, and about 55 percent of the budget consists of entitlements such as Social Security and Medicare, considered “the third rail of American politics.” So-called discretionary spending is almost as hard to cut, because it benefits constituencies that would raise hell if their government checks shrank. Most economists think that multibillion-dollar farm subsidies are wasteful, for example, but farm-state legislators make sure they’re renewed every year. “When asked whether they favor higher spending, lower taxes, or a balanced budget,” says political analyst Michael Lind, “Americans answer, ‘Yes.’”

Can anything be done?

In the past, politicians have often appointed bipartisan panels of experts to insulate them from the political impact of unpopular decisions. In 1988, for example, the first President Bush created a commission that prepared a list of military bases to be closed. Congress had to approve or reject their recommendations in their entirety, rather than haggle over each base. This year, President Obama asked Congress to approve a bipartisan deficit reduction commission with similar powers. When Republicans in Congress balked, Obama created the commission by executive order. But it doesn’t have the power to force an up-or-down vote in Congress.

What can the committee do?

Hold hearings, issue a report, and perhaps influence public opinion. But don’t get your hopes up. The Democrats on the panel generally prefer to raise taxes on the wealthy and cut what they see as waste in the defense budget, while Republicans have rallied behind a plan by Wisconsin Republican Rep. Paul Ryan that would cut income- and capital-gains taxes to stimulate the economy, while raising hundreds of billions through a national sales tax. Ryan’s plan cuts spending by privatizing Social Security and replacing standard Medicare with government vouchers to buy private insurance. Forging a consensus between these approaches seems unlikely, but as even White House budget director Peter Orszag concedes, the status quo is not a viable option. “We’re on an utterly unsustainable path,” he says.

Paying at the cash register

In their search for a relatively painless way to cut the deficit, many economists advocate borrowing an idea from Europe—the Value Added Tax. The VAT is a national sales tax, assessed on nearly every item purchased by businesses and consumers. Experts predict that a 1 percent VAT in the U.S. would raise $1 trillion in a decade, while discouraging debt-driven spending and encouraging saving. But unlike income taxes, sales taxes are “regressive,” taking a larger share of poor people’s incomes than those of the better-off. Still, many business leaders are starting to think a VAT is inevitable; more than half of executives polled in a recent survey expect one to be imposed within five years. “When politicians finally confront the looming crisis,” says economist Christopher Swann, “a VAT would be an invaluable tool.”

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