Every year our federal government spends more money that it takes in – thereby creating an Annual Deficit. The cumulative result of all these deficits has created an enormous National Debt. Everyone is very frustrated by the Deficits and the size of the National Debt, but most people only know some of the facts. So, here are the data:
The chart below shows the Federal Budget and Deficit for some years 2007-2015
Federal government Income comes from various taxes and duties.
Permanent income taxes were established in 1913 and are the largest source of revenue (45%) for the federal government. From 1913 – 1981 the top marginal income tax averaged approximately 70%. That changed in 1982 with the Reagan tax cuts and top marginal rates have averaged 35-39% since that time.
The second largest source of revenue (31%) is taxes collected for Social Security (which started in 1935) and Medicare (which started in 1965). These are considered “payroll taxes” and are paid equally by the employer and the employee. The rates for Social Security have risen from 1% in 1935 to 6.2% today and that rate is applied to a maximum income amount of $118,500 (not more if you earn more). The rates for Medicare have risen from .35% to 1.45% today and until 1993 they were applied to a maximum income amount of $135,000, but today there is no maximum amount – so you could be charged 1.45% on income of $1m or more. To be clear, the employer and the employee both pay these taxes at the same rates.
The third largest source of revenue (10%) is corporate taxes. These taxes were first introduced in 1909 and since that time they have varied greatly. From 1950-1968 the top marginal corporate tax rate was 50%. From 1970-1987 the top marginal rate was 40%. Reagan reduced this rate to 34% and in 2016 it is 35%. However, there are many deductions and loop-holes in the corporate tax system and many large, profitable companies pay an effective tax rate considerably lower than the 35% rate. (eg. Despite earning billions in Income, GE, Boeing, Prudential Qualcomm, Time Warner, CBS and Verizon have paid less than 10% in corporate tax on their income in each of the last 5 years).
Excise Taxes, Custom & Duties combined are the fourth largest source of revenue (5%). Starting with President Reagan and continuing through President Clinton, America adopted a “free trade” policy to encourage trade among our trading partners (the largest of which are China, Canada, Mexico, Japan and Germany). This in turn has led to a lowering of duties and tariffs such that only 30% of all imported goods into the USA are subject to tariffs. Our current level of income from custom duties and duties is at a historic low.
Since 1955, Federal Government Income has averaged 17.5% of GDP. With the reductions in income, corporate and excise taxes noted above, Federal Income fell to 15% of GDP for the period of 2000-2012. Today, it is at 18.2% of GDP.
Federal Spending – where does the money go?
On an annual basis, our federal government spends approximately $3.7 trillion. The four biggest spends are for:
- Social Security (created in 1935), Unemployment and Labor – $877 billion;
- Medicare (created in 1965) and Health – $921 billion;
- Military – $562 billion;
- Interest on Debt – $260 billion. When taken as a percentage of GDP, our interest spend is at an all-time low. Currently it takes 7% of annual government spending (compared to 15% of spending in the 1990s when interest rates were higher). If interest rates rise our annual interest payments would likewise rise thereby compounding our problems.
These four areas alone consume 71% of the $3.7 trillion in spending. Most people agree that these four areas are considered “Mandatory” spending – programs that were established by Congress years ago and are not subject to annual review. (You could argue that Military spending is “discretionary”, but try lowering the military budget and see how far you get with that.) That leaves 24% of the budget which is considered “discretionary” – that portion of the budget that is decided by Congress through the annual appropriation process. These programs include Food Assistance, Housing, Unemployment, International Affairs, Energy, Transportation, Veteran’s Affairs and other Government administration. In total, these programs cost approximately $1.1 trillion per year.
In 2015, we spent approximately $439 billion more than we had in income, and so we borrow that $439 billion from various sources (more on that below) – and that’s the Annual Deficit.
Deficits are nothing new
Since 1900 our federal government has had a deficit in all but 14 years – that’s 101 years of deficits. And THAT is what has created our National Debt of $19 trillion.
Modern day Presidents on Deficits and the National Debt:
Despite their campaign promises to balance the budget and reduce the National Debt, our Presidents and Congressional Leaders have accomplished very little on this issue. The Federal Debt has increased under every president in the 21st Century. (The last time the Federal Debt did not go up was in 1895!). Here’s the track record of the modern-day presidents:
- During the 1980’s President Reagan never once proposed a balanced budget for adoption by the Congress and deficit spending soared during his presidency and as a result the Nation Debt almost tripled from $907 billion to $2.6 trillion.
- During the 1990’s, President Clinton did have a budget surplus in the last 4 of his 8 years in office but the National Debt increased (slowly) from $4 trillion to $5.6 trillion during his administration.
- During the 2000’s President Bush ran a deficit in every year and increased the National Debt from $5.6 trillion to $10.5 trillion (caused primarily by the recession of 2001, reduced revenue from tax cuts and the wars in the Middle East).
- During the Obama administration, there was a deficit in every year and the National Debt increased from $10.5 trillion to $19 trillion (caused by the Financial Crisis of 2008-09 and the on-going wars in the Middle East.)
If there is a small amount of good news, it’s that since 2009 our deficits have been falling. But, they are projected to grow dramatically starting in 2017.
This recent temporary decrease in deficits from was due to:
- The economic recovery and growth in our GDP after the TARP spending;
- Increased revenue from economic growth and various additional taxes (from 2.1 trillion in 2009 to $3.4 trillion in 2015); and
- Winding down of the Middle Eastern wars;
- Relatively low increases in spending (from $3.3 trillion on 2009 to $3.4 trillion in 2015)
To whom do we owe the National Debt?
- About 37% of our $19 trillion in debt is owed to foreign governments and investors. We owe China $1.3 trillion and Japan $1.1 trillion – combined that’s about 13% of the total debt. We owe other international investors another $3.7 trillion.
- The rest of our debt (about 63%) is owed to private investors, other federal and local government agencies. (eg about 30% of the total federal debt is owed to the Social Security Trust account – more about that in another post).
The chart below only goes to 2011 and shows a National Debt of $16.4 trillion. As of February 2016, the National Debt is $19.2 trillion. Note the sudden increase in our Debt from 1980.
Why does this happen? The reasons are many:
- Deficits and National Debt are not new to America. We had a huge National Debt in 1778 because of the monies borrowed to fight the Revolutionary War. The Debt ballooned right after the Civil War and jumped again after WW I and WW II. But, from 1950-1980 the Debt grew only at the rate of inflation. Then as you can see from the chart above – starting in approximately 1980, the Debt grew exponentially.
- Simply put, our spending has been growing more quickly than our revenue. The income tax and corporate tax cuts in the 1980’s have largely remained in place and this has restricted revenue growth to a level considerably lower than the growth of spending.
- Some people do not believe that we should balance the budget. They believe that the Deficits are actually “investments” in our future and are therefore justified – as long as the cost of paying for interest on the debt if a relatively low percentage of GDP.
- Politicians are indebted to lobbyists who helped get them elected, and every lobbyist has their pet spending program. Speaking about spending cuts in general terms is appealing to everyone, but when it comes time to reduce or eliminate a specific program, the resistance grows. As a result, very few programs, once initiated, are ever curtailed.
How do we fix this?
In 1798, when the newly formed country had a significant debt following the Revolutionary War, Thomas Jefferson first suggest that a solution to this problem would be to add a balanced-budget amendment to our Constitution which would require that the government cannot spend more than its income. But that idea did not pass in 1798 and although politicians have regularly proposed it during their election campaigns, no such provision has been adopted by any Congress of either party. Oddly, such balanced-budget provisions have been added to the constitutions of 49 US States and the countries of Germany, Hong Kong, Spain, Italy and Switzerland – proving that it is possible to balance the budget of a government if there is a determination to make it happen. (Note: Most balanced-budget provisions make an exception for times of war, national emergency, or recession, or allow the legislature to suspend the rule by a supermajority vote.)
It’s popular rhetoric for politicians to suggest that they would fix this problem by just eliminating some federal departments entirely. But the fact is that you can’t eliminate the annual deficit even if you completely eliminate the Environmental Protection Agency ($8 billion) and the Department of Energy ($30 billion), all Food Stamps ($70 billion) and the Department of Education ($60 billion). Many people believe that these departments deliver some value and therefore would be opposed to shutting them down, but even if you closed them ALL the Annual Deficit would only be reduced by $168 billion. Which still leaves a deficit of about $271 billion using the 2015 data. But, the most recent projections are that given our current revenue and spending plans, our deficits will increase dramatically over the next 10 years.
The only way we can ever balance the budget is by having the Congress and the President work together to address the issue by:
- spending a lot less on ALL programs – including the so-called Mandatory / Entitlement programs; and
- growing the economy so that taxpayers – individuals and corporations – earn more and therefore pay more in income taxes; and
- revising and simplifying the tax code – to make it fair and easier to understand and comply with for everyone ; and
- raising income by means of additional taxes – such as a federal Value Added Tax (which most western countries have already adopted).
Of course two of these ideas, while financially sound, are hugely unpopular and no politician would ever be elected by suggesting them. Even if these ideas were to be proposed while in office, the same party would have to control the House, the Senate and the Presidency AND they would have to have the courage to overcome the objections of the lobbyists (the people who provide the political campaign financing to these politicians) who all want their programs to be protected. That’s why, politically, this is hard if not impossible.
The prescription above – like most prescriptions – has a bitter taste. Everyone knows that this is the cure to our problem, but in our current political climate, it is highly unlikely that we will take the medicine. Instead, our political leaders will rant about the problem and then, once elected, they will take credit, not for eliminating the deficit or the debt, but for simply slowing down its growth. That solves nothing.
This story does not have a happy ending.