Federal Spending and National Debt

The Effects of Federal Spending and Federal Debt

The federal government spends
an enormous amount of money each and every year. In 1998 the
government spent over 2 trillion dollars. Clearly spending of this
nature will have a significant impact on the American economy.

The government spending impacts
the economic in the following ways:

  • It affects the allocation
    of resources – where government programs are created or bases
    built redistributes capital. If we close a base in Podunk and open
    one in Tuskegee the citizens in Podunk lose a substantial form of
    income. Likewise choosing one government contractor over another
    or building roads in one area over another has dramatic impact. In
    the case of agriculture this may mean price support legislation
    that impacts on different areas of the country.

  • Affects the distribution of
    income – Income for the poor is directly effected by changes in
    transfer payments. Taxes have what I call the Robin hood
    effect. They take from the rich and give to the poor. This is
    redistribution of wealth and income. Government expenditures
    effect the income of individuals depending on the contracts the
    government enters into. Base closings, factory closings

  • The government may compete
    with the private sector – Government run hospitals, other health
    departments that compete with private facilities are an example of
    such competition. While this competition may not always be a
    positive externality it may be. On the negative side said
    government run facilities may force private employers out of
    business because private firms need to operate in terms of profit
    and loss and the government run facilities have no such
    consideration. On the positive side, however, having government
    run facilities compete against the private sector may create the
    kind of competition needed to improve services.

When the government spends more
in a given year then it takes in that means there is a
deficit. When this deficit is carried over from
year to year it is a debt.
In 1900 this nation was basically debt free, approximatley 2 billion
dollars which is an inconsequential figure, even in those days. In
1929 the debt was 16.9 billion and when the Depression began and
World War II occurred the United States under Franklin Delano
Roosevelt began true deficit spending. All of those New Deal programs
were paid for with money we did not really have. The debt in 1940 ran
to 42.9 billion and mushroomed to 258 billion as the nation foughjt
World War II. From 1945 through 1961 the debt grew minimally,
increasing to only 296 billion in 1961. When one factors in
inflation this means the value of the debt declined significantly.
Even through the 1960s and 70s which included Vietnam, the space race
and the arms race the debt only grew modestly increasing to 789
billion in 1979. This was still a relatively low and manageable
amount factoring inflation and growing GNP. Our real debt problems
began during the Ronald Reagan administration. In 1981 Reagan passed
the Emergency Recovery Tax Act that lowered taxes but increased
spending, especially on the military. This basically created an
enormous debt. nder the Reagan administration the debt grew from 930
billion in 1980 to 2.6 trillion dollars in 1988. This means the debt
grew 300% in eight years after only growing about 150% from 1950 to
1979. In 1997 our national debt reached 5.4 trillion and only
during the economic boom during the Clinton administration did it
slow. In 1998 the debt was 5.5 trillion, in 1999 it was 5.6 trillion
and was the same in 2000. Since the election of George Bush the debt
has begun to rise again. In the four years the Bush has been in
office, and again cutting taxes while increasing spending, the debt
has risen from 5.8 trillion in 2001 to its current high of over 7
trillion dollars. (all figures available at

The federal deficit affects the
federal budget in a variety of ways. Deficit spending is spending
more than is collected in revenues. Sometimes a deficit is planned by
the government, or sometimes it occurs because factors in the economy
have reduced the amount of revenues or increased the amount of
expenditures. In 1994, the government predicted a $264 billion
federal spending deficit. From where it stood in 1993, the government
said that the economy could go one of two ways. It could either be
stronger than expected meaning that the federal revenues would go up
and expenditures, thus cutting the deficit. Or the economy could be
weakened and tax collections would decrease. People would lose their
jobs, and unemployment compensation would rise, thus increasing the
deficit. In recent economic history, it seems as though deficits tend
to appear more frequently than surpluses. The largest deficits
occurred during WWII, and throughout the 1980’s with the
implementation of Reaganomics. When the government runs a deficit, it
must borrow money from others in order to finance the shortage of
income. Generally this is done by having the Department of the
Treasury sell bonds and other forms of government debt to the public.
If all federal bonds and other debt obligations are added up, then
there is a measure of the federal debt. This debt increases whenever
the government sells more bonds to finance deficit spending in a
given year. It will continue to grow as long as the government spends
more than it collects in revenues. Therefore, if the government turns
up a zero budget deficit one year, that doesn’t mean that the debt
will go away, instead it means that it won’t get any larger.

There are many ways in which
the national debt can affect the overall state of the economy.

Public v. Private
– Public debt
is where we owe most of the federal debt to ourselves whereas private
debt is owed to others. One of the fundamental differences between
the two is that when a person goes into debt by borrowing money from
a bank there is then established a repayment system or agreement.
When the federal government borrows money, however, it gives little
thought to how it will be repaid, let alone when. Yet in all
actuality, there is no real reason as to why the government would
have to pay off the federal debt. When it is time to pay off old
bonds, the government issues new ones. Another difference between the
two types of debt has to do with the loss of purchasing power. To an
individual who borrows money, they sacrifice a good portion of their
purchasing power because the money is gone and cannot be used to buy
more goods and services. When the federal government repays a debt,
there is no loss of purchasing power because the taxes and revenue
collected from some groups are then transferred to others.

2) The Distribution of Income
– Theoretically
speaking, if the government borrows money from the wealthy, and as a
result the burden of taxes falls on the middle class and the poor,
taxes would be transferred to the rich in the form of interest
payments on the debt. If the government borrows money from the middle
class instead, and if the burden of taxes fall on the rich, those
taxes would be used to make interest payments to the middle class.
The federal tax structure determines the distribution effects.

3) A Transfer of Purchasing
– Federal debt
causes a transfer of purchasing power from the private sector to the
public sector. As a rule, the larger the public debt, the larger the
interest payments, hence the more taxes needed to pay them. As a
result, the public has less money to spend on their own needs.

4) Individual
– taxes
needed to pay the interest can cut down the incentives to work, save,
and invest. Individuals and businesses might feel less inclined to
work harder and earn extra income if higher taxes will be placed on
them. Many people feel that the government spends taxpayers’ money in
a heedless manner. If people feel that their taxes are being
squandered, they are less likely to save and invest.

5) Higher Interest
– When the
government sells bonds to finance the deficit, it competes with the
private sector for scarce resources. At times there is the
crowding-out effect Private borrowers are forced to pay the higher
rates or leave the market. The increased demand for money causes the
interest rate to go up. This increases forces borrowers to either pay
higher rates, or to stay out of the market.

In recent years there have been
many attempts by the government to bring the federal deficit under
control. One of the first actions taken by Congress was the
Balanced Budget and
Emergency Deficit Control Act of 1985,
or Gramm-Rudman-Hollings (GRH) that tried to mandate a balanced
budget. The central idea in the GRH was a set of federal deficit
targets for Congress and the President to meet over a six year span
of time. The federal deficit was to decrease each year until it
reached zero in 1991. If in event, Congress and the President could
not concur on a budget that met the target in any given year, the
automatic reductions would take over and reduce spending. Splitting
reductions equally between defense and non defense expenditures would
do this. This law was popular among legislatures because it reduced
spending without forcing Congress to vote against popular programs.
Yet in the long run, the GRH failed, leaving the country with a
deficit of $269.5 billion in 1991. The reasons behind it were simple.
First, Congress discovered that there was a loophole in the law that
allowed it to pass spending bills that took effect two or three years
later. Because the GRH only set the deficit estimate for one year at

a time, these bills didn’t conflict with GRH. Secondly, in July of
1990, the economy began to decline. This triggered a safety valve in
the law that suspended automatic cuts when the economy was weak. The
combination of spending bills that encompassed GRH, the suspension of
automatic budget cuts, and the lower federal revenues caused by the
declining economy all added to the enormous budget deficit. As a
result, a balanced budget never occurred. Another piece of
legislation passed by Congress was the Budget Enforcement Act (BEA) of
. The main
attributes to this law were the act of combined spending caps with a
“pay-as-you-go” provision in attempts to limit discretionary
spending. Under this provision, reduction somewhere in the budget had
to counteract any new program that required additional spending. The
BEA also required that five-year revenue estimates be prepared for
each new legislative act. If offsetting cost reductions could not be
found, then across-the-board spending cuts would be made to offset
the extra costs. Though the BEA was harder to get around than the
GRH, it was limited by several provisions. First, it applied only to
discretionary spending, therefore excluding Social Security and
Medicare. Second, it included a safety provision that allowed for
suspension of the act if the economy enters a low-growth phase, or if
the President declares an emergency. A third piece of legislation was
the Omnibus Budget
Reconciliation Act of 1993
. Designed by President Clinton, this Act was an
attempt to trim approximately $500 billion from the deficit over a
five-year period. With the enormously high deficit in 1993, the act
was intended to reduce only the rate of growth of the deficit. The
major provisions of this package were tax increases and spending
reductions. The program made the personal income tax even more
progressive, and targeted the richest percentage of Americans for a
tax increase.

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