In this installment of my series on the national debt I explain why the national debt matters.

The U.S. government owes a whole bunch of people a whole lot of money. Is this a problem? Well, like most things macroeconomic, the answer depends. Generally speaking, there are two things about which to be concerned when the federal government carries debt.

The first cause for concern is interest rates. When the government borrows money, it borrows from the same marketplace as everybody else in the economy. The U.S. government, however, is a bit different from every other borrower - it borrows massive amounts of money each year. In 2005, it borrowed about $300 billion from the public.

Money can be thought of like any other good in the marketplace; the less there is, the more expensive it becomes. However, instead of calling it "price", the price of money is called the "interest rate." When the government, or any other borrower, obtains funds from the money market, it reduces the quantity of dollars available to everybody else. This drives up the price of borrowing money - interest rates rise.

Now, when theFederal Reserve Board decides that the economy is growing too quickly and fears that rapid inflation will set in, the Fed uses what powers it has to raise interest rates in an attempt to slow the economy down. Conversely, during a recession, when the economy shrinks and unemployment levels increase, the Fed lowers interest rates. The Fed attempts to control the economy through setting interest rates. National debt has the exact same effect on the economy; federal borrowing of money can raise interest rates thereby restraining the growth of the economy.

The second problem of the government carrying debt is the same problem that afflicts anybody who carries debt - it costs money to have debt. For every dollar of debt that the government carries, it has to pay someone for the privilege of owing them money. This cost, as mentioned above, is known as the interest rate.

The U.S. government is bound by law to make payments on the interest on the debt that it owes. The more debt the government carries, the more interest payments it has to make, the less money that could be used to fund other things (or even lower taxes). In 2005, the government spent $184 billion paying interest on the national debt. Consider: non-defense, discretionary spending in 2005 was $465 billion; interest on the national debt represents 40% of that. Consider also that in 2005 the federal government spent a total of $2.5 trillion, and of that amount about 7.5% was spent on paying for interest on the national debt.

For these two reasons, it makes sense to avoid national debt. There are, of course, many nuances to this discussion, centered around what levels of debt are OK and what are not; when is it better to incur debt than not; and other macroeconomic factors that influence and counteract the effects of a national debt.

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Next: What is the national debt?

(This is part II of a continuing series on the national debt. Part I can be found here)

In today’s Washington Post, Robert Samuelson chides President Bush for boasting about a $300 billion deficit, but finishes his column by shifting some of the blame for the atrocious fiscal policies of the Republican Congress and President to the Democrats.

For fiscal 2006, which ends in September, the administration projects a $296 billion deficit; for fiscal 2007, the estimate is $339 billion. How could anyone boast about that? [...]

I have reserved my harshest scorn for Republicans, who are (after all) in power. But Democrats aren't much better. The nub of the matter is spending. When Republicans passed the Medicare drug benefit -- the biggest new program in decades -- Democrats actually advocated a more costly version. Whenever anyone suggests curbing spending, Democrats screech: Spare Social Security and Medicare. But Social Security and Medicare are the problem.

Just as Republicans now say their policies have cut deficits, Democrats contend their policies produced budget surpluses from 1998 to 2001. Nonsense. Those surpluses resulted mainly from the end of the Cold War (which lowered defense spending) and the economic boom (which created an unpredicted surge of taxes).

Nonsense, indeed. Mr. Samuelson’s treatment of Democrats with respect to the current fiscal situation omits several critical facts that completely undermine the thesis that Democrats should share blame for the current budget deficit: Democrats support PAYGO, Democrats are willing to raise taxes, and Democrats are not in power.

Firstly, Democrats support fiscally disciplined "pay-as-you-go" rules, or PAYGO; Republicans do not. PAYGO rules require that increases in spending or decreases in revenue be matched with offsetting revenue or spending measures. These rules were in place until 2002; the same year that the federal budget flip-flopped from surplus to deficit.

Republicans have consistently thwarted Democratic attempts to re-implement PAYGO to restore fiscal discipline. The most recent and salient example of how Democrats and Republicans fundamentally differ is the recent Senate Budget Committee passage of Sen. Judd Gregg’s (R-NH) Stop Overspending Act 2006. By a party-line vote, Republicans defeated ranking committee member Sen. Kent Conrad’s (D-ND) attempt to attach a PAYGO amendment to the bill.

Another significant difference between Democrats and Republicans with respect to the budget is the Republicans’ rigid opposition to tax increase (and conversely, their unquenchable thirst for tax cuts). Mr. Samuelson likes to thrash the spending policies of Democrats, but fails to appreciate their preferred tax policies. Mr. Samuelson attributes the surpluses of the 90s to defense spending cuts and a booming economy. While both of these things occurred, you can see on the chart below that defense cuts are only a fraction of the story. Where that red line begins a precipitous drop is the same moment when President Clinton and a Democratic Congress raised taxes in 1993.

And finally, the Democrats control nary a branch of the government. So, it seems quite odd that Mr. Samuelson lays any of the blame of the budget deficit on the Democrats. He cites their support for a more expensive Medicare drug plan - a plan that didn’t pass Congress - as part of the reason why Republicans pass such expensive spending measures and refuse to find revenue sources for those measures. Yet, somehow, because Democrats voice opposition to spending cuts in Medicare and Social Security, - never mind that these two programs are wildly popular among all Americans, red and blue state alike - we are saddled with unending budget deficits. This is a bit of Mr. Samuelson’s logic I truly fail to grasp.

While the economy, as Mr. Samuelson asserts, "has little to do with the White House's economic policies", PAYGO rules and tax policy are fully controlled by the federal government. So, while the Democrats cannot take credit for the booming economy of the 90s, they can take credit for the federal budget policies that lead to the surpluses of the 90s. Blame for the train wreck that is our federal budget can be put squarely on a Republican Congress and President that have no appetite to raise taxes or to implement budget rules that force fiscal discipline.

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A reader writes:

Isn't the national debt a better picture of our fiscal condition?

Where's the good news? Doesn't the administration simply have more payroll tax money, etc., to mask the debt situation?

Excellent questions indeed and an excellent prompt to talk about the national debt. But, the discussion is a bit lengthy for a single post, so I’m going to start a series of posts about the national debt.

There’s been a lot of talk about the deficit lately (it’s getting smaller, tax cuts don’t pay for themselves, etc.), but absent from the discussion is the national debt. However, implicit in discussions about the deficit is the concern that deficits grow the national debt. So, let’s talk about the debt.

When President Bush took office in 2001 the national debt was $5.8 trillion, at the end of this fiscal year (September 30), that number will be $8.5 trillion. Since taking the helm of the nation’s finances, Mr. Bush increased total debt by 47%. President Clinton, on the other hand, presided over a 26% increase in total federal debt ($4.4 — $5.6 trillion). President Reagan increased nominal national debt by 113%.

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But these numbers are somewhat misleading because they do not account for inflation. A more helpful way to understand national debt is to measure it in context of the size of the overall economy. Measured in these terms, Mr. Bush has increased national debt from 57.4% of GDP to 63.7% (projected). That’s an 11% increase. President Clinton’s are significantly better. Under Mr. Clinton, the national debt actually shrank - from 66.2% of GDP to 58%.

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Next: Why the national debt matters

When the president repeats his mantra "cut the deficit in half by 2009", one could reasonably assume that the downward trend in deficits would continue past 2009 - as if "half in 2009" was a milestone of sorts. But, au contraire! The "half in 2009" is not a just a milestone but a turning point - the point where deficits start growing again. It’s right there in black and white in the president’s FY2007 budget, but it’s starkly absent in his speech.

From page 223 in the Analytical Perspectives document of the President's FY 2007 Budget:

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Is Bush is aware that many, many more people hear his words than read his budget? Perhaps he should tell the whole story when speaking and not assume that his audience is familiar with the relvent material. I'm just saying...