When a national government, such as the federal government of the United States, spends more money than it takes in from taxes, tariffs, and other revenue sources it must borrow from the private sector to meet its financial obligations. If this goes on year after year the accumulated debt is referred to as the national debt. The national debt includes not only the money the government has borrowed, but also the interest it must pay on the borrowed money. The U.S. government, for instance, finances its deficit spending through the issuance of IOUs in the form of Treasury bills, notes, and bonds. Deficits not paid by the end of the fiscal year must be carried over to the next year. If this practice continues year after year with the government borrowing money not only to meet expenses but also to repay interest and principal from previous years the national debt soon balloons. The terms "deficit" and "debt" are sometimes used interchangeably, but are not the same thing. Spending more money in one year than revenues for that year results in a deficit or deficit spending. If deficit spending is allowed to go on year after year the result the large accumulated debt becomes known as the national debt.
The idea of a national debt is controversial with some economists and government officials, who argue that there is nothing inherently wrong with federal government expenditures exceeding revenue. Others, however, find the idea abhorrent and the height of fiscal and political irresponsibility. The debate over deficit spending and a resultant national debt is not new to American economic history and goes back to the beginnings of the country. In 1781 Alexander Hamilton wrote a letter to a friend in which he discussed government spending. "A national debt, if it is not excessive, will be to us a national blessing," Hamilton wrote. Thomas Jefferson, however, took quite a different view. Jefferson said that public debt was a danger and to be greatly feared. In 1798 he wrote a letter to his friend John Taylor in which he addressed amendments to the constitution. "I mean an additional article taking from the government the power of borrowing," he wrote.
Many Americans have always lived under federal deficit spending and a national debt, especially those Americans bom after the 1930s. But federal deficit spending and the national debt are not unique to the twentieth century. According to economist Alan Murray, in the 150 years prior to 1932 the federal budget was balanced or showed a surplus in two of every three years. Hamilton, as stated before, favored deficit spending and thought that the ability of a country to borrow and invest made economic sense for the country and its citizens. Jefferson, however, took a more moralistic view and believed public borrowing was akin to public corruption. America's wars have always been costly, have always strained the federal budget, and they have always been financed through deficit spending. Andrew Jackson loathed public borrowing and quickly eliminated the debt leftover from the War of 1812. The Republicans likewise quickly rid the United States of its Civil War debt. In fact the fervor with which these Civil War debts were retired prompted a British diplomat to write back to England: "The majority of Americans would appear disposed to endure any amount of sacrifice rather than bequeath a portion of their debt to future generations." Thus Americans in the past were willing, albeit reluctantly, to endure deficit spending for reasons of national sovereignty, but once the crisis had passed every effort was made to retire the debt as quickly as possible.
This view of deficit spending and national indebtedness changed dramatically when the federal government began following fiscal policies set forth by the British economist John Maynard Keynes. In 1936 Keynes published his General Theory of Employment, Interest, and Money. In doing so he replaced Adam Smith, the 18th century British economist who wrote The Wealth of Nations, as the world's most influential economist. Smith believed in a balanced budget, but when this was unavoidable any resultant public debt should be paid off as quickly as possible. Smith also believed that an "invisible hand" was always at work in capitalist economies and working to correct market place shortcomings sans government interference. Keynes conversely believed that under certain circumstances Smith's "invisible hand" did not work or worked to slowly. During a depression, for instance, people do not spend money to purchase goods and services because there are not enough workers with disposable income. This causes companies to lay off more and more workers who likewise cannot spend money they do not have. Keynes' solution for breaking this cycle calls for the government borrowing and government spending to "kickstart" the economy.
Upon arrival in 1936 Keynes' theories did not, as is commonly believed, have much affect on the fiscal policies of the Roosevelt administration and America during the Great Depression. In fact Roosevelt found Keynes to be "a little wacky." It wasn't until after World War II that Keynesian economics took hold in the United States. Keynes believed that economic cycles—periods of inflation and periods of recession/depression—could be obviated by the government reducing the money supply (cooling inflation) or by the government borrowing and spending money (boosting the economy.) Keynes saw nothing wrong with government borrowing because in essence it borrowed from itself—from the citizens and institutions that make up the nation and the body politic. This is unlike a family or a business that cannot borrow from itself—it must borrow from outside itself. Following World War II federal fiscal policy under the influence of Keynesian economists, became, for the first time in America's history, aimed at something other than eliminating a war induced national debt. Keynes' ideas became "… commonplace, at least in Democratic administrations," according to Murray. "By the time of the Kennedy and Johnson administrations, Keynesian-trained economists enjoyed considerable influence in the executive branch, offering advice on how to use budget deficits to spur the economy in times of weakness," Murray continues. Republicans generally preferred economic policies that came to be known as "supply-side economics."
Because of the unpopularity of imposing higher taxes to finance military spending during the Cold War, deficit spending returned by the 1960s. Lyndon Johnson, for instance, was loathe to raise taxes to finance the Vietnam War and his Great Society social programs. Although it must be said that America's last budget surplus was in 1969 during the Johnson administration. During the 1980s the Reagan administration simultaneously cut taxes and further escalated military spending causing the national debt to continue to grow. By the end of 1981 the national debt had risen to an all time high of $1 trillion; five years later it had doubled. The 1985 Gramm-Rudman Balanced Budget and Emergency Deficit Control Act, which set ceilings on the national debt beyond which the government could not borrow, failed to eliminate deficit spending.
By 1995 the national debt had grown to more than $4 trillion. That figure represents the amount of accumulated deficit since 1969, the last year the federal budget operated in the black (a budget surplus was expected in 1999 but as of this writing it was only a projection.) Not only has the national debt gone unpaid from year to year, but each year since then, the federal government has overspent, forcing it to borrow with interest. In fiscal year 1995, for instance, the federal government overspent by more than $192 billion with billions more in interest added to this sum. In 1995 the accumulated national debt was $4,961,529,000,000.
In 1998 the Congressional Budget Office released a study entitled Long-Tenn Budgetary Pressures and Policy Options, which predicts America's economic situation well into the 21st century. The report was analyzed by N. Gregory Mankiw for Fortune. According to Mankiw, the report predicts that the next few decades will show approximately balanced budgets if not a few years with small surpluses. Government debt is likely to drop from today's 47 percent of Gross Domestic Product (GDP) to about 17 percent by 2020. After 2020, however, America's baby-boomers will start drawing on entitlement programs, especially Social Security, Medicare, and Medicaid. Currently these programs are 8 percent of GDP, but by 2040 they are expected to be 17 percent of GDP. While federal government receipts will remain constant at 20 percent of GDP by 2050, the government debt is expected to be 206 percent of GDP, higher even then the national debt at the end of World War II. After 2050 the debt is expected to continue to increase. The solution, according to the Congressional Budget Office is an immediate 8 percent cut in spending or an 8 percent increase in taxes. "Frightening though that solution is, what's even worse is the probability that no one will act on it," Mankiw writes.
[ Michael Knes ]
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Coy, Peter. "Debt is Shrinking. Is That Good?" Business Week, 22 February 1999.
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Mankiw, N. Gregory. "Government Debt: A Horror Story." Fortune, 3 August 1998.
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Thompson, Kenneth W. ed., The Budget Deficit and the National Debt. New York: University Press of America, 1997.