Impact of the National Debt on The Overall State of the Economy

1) Public v. Private debt- 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 Power- 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 Incentives - 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 Rates - 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 1990.

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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