Federal Spending, Debt, and Deficits

Most of us are taught at a young age that we should avoid spending money that we don’t have.

We are taught to earn and save our money, and to only borrow money as a last resort. Indeed,

even as adults most of us believe that debt, or something owed by one party to another,

is a negative thing. However, the truth is more complicated, especially with regards

to governments. In this tutorial, we will be looking at how governments spend their money, and

where they get money from if they don’t have it. Government spending meets a wide variety of needs.

It covers the costs of resolving conflicts, defending a society from other societies,

and provides public services that benefit the entire population. Ideally,

all government spending is funded by taxes, or required payments to the government. We

will learn about the different types of taxes in the next tutorial, but it is the case that

literally anything can be taxed, and some things can seem arbitrarily taxed. However, most citizens

accept that taxes are a necessary way to fund the government, whether they like paying them or not.

But what if the government doesn’t receive taxes to pay for all its obligations? Well just as

individuals must borrow money to pay for things they cannot afford, governments often do the

same. Whenever a government can’t pay for all its obligations in a given year, this creates

a deficit, or shortfall of money in a given period. If a government gets more tax revenue

than it needs for obligations, this creates a surplus, or excess of money in a given period.

When the government borrows money, it doesn’t go to a bank and apply for a loan like we do.

It usually sells securities to individuals, businesses, governments of other countries,

and even domestic government organizations. These securities go up in value and can be cashed out at

a later time, so the deals are usually a win-win. For example, say you want to loan money to your

government. This isn’t an act of charity, it’s an investment. Say you buy a savings

bond from the federal government. Years later, you can cash in this savings bond with interest,

meaning you made money from the purchase. Government borrowing generally only includes

borrowing from the private sector of an economy. In most countries, the big holders

of government debt hold it in pension funds, which invest in government debt on behalf of the

individual members. Whenever you hear that your government is in debt to other countries, this

is a misleading statement. Your government is in debt, first and foremost, to individuals who are

making money off the fact that governments need more money than is coming in from tax revenue.

With that said, most economists agree that too much government debt is indeed a bad thing. Too

much debt can decrease the confidence in the currency of a country, which in turn could lead

to inflation. As a national debt increases, the likelihood of the government defaulting on its

debt obligations increases. Defaulting on a loan just means failure to pay it back. Another concern

of rising debt is increasing interest rates on government securities. If more and more people in

the private sector view loaning money to a country as risky, interest rates will go up, and in turn

prices will go up. This will also cause interest rates to go up in other lending markets as well.

Economists often use the debt-to-GDP ratio as a metric when examining whether a particular

country is able to pay back its debt. The debt-to-GDP ratio measures the

ratio between a country’s government debt and its gross domestic product, or GDP,