As we move toward the March deadline for raising the national debt ceiling and the accompanying debate over how to deal with federal spending, it is worth knowing just where our tax money goes and who holds our federal debt. The common, but erroneous, belief is that we are mostly in hock to China (accompanied by a concurrent myth that China could bankrupt the U.S. by calling in all our debt at once).
This graph from Connect the Dots USA (a great place to find economic data in graphic form) shows, though, that nearly a third of our debt is owed to U.S. government trust funds including Social Security and Medicare, a bit more than another third is owed to U.S. investors and a final third is owed to other nations. The biggest single chunk of debt we owe is $2.7 trillion to the Social Security trust fund, which is invested in special government securities (effectively, the government has “borrowed” the money from Social Security, issuing bonds that are not negotiable on the open market, but instead are promises by the treasury to pay back all principle and interest to the fund).
Despite all the talk about China virtually owning us, that nation holds only some $1.16 trillion or 7% of our national debt, about the same as that held by our close ally, Japan. State and local governments and pension funds hold as much of the debt as China does. For instance, CalPERS, the pension fund I’m a member of, holds some $22 billion of U.S. bonds and treasury notes. Moreover, the world economy being what it is, U.S. treasuries are seen as the safest place for big investors (especially foreign countries) to put their money. Our debt grows because the federal government spends far more than it takes in in taxes. In 2012, taxes were about $2.45 trillion, spending was about $3.64 trillion. The other $1.19 trillion we had to borrow. The interest alone we paid on our debt last year was $247 billion, about 7% of the total federal budget.
Back in 2001, we actually had a balanced federal budget, spending only as much as we took in in taxes. Why did that change? Economist Paul Krugman summarizes the causes of increasing debt: “What happened to the budget surplus the federal government had in 2000? The answer is three main things. First, there were the Bush tax cuts, which added roughly $2 trillion to the national debt over the last decade. Second, there were the wars in Iraq and Afghanistan, which added an additional $1.1 trillion or so. And third was the Great Recession, which led both to a collapse in revenue and to a sharp rise in spending on unemployment insurance and other safety-net programs."
Here’s another chart showing all the major sources of continuing deficits through 2019. The biggest continuing piece is the Bush tax cuts, with the ongoing economic drag of the Great Recession a somewhat distant second.
So, the debt ceiling. U.S. law requires that the government not spend more than it takes in. Since for years spending has exceeded taxes, the rest has come from borrowing. Early on, Congress authorized each individual increase in borrowing. With the advent of World War I, Congress shifted to a general debt ceiling that allowed ongoing borrowing as long as it remained no higher than that ceiling. Increasing the debt ceiling allowed the government to continue to borrow enough to pay its debts (or at least the interest on these debts). For most of subsequent time, increasing that ceiling was a formality, hardly debated.
In 2011, the issue grew heated as Republicans in Congress initially refused to pass a debt ceiling increase without a concomitant reduction in federal spending. President Obama strongly responded that the debt ceiling had to be increased or else the U.S. risked defaulting on its debts, something, he said, that would damage the U.S.’s world economic standing. Finally in June of that year, Congress and the president agreed to a debt ceiling increase that included some spending cuts, though not enough to satisfy the staunchest of conservative deficit hawks. Even so, the bond rating agency Standard & Poors cut the U.S.’s credit rating for the first time ever, and the stock market plunged 5.6% in one day.
Should we replay this battle in March, when the debt ceiling will next need to be raised? I’d say that anything even remotely resembling the 2011 debt ceiling battle will bring economic troubles at least as great as in 2011. Since President Nixon ended the U.S. currency’s connection to gold (the gold standard) in 1971, U.S. money has been based solely on the full faith and credit of the government as defined in Article IV, Section 1 of the United States Constitution. Essentially, we are trusted to pay our debts as long as we are good for them. (That’s, perhaps, a tautology, but without something else valuable to back up our currency, our trustworthiness is all we have.) 2011 showed just how fragile that full faith and credit can be.
So it comes to this: with a debt ceiling increase, our debt will rise by about 8% a year in the near term, that’s unpleasant, but it gives us time to bring spending back in line with revenues. Growth in the economy will give us more breathing room and enough new income to continue to pay our bills with less borrowing. Without a debt ceiling increase, we will have to decide immediately how to cut federal spending by a third, instantaneously wiping out all funding for discretionary items like, say, the entire defense budget, along with our ability to pay the interest on the debt we already owe, all the while warring over the efficacy of huge cuts to Social Security and other entitlements.
Neither choice is pretty, but that’s where it is.