Government Budget

Budget Deficit Government Budget What are the consequences of an ever-burgeoning federal deficit and debt? Will there ever be a solution or compromise? One of the most hotly-contested issues in contemporary American political life is how to deal with the current budget deficit. Despite running surpluses during the 1990s, the current budget is widely considered out of control by both Democrats and Republicans.

The reasons for the deficit include two costly wars abroad and increased defense spending overall after 9/11; tax cuts, and the recent recession which required federal spending in the form of unemployment assistance and assistance to the states (who are legally required to balance their budgets); and less income tax revenue because of job losses. There also systemic factors that have contributed to high budget deficits (Amadeo 2012). Overall, "mandatory spending has increased.

Spending to pay benefits for Social Security, Medicare and other mandated programs has been more than $2.3 trillion a year since FY 2011" (Amadeo 2012). However, it should be noted that not all budget deficits are considered 'bad.' Contrary to the classical economic theory of his day (which advocated balancing a budget as part of austerity measures during a recession), the influential British economist John Maynard Keynes advocated the exact opposite.

"The classical economic theory as developed by John Maynard Keynes holds that in times of severe economic contraction in the private economy, it is permissible for the sovereign to go into debt and increase spending to compensate for the falloff in consumer and other private sector expenditures.

The rationale is that this short-term increase in the public debt will retard the rise in unemployment, limit the impact and duration of the economic recession and in the long run lead to overall better economic performance, with limited effect on the ratio of public debt to GDP" (Filger 2010). When a recession spirals out of control, the government must stimulate the economy with spending, otherwise people will continue to hoard money, not spend out of fear of losing their job, and the economy will continue to decline.

However, even Keynes believed that when the economy was relatively prosperous, it was essential to reduce the budget deficit. "Keynes also believed that in times of relative prosperity sovereigns should create budget surpluses. His belief was that booms and busts were an integral characteristic of modern capitalism, and that the accumulation of reserves during times of plenty would enable governments to engage in temporary deficit spending to combat a severe recession" (Filger 2010).

When the government is engaged in deficit spending, it must borrow more from both the public and private sector. One current concern is the fact that China 'holds' so much U.S. debt, despite the fact that U.S. And Chinese interests are far from synonymous in terms of foreign policy, human rights issues, and Chinese business practices. Large amounts of debt also mean that a country is paying high interest payments, which is money that is not invested back in the country and causes little profit in the long-term.

This means that later generations must pay higher taxes and that there will be a further drain on the economy in the future in the form of high interest rates. "If the govt sells more bonds this is likely to cause interest rates to increase. This is because they will need to increase interest rates in order to attract investors to buy the extra debt. If govt interest rates increase this will push up other interest rates as well" (Economic effects of a budget deficit, 2012, Economics Help).

The government must always weigh the risks of not spending at a deficit during a recession with the risks of allowing the recession to fester, generate more unemployment in the long-term, and further destabilize the economy. It must also contemplate the risks of not spending money on vitally important social and economic programs, such as education, versus the risks of the deficit. Many economists believe that "on a year-by-year basis, a budget deficit is not really a concern. The U.S.

government is like the world's best customer -- it buys a lot, and since its economy has been one of the world's strongest, it has always paid the debt back. However, as the debt continues to increase, eventually someone, somewhere, will get antsy and start to demand their money back. This is exactly what happened to create the eurozone debt crisis" (Amadeo 2012). Given the recent downgrading of the U.S. credit rating, this is not merely of a theoretical concern, but could pose a real threat.

"Ratings firm Egan-Jones cut its credit rating on the U.S. government to AA- from AA,.. The firm said that issuing more currency and depressing interest rates through purchasing mortgage-backed securities does little to raise the U.S.'s real gross domestic product, but reduces the value of the dollar" (U.S. credit rating cut by Egan Jones Again, 2012, Reuters). Of the two current candidates, "Obama's goal is more restrained; he wants to keep deficits from growing faster than the economy" or the rate of GDP by using spending caps.