U.S. deficit impact could be felt for decades

John W. Schoen Senior producer • Profile • E-mail

Tuesday’s report that the U.S. budget deficit will swell to $1.2 trillion in the current fiscal year isn’t a complete surprise. President-elect Barack Obama warned this week of "trillion-dollar deficits for years to come."

But the grim projection from the Congressional Budget Office has many taxpayers wondering: How much longer can we keep this up? And what happens if the government borrows too much?

The deficit has a number of causes: a shrinking economy has cut deeply into estimated tax revenues, hundreds of billions have spent bailing out the  financial system, and Congress has systematically failed to bring expenses and revenues in line.

With the economy still reeling, Obama and Congress are readying a recovery plan of tax cuts with new spending programs that could add another $775 billion to the deficit over the next few years.

Here’s what’s at stake for American taxpayers:

How long can the government sustain all this borrowing and spending?

The only honest answer: No one knows. For the past few decades, a number of economists, analysts and some members of Congress have been pressing to balance the federal budget; some have called it a national security issue. The U.S. has run an operating budget every year sinece 1961 except for 1999 and 2000. Meanwhile the economy has generally expanded, leading some to conclude that rising national debt isn’t a major problem.

Proponents of this idea argue that the overall level of debt is less important than its relationship to the size of the U.S. economy. If you’re carrying a $5,000 credit card balance with an annual income of $30,000, your debt load is going to ease considerably if you get a new job that pays $60,000. You could then double your debt and carry the same load on a percentage basis.

Has the government ever had to deal with this much debt?

Today, the national debt of $10.6 trillion is about two-thirds of the nation's $14.4 trillion gross domestic product. We’ve seen much higher: During World War II, the debt was more than double GDP.

But when the war ended, defense spending plunged and the economy surged, bringing the ratio back down to 60 percent by the early 1950s. That’s about where it was in the late 1980s and early 1990s before concerted efforts by Congress and the White House balanced the budget and cut that ratio below 60 percent. In the past eight years, heavy tax cuts and spending on the war and prescription drug benefits pushed the percentage back to the mid-60s.

That ratio is almost certainly headed higher. The congressionally approved bank bailout program will add at least $700 billion to the debt. Another $775 billion for the proposed recovery package would push the overall national debt closer to 85 percent of GDP.

Why are we doing this? If the deficit is so big, shouldn’t the government be trying to shrink it?

Over the long run, spending will have to be cut or taxes increased — or both. But in the short term, both of those moves would push the economy deeper into a recession that is already shaping up as one of the worst in decades.

The hope is that the government’s massive intervention can break a downward economic spiral that shows no signs of letting up. Falling home and stock prices have destroyed trillions of dollars of wealth, forcing companies and consumers to cut back. Job losses have further cut into spending and home buying, bringing more layoffs.

The flood of federal money will take time to work its way through the system; some programs will work more quickly than others. The Fed’s effort to push mortgage rates lower is barely under way, and rates already have fallen sharply. On the other hand, there’s evidence that banks are hanging on to much of the money they have received through the Treasury's so-called TARP program.

The gamble is that the economy will begin growing again and the government will recoup some of the borrowed money by selling off assets it is buying in the bank bailout program, bringing the debt-to-GDP level back down to (roughly) currently levels.

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