Debt vs. Deficit

I know a bit about economics. I’ve taught it to undergrads at San Francisco State and Stanford, and I’ve created five online economics courses (including one for Dartmouth and two for the University of Chicago). So Rachel Maddow is killing me every time she says extending the Bush tax cuts to the richest segment of our population will add $700 billion to the deficit. She says it in this clip, about 45 seconds in:

Rachel is mixing up the deficit with the debt. That’s a big mistake — and a rookie mistake, at that:

  • The deficit is the amount government spending exceeds revenue in a given year.
  • The debt is the total accumulation of annual deficits (and surpluses) over our nation’s history.

Suppose a country had been around for just five years. If it ran deficits of $100 million in each of those five years, it would now have a debt of $500 million.
Extending Bush’s tax cuts for the rich is projected to increase our national debt by $700 billion over the next ten years. When Rachel said deficit instead of debt, though, she was saying that’ll happen in a single year. And since the tax cut would be ongoing, people might think it would add $700 billion to the deficit year after year, increasing our national debt by $7 trillion over the next decade.
That would be wrong.
It’s important to get this right. I favor extending the tax cuts for the poor and middle class, but not for the rich, and here’s why:
1. Deficit spending makes sense during a recession, especially a severe one.

  1. Tax revenues fall during a recession (because personal and corporate income has fallen, which leads to less income tax revenue).
  2. Right now we need people out there buying things, so businesses have reason to hire more employees.
  3. If the government lowered spending to match its lower revenues, we’d end up with even fewer things being bought, which would worsen the recession.
  4. That’s why the government increases spending in bad times — more purchases means higher employment, and then those newly-employed workers start purchasing more stuff themselves, which means still higher employment, and we find ourselves in an upward economic spiral instead of one going down.
  5. Thus, lower taxes and higher spending make sense during (some) recessions.

2. The deficit is now dangerously high.

  1. Yes, we need to be running a substantial deficit now, but we don’t want to keep doing that when the economy is stronger.
  2. A high deficit means the government is borrowing lots of money that year.
  3. In order to raise more and more money, the government has to pay higher and higher interest on the money it borrows, which raises interest rates across the whole economy.
  4. This make it harder for businesses to borrow the money they need to expand production and employment.
  5. That’s not a problem right now, but it will be once the economy starts to recover and businesses want to invest.
  6. High interest rates also discourages consumers from buying big-ticket items like cars, homes, and major appliances.
  7. Yet it looks like our deficit will just go on and on and on, especially if we implement long-term tax cuts.

3. Because the deficit is so big, we should only increase it if the economic pay-off is huge.