Why The Federal Budget is Not Your Household Budget

by shaun

Well, we made it through the debt ceiling. Sort of. There was a large budget cut (make no mistake, 1 trillion dollars is a lot of money), but small in the overall scope of things. Is our debt long-term solvent? No, not by any means. Is right now the time to make it so? Most all economists assert absolutely not. So, a lot of the plans proposed by moderates in the U.S. Congress have been centering on plans that make short-term deficit spending now, while reducing the overall cost curve and lowering deficits in the next 5 or so years, after the recession has passed.

All that said, I’ve seen this quote by Dave Ramsey make some headlines, and thought it worth discussing:

If the US Government was a family, they would be making $58,000 a year, they spend $75,000 a year, and are $327,000 in credit card debt. They are currently proposing big spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget and debt, reduced to a level that we can understand.

The quote is, for all intents and purposes, mathematically correct, but insinuates a misleading principle. That principle is this: that federal budget is like, and should be compared to, our personal household budget. The argument goes that the U.S. government should manage its debt and budget like you or I do.

The argument has emotional appeal, for sure – with money being tight, and the middle class squeezed more than ever, why shouldn’t government cut back? Why shouldn’t we reduce the level of services (an important thing to remember is “government spending” is, in essence, public services) just like I’m reducing the amount I spend? It makes sense emotionally. Does it logically?

Not really. Here I’ll lay out a few reasons why the argument, when under scrutiny, doesn’t hold water.

1. Families Don’t Issue Their Own Currency

If my family was in debt, and I was the same as the federal government, I then plausibly could just call up my nephew Mr. Treasury, print off the exact amount of money I was in debt for, and pay it off. Secondly, all government IOUs are accepted as payment; it usually spends by crediting bank deposits, then cash, then Treasury bonds. So, if I were the government, I could just issue a Shaun bond, and pay off my debt that way. Unfortunately, I can’t.

2. Inflation Drives Affordability

If you and I run out of money, we simply stop spending. We are “revenue constrained” in our spending personally – meaning that we can only spend what we take in. The federal government is not backed by gold, or another barterable item, but by credit. What does this mean? This means, since 1971, when we moved off of the gold standard, the federal government no longer had to convert dollars to gold. Which means the federal government can print off as much money as it likes, without being revenue constrained.

But wait, won’t this cause inflation? Absolutely, if done too much. You just have to watch prices on treasury bonds to see if inflation is rising. But this has far-reaching implications; when the government spends too much, we don’t assert that it’s because it will run out of money (because it can’t), we assert that it might cause inflation (or worse, hyperinflation). This is a logical and reasonable claim.

But that means that the federal government isn’t revenue constrained – it’s inflation-constrained. This means the real driver of when the government can spend, and when it cannot, is inflation. So, if inflation is high, the government should raise taxes (or stop cutting taxes) and cut spending. When inflation is low (as it is now, with core inflation at 1.6%), the government should be spending money. So, currently, we have low core inflation, (I’ll do another post on why I’m using core inflation, and not core inflation + commodities, later) meaning that our fiscal policy should be to increase spending – the GDP formula of “GDP = consumer spending + private investment + government spending + (exports – imports)” asserts this as well. Then, once inflation starts to rise, we decrease spending and raise taxes.

3. I Can’t Decide What I Get Paid

If I was in debt and making $40,000 a year, then I would normally have to cut my personal spending and adjust my lifestyle, or find a new job. However, if I can’t find a new job, I’d have to do the former. (In fact, a big reason the topic argument appeals emotionally to most people right now is because finding a job currently is very difficult.) However, the federal government is not like me – it can simply raise revenues. This can be done by levying taxes, cutting tax exemptions, reducing payments, cutting subsidies, selling bonds, and more. I, however, can’t tax my neighbors and force them to give me money (or “more” money, for that matter).

4. There’s No Due Date

A small point, but a main reason we worry about debt personally is those bills that come in the mail (and then subsequently, the collection agencies). If I don’t pay my debt, I lose whatever it is I bought with it – or something else I own. There’s a due date on my debt; a deadline, so to speak, in which I have to pay my debt.

The federal government doesn’t have this. There’s no day of judgement in which the U.S. government must pay its debts or be taken over. In fact, the U.S. government has been in debt for every year of its existence except 1835-1837. A minor point, but it’s worth noting.

5. I Don’t Owe Money to Myself

Most all of my bills are to entities other than my family – auto loans, credit cards, a mortgage, medical institutions. However, roughly 70% of the debt the U.S. has issued is to itself; creditors such as investors, t-bond holders, government accounts, or the Federal Reserve. In other words, debt you owe to yourself is not the same as debt owed to someone else.

6. Debt Insures Stability

Because of #5, those involved in the debt of the United States are financially invested in making sure that the currency of the federal government stays solvent, lest they not be paid back what they are owed. They would much rather see a stable currency instead of inflation that inflates away the IOUs they hold, and have a vested interest in making sure they can continue to collect interest payments on U.S. debt.

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There are quite a few reasons that the federal debt doesn’t equal the household debt. While our long-term deficit is definitely an issue worth doing something about, there are better reasons to do so (long-term solvency, currency inflation, interest payments) than saying we need to “balance” our budget like a family does.