The Danger of Deficit

Against the grim backdrop of American families trimming expenses and consumers delaying spending, the White House has released the budget for 2011. The plan features no surprises in its allocations—$1.48 trillion for national defense and social security—but in keeping with the Obama administration’s goal to stimulate economic growth, the 2011 proposal did come to a record-high total: $3.69 trillion.

The White House budgets translate to a $1.6 trillion increase to the fiscal deficit by the end 2011, which will require government to borrow one of every three dollars it spends in that year. The general consensus among political advisors is that increased government spending is necessary into order to spur consumer demand during the recession. The 2008 and 2009 stimulus packages followed this logic, as does the proposed tax break to companies who hire new employees in 2011. In short, the government is replacing private spending (weakened by a depressed economy) with public spending. Their argument runs “better to run a few years of budged deficits than risk exacerbating the recession.” This shortsighted logic fails to consider the consequences of the proposed deficit.

The American people will eventually need to bear the burden of the debt, so future tax increases are nearly inevitable. Included in Obama’s 2011 budget is $251 billion that exists merely to make interest payments on past deficits, which will make up 15% of the total budget. In the past, government debt was less problematic since the debt was financed by American investors who receive future returns in the form of interest payment (and would thereafter reinvest in American businesses or banks). Today, on the other hand, international investors and governments fund a much larger proportion of our debt. Interest is paid for with American tax dollars but flows to the pockets of international entities.

The domestic and international political consequences associated with a large deficit are imposing and numerous. Taxpayers are already facing increases as Obama is forced to phase out the Bush tax cuts (in part) to counter-balance spending increases. In addition, China, as the single largest holder of U.S. government debt, will wield economic influence over U.S. fiscal policy as it continues pick up still more of the tab.  Deficit spending also reduces U.S. credit, limiting the government’s ability to raise money from both foreign and domestic investors. Prospects for deficit spending in the future, even for necessities, are limited.

Of even greater concern, the proposed increase to government spending and borrowing could slow economic recovery. The United States could face the “crowding-out effect,” in which the government competes for the same money as private firms. Investors choose either to loan to the government or to invest privately. As the government offers more bonds, fewer investments will be funneled to private economic actors. The interest rate that the Fed has worked hard to keep low could also increase as a product of increased government demand for money, which would raise the price of loans for businesses and consumers. This results in fewer factories built, fewer workers hired, and persistent, high mortgage rates–-all of which Obama is trying to prevent by increasing government spending.

The prevailing political logic leans toward spending as the policy prescription for an ailing economy, and spending is precisely what the White House has proposed to remedy high unemployment rates. This proposition overlooks the penalties that large budget deficits deal to the American people and U.S. influence abroad. Although job creation is a popular and worthy goal in the short-run, long-term economic stability should remain our ultimate target.