Musings on the U.S. National Debt…Part 1

So how do we reverse the upward national debt trend? If you haven’t already, you’re going to be hearing a lot more about the national debt between now and November elections.

From the July 11th, 2010 article Debt Happy, I noted there are four ways to reduce debt burdens. The most viable option is:

By paying down debt via accumulated savings

So how can the government have accumulated savings? By spending less than they take in (a.k.a., having a budget surplus). How does that occur? There are three schools of thought (some of which you may have already heard in the media):

1) Cut spending – if you cut spending, maybe income will outpace spending.

2) Increase/raise taxes – forget spending, just raise income to be greater than spending.

3) Cut taxes – with less taxes levied, maybe the economy will be stimulated – people will spend more and new businesses and jobs will form, resulting in more streams of tax revenue than before.

Each school of thought has its problems…

1) Cutting spending is political suicide for politicians – creating a conflict of interest. When entitlements go away, the low to upper middle class electorate who receive the entitlements (and who represent the largest chunk of Americans) get angry and vote politicians out of office. Additionally, and this is important, tax increases are permanently adopted into law BUT spending cuts are almost NEVER fully adopted. Thus, a long-lasting effect is not realized for spending cuts as they go by the way side rather quickly and spending continues.

2) Obviously increasing taxes is not a popular option for politicians either. Just like cutting entitlements, politicians risk being voted out over tax increases by the lower and middle class. Sure, the ultra rich get angry too with tax increases, but they only represent less than 5% of the population. The only thing they can do to get even is reduce campaign funding contributions. Plus, “they can afford it” right? Understand this, however: Increasing taxes for the purpose of raising revenue sounds good, but additional taxes actually weaken the incentive for production and consumption. Weakened production and consumption of goods results in fewer goods sold, fewer employees needed to make the goods, and then less people with jobs spending in the economy – all resulting in less taxes being received by the government (a “trickle down” effect, if you will – only in the negative). Thus, tax increases historically have the opposite effect – less revenue received than what was initially projected. Not to mention, this option does nothing to address government spending problems.

3) Cutting taxes to stimulate the economy can also have issues. For one, it just sounds counterintuitive…how can cutting taxes actually cause more revenue for the government? Two, the rich somehow tend to get more favorable treatment from tax cuts than the rest of the country…strange phenomenon that is. Three, and more importantly, if tax cuts happen at the wrong time (during an economic depression, for instance), there is no guarantee that those cuts will help incentivize production or spending. Having to pay less taxes doesn’t do much good for someone who’s already out of work or for a business that has had to close its doors.

Historically, what you’ll find is one or a combination of these strategies (mostly just one). Most have had very little success, obviously. Progress in these things doesn’t land you at $13.2 Trillion in debt. Bottom line, we’re in this mess because the government can’t stop run-away spending with their credit card – and the bill comes to us. Regardless, whatever solutions are enacted to try and fix the problem, it will take a long time to reverse the upward trend and most likely be a painful road…