Ballooning US deficits: Future Tense

January 14th 2013

When you as a household or business, spend more than your income, you are harshly criticized. Even the state governments in the United States are not legally allowed to keep deficits. But, this rule does not hold good for the country as a whole. In fact, the US government is actually spending more than it earns since the past decade. And currently, the deficit level of US has reached such a proportion that it has raised eyebrows on the long-term prospects of the country. Many experts are of the opinion that if the country is not able to arrest the deficit in time, it could undermine prospects of economic growth and investments in the long run. Fears are widespread that it may even lead to higher unemployment, weaken US competitiveness and erode the quality of life of the Americans. Apart from these, there are rising concerns that galloping deficits may result in higher rate of interest, stymie economic growth and force the government to spend more and more to make payments on past dues. This will in turn leave less for services and other government functions. In other words, if the US people want the kind of programs that they are enjoying now, they will need to pay more in taxes.

The deficit is the difference between spending and revenue on a yearly basis, and total debt is the result of annual deficits accumulated over decades. For the current fiscal year, the deficit is estimated to cross $1.5 trillion, up from $459 billion in 2008. The maximum debt level set by the Congress is $14.3 trillion and the current debt level is just a shade way from the maximum debt level set by the Congress. Given this situation, the pertinent issue that is doing the rounds whether or not the US will increase the maximum debt level so that the government can continue its borrowing program.

The run up to the crisis

A lot of factors can be attributed to this rising deficit. The massive stimulus program to tide over the recession, huge costs due to wars in Iraq and Afghanistan have led to this mounting deficit figures. In addition to these, low tax revenue due to the weak economy and rising expenditures for entitlements such as Medicare, Social Security and the prescription drug program enacted in 2003, have resulted into escalating debts of the country.

The recent debt crisis in many countries in Europe, have brought the crisis in the United States in the forefront. In as recently as in mid-April, Standard & Poor’s – the leading global rating agency, downgraded its outlook for US government debt from ‘stable’ to ‘negative’, as the country has not come up with any convincing debt-reduction program. Bill Gross, the legendary investor, who manages the world’s largest mutual fund, Pimco, said that he had eliminated US treasuries from his portfolio due to prospects for poor returns. China, the largest creditor to the United States, has indicated that it may move to diversify into other forms of debts to reduce risks.

One of the ways available to the government to finance deficits is to borrow. The US government has been financing deficits by selling government bonds such as selling US treasuries and then selling new bonds to pay off the old ones which is akin to individuals shifting debt from one credit card to another. This however requires that the government needs to pay more interest rate to attract creditors. Currently, the rate of interest associated with key 10-year US treasury note is 3.35%. However, dangers are lurking that it may go up to 6% to 7% level.

Whatsoever, over the years the US Treasury bonds have established such an impregnable reputation that it would not be quite easy to break it. The global investors still have adequate faith on US treasuries. They are of the opinion that Washington will surely do something to manage the crisis otherwise situation will go out of hands. They are of the view that US treasury bonds are safer bets than other alternatives such as government bonds sold by other countries, corporate bonds or stocks.

Plans to reduce deficits

Currently, there are two major proposals –Paul Ryan proposal and the Barrack Obama proposal, to contain the deficits. Both the proposals have recognized that the government-sponsored health care programs – Medicare and Medicaid are mainly responsible for this mounting deficit. Both the plans have not preached for tax increases on the middle class to contain the deficit. There has not been any specific proposal of taxes. However, there is an agreement that health care costs should be trimmed down. However, there will be far-reaching implications of lowering down health care costs. Price of lowering down health care costs may also be politically very costly. Chances are there, but not in the near future, that the citizens of the United States may face unpleasant combination of benefit cuts and higher taxes.

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