Tuesday, November 6, 2012

PF 2012 Tax Increases Topic - Background Info

This is part 2 of a series on the December 2012 Public Forum debate topic. For part 1 click here.

Purpose of this Article

I want to write this article to lay down some foundations upon which to build the Pro and Con advocacy for the December 2012 PF resolution calling for prioritization of tax increases over spending cuts.  Generally speaking I think most people (myself included) have a somewhat superficial knowledge of how taxes and spending are combined in the US budget. This topic, as seems to be the trend in PF Debate, is broad.  There are literally dozens of different kinds of taxes people must pay in the US.  Further, while we may have a basic understanding that government spends money, we may not fully comprehend the breadth of spending and the implications reductions in the amount of government spending have upon the economy or the general good of the citizens.  Finally, and it may be too early to make this claim, I see big problems in the Pro burden with respect to WHY proponents should advocate tax increases over spending cuts other than it allows us to keep spending on things we like.  So, in order to allow the most fair debate possible, it is necessary to first understand the issues behind the resolution.

A Crude Economic Model

Most people, even high school students, will understand that spending requires income and the same is true for governments.  If I want to buy a cup of coffee, I need to hand over a dollar (or several dollars if I go to Starbucks).  If I want to buy a house, I may not have $200,000 in my savings account, so I need to borrow the short-fall and if I do, I will need to pay it back with interest.  In the case of the house, if we assume the house costs $200,000 and I have $50,000, I am still $150,000 short so if I decide to buy the house, there will be a deficit of $150,000 which I must borrow which then puts me $150,000 in debt.  Assuming, I have a steady income and I am able to make my payments, my initial debt will steadily decrease over time.  If my income should increase either because I get another job or I reduce spending on other things, I may choose to pay more on my debt to reduce it more quickly.

Now, let's say I am the lender and someone wants to borrow $150,000 from me to buy a house.  I will assess the risks of loaning the money.  I will consider the value of the home to be purchased and consider whether that value will increase or decrease over time.  I will look at the ability of the borrower to pay back by insuring her income or potential to increase income is sufficient to make the payments, and since I want to make money on this transaction, I will charge an interest rate proportional to the risk.  For most borrowers, the risk is measured, among other things, by the borrower's credit rating which is a measure of their ability to meet their financial obligations.

Finally, if the borrower somehow is unable to make the full payments required to pay back the loan, the borrower's debt will increase because the interest on the loan begins to accrue, meaning it starts to accumulate.  When this happens, the borrower can do several things.  1.) The borrower could borrow more money to make the payments on the loan but this adds additional debt which will need to be paid off.  2.) The borrower could try to obtain additional income to make the payments.  3.) The borrower may cut other expenses, perhaps buy less food, eliminate going to the movies, in order to have more money in which to pay off the loan.  4.) The borrower may declare bankruptcy.

Extending the model to the government, it works in fundamentally the same way.  The government has expenses, like payrolls, the day-to-day cost of sustaining the military around the world, health care, etc.  Those expenses are met by revenues (income) which mostly comes from taxes.  When the amount of expenses is greater than the amount of revenue, the government borrows money to make up the short-fall.  Usually, the government borrows by selling securities and bonds which it promises to pay back with interest.  These days, many of those securities are being purchased by foreign entities, hence we hear things like "China is financing our debt".  The government's credit rating, is a measure of how reliable or trust-worthy is the promise to pay back those loans.  Very recently, the government credit rating was reduced which makes bond and securities holders nervous and less likely to want to buy more for fear the government may default (fail to payback) on the loans.

Some Clarifying Definitions

Defined by Merriam Webster as an excess of expenditure over revenue.  In other words when bills are $5000 per month but the available income is only $3000 per month, there is a deficit of $2000.

Deficit Spending
The amount by which a government, company, or individual's spending exceeds its income over a particular period of time. also called deficit or called budget deficit. opposite of budget surplus.

National Debt
Total outstanding borrowings of a central government comprising of internal (owing to national creditors) and external (owing to foreign creditors) debt incurred in financing its expenditure. National debt is divided generally into three categories: (1) Floating debt, short term borrowings such as treasury bills, various ways-and-means advances, and borrowings from the central bank. (2) Funded debt, short-term debt converted into long-term debt. (3) Unfunded debt, national savings certificates, savings bonds, premium bonds, and securities repayable in foreign exchange (payment of which affects the country's balance of payments). National debt plays a crucial role in a country's financial system as government securities (being a secure vehicle for investment) form an important part of the reserves of its financial institutions.

Debt vs Deficit
The deficit is the difference between the money Government takes in, called receipts, and what the Government spends, called outlays, each year. Receipts include the money the Government takes in from income, excise and social insurance taxes as well as fees and other income. Outlays include all Federal spending including social security and Medicare benefits along with all other spending ranging from medical research to interest payments on the debt. When there is a deficit, Treasury must borrow the money needed for the government to pay its bills.
We borrow the money by selling Treasury securities like T-bills, notes, Treasury Inflation-Protected securities and savings bonds to the public. Additionally, the Government Trust Funds are required by law to invest accumulated surpluses in Treasury securities. The Treasury securities issued to the public and to the Government Trust Funds (intragovernmental holdings) then become part of the total debt.

Applying the above definitions, we see that when the government spends more than it takes in, it is doing deficit spending.  The amount of that deficit accumulates day to day or month to month.  The accumulation is the national debt.  So if the deficit (the excess of expenses over revenues) is $1 trillion per year, after four years the national debt will have increased $4 trillion (4 x 1 = 4) even though the deficit remains at $1 trillion.  As of the date of this posting, the national debt has accumulated to approximately $16.2 trillion.

Budget Surplus

The amount of the deficit will vary year to year depending on the budget.  It happens at times, a particular budget, which is basically the government's annual spending plan, may cut spending to such an extent, the revenues exceed the spending.  When this happens there is a "budget surplus".  During those years when there is a budget surplus, there would by definition be no deficit but the debt would still be present.  Only when the surplus is applied to paying down the debt does the amount of the debt begin to reduce.

Debt Ceiling and Fiscal Cliff

As a way of managing the growth of the debt, Congress has enacted a "debt ceiling" which is basically an amount which caps the debt.  In other words, they say, we will allow the debt to accumulate to some limit and then we stop spending.  This was the scenario faced two years ago, during the so-called "debt ceiling" crises in which Congress refused to authorize an increase in the debt ceiling (which previously was almost always raised) without matching cuts in spending.  A last minute agreement was reached which raised the ceiling on the condition of formation of a bipartisan committee to devise a scheme to cut expenses and/or raise revenue.  To ensure, that the committee does the work intended, the compromise deal inserted a penalty which triggered automatic spending cuts and tax increases.  This penalty is what the politicians call the "fiscal cliff" and is set to take effect at the end of December 31, 2012.
(see: http://en.wikipedia.org/wiki/United_States_Congress_Joint_Select_Committee_on_Deficit_Reduction)

Simple Not It Is

In my overview, I've tried to keep everything in simple terms and make it fairly intuitive.  On one level, the similarities between personal finances and government finances are similar.  There is a budget which figures out based on income, how much money will be spent.  When more is spent than taken-in, there is a deficit which adds to the debt. When more is taken-in than spent, there is a surplus which can be used to pay down the debt.  The truth is, for those who feel this is too superficial, it is much more complex than these simple examples.  Many details are included into the calculation of the the debt, revenues, and outlays.  There are many diverse terms which have various meanings relative to different kinds of debts, revenues, etc. and really, a few courses in government/economics would help clear up some of the complexity.  I certainly hope for the sake of this debate, however, the explanations I have placed in this article are sufficient to give you a working background suitable for meaningful debate over the December resolution.

For the Pro position, click here.

For an index of other Public Forum debate topics, click here.


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