Debt Debate for Dummies: Six Keys to Understanding the Issue

—July 8, 2011 -- The American government is broke. Rather, like many American families, it uses borrowed money to operate on a daily basis. But unlike the average American, the government doesn't ask a bank or credit card company for more money; it can sell more debt on the open market and raise its own credit limit.

The government has sold debt almost since the beginning of the Republic. You can buy it in the form or Savings Bonds. Buy some here. Institutions, governments and professional investors from around the world also buy debt, but in much larger quantities. The Social Security system owns the most U.S. debt. Foreign governments, including China, own 31 percent.

With government spending and taxes key political issues, the Republicans and the Democrats cannot agree on how much more money to spend and borrow. If an individual wanted to borrow more, he would ask his bank to raise his credit limit. The government can do this by getting Congress to raise the debt ceiling.

And so White House and Congressional negotiators have been in closed-door negotiations for months trying to figure out a way to change the way the government spends money before they agree to borrow more.

Here's a simple guide to some key points of the debate:

How much money does the government owe?

The U.S. government owes more than $14.34 trillion dollars and counting. The average citizen's share of that debt is about $46,000. The government reached the legal debt ceiling on May 16, when it owed $14.29 trillion, but the Treasury Department has averted default by placing IOUs in some federal worker retirement accounts. On Aug. 2, this will no longer be permissable, according to Treasury Secretary Timothy Geithner. Congress has to approve raising the debt ceiling before then in order for the government to be able to pay all its bills.

How much more does the government need to borrow?

The figures are astronomical. The government pays more than $1 billion each day just on interest on the debt. Overall federal spending is more than $10 billion a day for all the services the government provides.

To keep up with all that spending, the nonpartisan government accountant (the Congressional Budget Office) estimates that the U.S. will add about $6.7 trillion to the national debt during the next decade. That's an increase of 47 to 50 percent in just 10 years.

Everyone seems to agree that this is an unsustainable path.

The Baby Boom generation is just beginning to qualify for Medicare and Social Security, and those programs will be overcome within decades because there aren't enough workers paying into the system to support the people retiring. CBO has said the size of the government's debt could equal what the entire U.S. economy generates within a decade.

The Budget: How much money will government spend and how much does it bring in each year?

Over the next 10 years the CBO estimates the government will spend $45.7 trillion. That includes the $25.8 trillion in mandatory spending on programs such as Medicare and Social Security and the $14.5 trillion in spending on programs that Congress appropriates each year – called discretionary spending – that makes up the rest of the federal government from the Pentagon to food stamps.

According to CBO estimates, the government will bring in some $39 trillion in revenues in the next decade. Revenues are made up of individual income tax ($19.9 trillion), corporate income taxes ($3.9 trillion), Social Security taxes ($12.2 trillion) and other revenues ($3 trillion).

The debate in Washington is over how to bring the situation into control, like a family cutting back spending or getting a raise to pay off its debts, or at least keep their debt at a manageable level.

The difference over the next 10 years between what the government expects to pay out, $45.7 trillion, and what it expects to bring in, $39 trillion, is approximately $6.7 trillion. Lawmakers and the administration are working to cut about $4 trillion from that potential $6.7 trillion in borrowing.

To accomplish this, the U.S. will likely have to cut its spending, raise taxes on much of the population, and cut back on the promises it makes to the elderly for Medicare and Social Security to bring the budget into balance. A family, to continue the analogy, might cut cable, spend less on groceries, look for a higher paying job and defer payments into their retirement account.

What happens if the government defaults?

This is a subject of some debate. Many Republicans have argued that if the government goes beyond Aug. 2 without raising the debt ceiling, Treasury will simply have to continue paying its creditors and stop funding other programs. But others argue that going past the Aug. 2 deadline would send a bad signal to global markets, put the U.S. credit rating in jeopardy, lead to higher interest rates, and kick off a worldwide recession.

David Walker, the former Comptroller General of the U.S. who is now a cut-the-deficit evangelist, said Thursday that people who own bonds will get their money. But there will be a $4 billion daily gap that the Treasury Secretary must close. Federal workers and contractors might not get paid. Watch his interview with ABC.

Others are less alarmist. Sen. Jeff Sessions, the top Republican on the Senate Budget Committee, vowed recently that the U.S. government, even after Aug. 2, will pay its bills to creditors. The question then becomes, however, What will it not pay and whether paying creditors but not government employees or businesses that work with the government might be considered a default?

"Choices won't be about, Do we means-test retirement for the wealthiest, but do we make dramatic cuts in vital programs?" said Ryan McConaghy of the centrist Third Way. Read their paper, Dominoes of Default.

Why not just raise taxes on the rich?

Economists agree that there is no silver bullet to solve the problem of the debt. You can't just raise taxes and make it go away.

According to McConaghy, if the government taxed every dollar that every American made over his or her first $250,000 in income, it still would not solve the problem.

There is some indication that policymakers want to use this opportunity to simplify the tax code. Americans pay a high tax rate, but enjoy breaks for everything from having children to charitable donations to interest they pay on their mortgage. The tax rate could be lowered if those loopholes were removed. But more people making less money might have to pay taxes.

The same works for companies. They benefit from loopholes for research and development, certain investments and more. Removing those loopholes is perhaps more likely, but it will not solve the problem of the debt. Add to this the unity of Republicans against any tax hikes.

Why not just cut government spending?

Just like raising taxes on the rich won't work, cutting spending alone won't work either. The retiring Baby Boom generation will start collecting Medicare and Social Security benefits. Just as most Republicans reject tax increases, most Democrats have rejected cuts to these programs. But short of scaling back benefits, annual cost of living increases, or raising the retirement age, the programs will soon spiral out of control. The trustees for Medicare have said that in its current trajectory, the program's hospital insurance account will run out of money in 2024.

How can the problem be solved?

Both sides, Republicans and Democrats, are probably going to have make very tough decisions. For Democrats that may mean cuts to entitlement programs. And for Republicans that may mean tax hikes. Many believe that both parties have to take part in the solution to get the public on board with it.

"We're going to need both revenue s and spending cuts. Certainly at the higher end of the scale, people are going to have to accept higher taxes," said McConaghy. "They either leap together or they don't leap at all, but if they don't leap at all, the markets will push them into much more difficult choices," said McConaghy.

But that brings us to the closed-door meetings at the White House. President Obama and House Speaker John Boehner and their respective cohorts are trying to find an agreement that averts default -- and may make everyone equally unhappy.