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First in a series

Where did the federal government debt come from?

By Masao Suzuki |
July 9, 2011
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This is the first in a series. See parts two, three, four and five.

San José, CA - In less than a month, the federal government will have to either raise the limit on how much it can borrow, or will have to slash spending by $120 billion each month. This is about 40% of total spending, or about the same as stopping all payments for the military and Social Security, the two most costly federal programs. The Republicans in the House of Representatives are threatening not to raise the debt limit unless the federal government promises to slash spending on domestic programs, including dismantling Medicare and putting most of the cost of health care on seniors.

This is the first of three economic commentaries to explain this issue. This commentary will be about how the large federal government debt came to be. The next two will be on what the Republican congress and the president are negotiating and what should be done about the federal budget deficits and debt that would help poor and working people.

Today’s federal government debt, often called the ‘Public Debt,’ goes back about 80 years to the Great Depression. In 1930, just after the start of the Depression, the federal government debt was very small, about $16 billion or 15% of the size of the economy as measured by GDP.* Almost all of this was borrowed during World War I, when the debt went up seven-fold.

Between 1930 and 1944, the federal government borrowed large sums of money, first to pay for the New Deal programs to try to aid those hurt by the Great Depression, then a much larger amount to pay for the military costs of World War II. By this measure the public debt went from 15% to 50% of GDP at the start of World War II, and topped out at 120% of GDP in 1945.

But between 1945 and 1980, the public debt fell to only about one-third of GDP. This was because the economy grew relatively quickly after World War II, boosting GDP. At the same time, the federal government did not have to borrow a lot, as their budgets were more or less balanced between tax revenues coming in and spending going out. Then in the 1970s, economic growth slowed but inflation picked up. Inflation made the money value of GDP go up, but the money value of the debt did not.

The big rise in the federal debt came over the last 30 years. There was a big increase in the 1980s as President Reagan cut taxes, especially for the wealthy, and increased military spending, leading to large budget deficits that added to the public debt. This was briefly reversed under the Clinton administration, which raised taxes on higher incomes and limited increases in government spending, leading to federal budget surpluses, where tax revenues were greater than spending, from 1997 to 2001. Tax revenues also went up with the long economic expansion in the 1990s, which went on for 10 years without a recession, the longest in U.S. history.

But then in 2001, the new Bush administration cut taxes, again benefitting the wealthy the most, invaded and occupied Afghanistan and Iraq, and dramatically increased military spending. There was also a recession in 2001, with a long jobless recovery, that cut tax revenues. Federal budget deficits came back and the federal debt grew rapidly. Then when the recession that began in 2007 was followed by the financial crisis in 2008, federal tax revenues sank as more and more people lost their jobs (about 80% of federal taxes come from income and payroll taxes).

The Obama’s stimulus spending in 2009 and 2010 came to about $800 billion dollars, or a bit less than 6% of the total public debt that is now more than $14 trillion ($14,000,000,000,000 or over 90% of GDP). The other 94% of the public debt mainly comes from three things: wars (from World War I and World War II to the current wars in Afghanistan and Iraq), tax cuts in the 1980s and 2000s, and the loss of taxes and extra spending on unemployment insurance and other social welfare programs during bad economic times.

Note that spending on Social Security and Medicare is not why the federal debt is so large. In fact, Social Security and Medicare taxes (known as FICA or federal Insurance Contribution Act - look for it on your paycheck!) have been greater than benefits paid, so that the combined programs have built up a surplus of more than $3 trillion. If Social Security and Medicare had run balanced budgets over the last 25 years, federal budget deficits would have been much larger during this time.

* Economists usually measure the public debt against the Gross Domestic Product, or GDP, which is the total value of output of goods and services produced and about the same as the total amount of national income. Using this measure allows one to compare the public debt over time as the economy grows and prices change.

Next: what the Republican Congress and the President are negotiating, and what should be done about the federal budget deficits and debt that would help poor and working people.