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Knowing How Deficits and Debt Work Can Help Investors Make Post-Pandemic Plans

For even a fairly astute person, these terms can cause confusion, so we’re breaking them down.

Photo by Morning Brew via Unsplash

A trillion dollars. This is what it looks like as a number: $1,000,000,000,000. A total of 12 zeroes.  Currently, in an effort to patch the huge economic hole created by COVID-19, people in Congress and the White House talk in multiple trillions of dollars. These numbers are dizzying even for those who themselves possess a goodly amount of wealth. So, as a first step in trying to “get our heads around” these astronomical sums of money, we will try to put them into some kind of perspective.

For example, take the current and almost exhausted CARES (Coronavirus Aid, Relief, and Economic Security) Act stimulus package, coming in at $2.2 trillion. TRILLION. If we look at the CARES price tag in terms of annual national budgets, for countries other than the United States, here is how far an extra $2.2 trillion would go:

  • It would be enough money to run Russia for almost a decade.
  • Greece would not have to collect taxes for the next two decades.
  • Egypt would have enough money to operate for the next half-century.
  • Residents of Bermuda would be tax-free well into the 22nd century.

In short, $2.2 trillion is A LOT of money. And it is money that, at the moment, the U.S. government literally does not have in the national bank account. To use a colloquial term, the current stimulus package will put the U.S. $2.2 trillion “in the hole,” and that is only part of the “deficit” for the year 2020. Not to mention, that $2.2 trillion will be piled on top of what the U.S. federal government already owes overall. That is, the national “debt.”

Particularly in recent months, we have heard the terms “deficit” and “debt” used quite often during discussions of current, and possible future, stimulus initiatives. This year, and every year, they directly affect the country’s annual budget, something that each president submits to Congress, usually during the first week of February. For even a fairly astute person, these terms can cause confusion, so following is a brief explanation of all three.

Annual “Deficit” 

The difference between the national “deficit” and the national “debt” is actually not that complicated. The United States has a new “deficit” every year. Simply put, the “deficit” is the difference between the amount of tax and other revenue the government collects in a given year, and the amount it spends in a given year.

For example, in 2019, the government earned $3.5 trillion through taxes and other revenue sources. But, also in 2019, the government spent about $4.4 trillion. So, the annual “deficit” for that one year was $984 billion.

To put that in perspective, at the time of writing this, primarily as a result of the current CARES Act stimulus package, and not accounting for any possible added stimulus spending, the annual deficit for 2020 is projected to be $3.8 trillion dollars. Trillion.

But, as of early July, both political parties hinted at further stimulus spending. For their part, the Democrats recently led the passing in the House of a proposal called the HEROES (Health and Economic Recovery Omnibus Emergency Solutions) Act. Price tag for the HEROES Act: $3 trillion. Trillion.

Doing the math, if passed and implemented this year, HEROES would almost double the 2020 deficit to $6.8 trillion. Republicans seem more reticent about a new stimulus package and, for the moment, have no formal proposal. But, this is an election year, and the pandemic shows no signs of disappearing any time soon. Also, the current president has recently come out strongly in favor of a second round of stimulus checks. Maybe not three-trillion-dollars’ worth, but any stimulus will further inflate the deficit.

Once again, dizzying amounts of money. So, what does this deficit spending do to the national “debt”?

“Debt” 

Not unlike the debt in a household, the national “debt” accumulates year to year. Each year’s “deficit” increases the national “debt” by that amount. In fiscal year 2019, Greg McFarland at Investopedia reports that the U.S. federal debt was $22.9 trillion. So, without further stimulus programs, according to the Congressional Budget Office (CBO), the anticipated annual “deficit” for the year 2020 will be $3.7 trillion. That “deficit” will increase the accumulated national “debt” to $26.6 trillion. Or, doing the math, that is an increase in the national debt of about 16 percent.

Without going into too much detail, it is important to know that the federal national debt is broken into two sections: intergovernmental holdings and public debt.

According to the article, “The National Debt Is Soaring, So Will Taxes Go Up?” on the Acorn+CNBC website, intergovernmental holdings account for about 26 percent of the national debt. Simply put, this is money the U.S. Treasury owes to other federal agencies. For example, Social Security still takes in more in taxes each year than it needs to operate, so it takes that additional revenue and invests in the treasury.

Public debt, according to the same article, is about 74 percent of the national debt. Of that 74 percent, foreign governments hold about one-third of that debt. Of that one-third, China holds about $1.1 trillion, while Japan holds about $1.27 trillion. But, the biggest holder of U.S. debt is…the United States itself.

That includes U.S. banks, investors, state and local governments and other companies and funds. And while the Federal Reserve, as the Acorn+CNBC article points out, is not actually part of the government, it holds the majority of the U.S. public debt, about $8 trillion. One reason being, “treasuries” (bills, bonds, notes) are considered a safe investment because the U.S. has never defaulted on its debt.

So, what do these dizzying “deficit” and “debt” numbers mean to taxpayers?

Getting back to a family budget, when a household’s debt continues to grow there are basically two ways to reduce it: Increase income, decrease spending. For the federal budget that means increasing revenue through raising taxes, or generating cash through issuing and selling government-backed debt, namely treasury bills and bonds. It may also have to decrease spending by cutting the budgets of various programs or eliminating them.

Predicting the future is a dicey business, and that is not our purpose here. Instead, we want you to understand how “deficits” and “debt” interact and impact our nation’s budget. Meaning that when policy changes are implemented to increase or decrease either one, you will be able to make even more informed personal and professional financial decisions.

Northwestern Mutual is the marketing name for NM and its subsidiaries. Al Schor is a representative of Northwestern Mutual Wealth Management Company®, NMWMC Milwaukee, WI, a subsidiary of NM and limited purpose federal savings bank, and registered representatives of Northwestern Mutual Investment Services, LLC (securities), a subsidiary of NM, registered investment advisor, broker-dealer and member FINRA and SIPC.