Volume 9: Fiscal Policy, Part I: Taxes


The belly of the beast

Where does it come from?

“There’s one for you, nineteen for me.” – The Beatles

 

The U.S. Federal Government does almost everything on a massive scale.

The rest of the world shares eight aircraft carriers. The U.S. has ten. Eisenhower wanted some highways like the ones he saw in Germany? Let’s build 47,856 miles of Interstates. The Federal Government spends close to $1.1 trillion per year just on health. That’s more than the entire GDP of Mexico – and 180 other countries.

But the Federal Government is almost as good at collecting money as they are at spending it. To pay for all these goodies, they need to collect $3.6 trillion each year. That’s $10 billion per day, seven days a week, 365 days a year. The collection of this money greatly affects everything citizens do: how people work, invest and spend.

  • What is the difference between the deficit and the debt?

  • What are some principles of a good tax policy?

  • How does the Federal Government raise tax revenue?

 

What is the difference between the deficit and the debt?

Before we dive into the weeds, we’re gonna get some of our terminology and concepts straight. If you think you already know this, well, you can skip ahead at your own peril. But it isn’t an easy topic – so if we are going to talk about it, we need to agree what we’re talking about.

The Federal Deficit is the difference between what the Government takes in and what it spends. It is usually expressed as an annual number, but doesn’t have to be. If a government:

  1. Takes in $3 trillion from taxes, fees, penalties, et cetera and,

  2. Spends $4 trillion on Social Security, aircraft carriers, trips to Mar-a-Lago and the like,

Then the deficit for that year is $1 trillion(1). They need to come up with that amount from somewhere, usually by borrowing(2).

The Federal (or, more commonly, “National”) Debt is the total amount of all the Federal debt outstanding at a point in time. If the Treasury sells $50 billion of 4-week Treasury bills, the debt increases by $50 billion. When they are paid back in 4 weeks, it will decrease by the same amount (if no new debt is issued).

The deficit and debt are related. The debt is a snapshot, taken at a specific time. The deficit is the activity of the government over a period. As an approximation, the debt today is equal to the debt 1 year ago, plus the deficit over the last year(3).

I’ve heard many times – even in reputable sources – that “President Obama increased the deficit”. This isn’t true. When he took office, the deficit was $1,413 billion. The 2017 FY budget projects a deficit of $504 billion(4). So he decreased the deficit by around two-thirds. However, because there were deficits, it is true that the debt increased under President Obama.

To get a little more technical, the total (or “gross”) National Debt has two components:

  1. Debt held by the public: all the debt held by people, corporations, foreign governments and the Federal Reserve System. This is around $14.5 trillion.

  2. Intra-governmental debt: debt held by other Federal accounts. Most of this is in the Trust Funds for Social Security, Medicare and others. This is around $5 trillion(5).

When you talk about the debt, should you talk about the total debt or the public debt? Well, it depends; we’ll use both at various points.

What are some principles of a good tax policy?

Before getting into the details of how we raise the money, let’s discuss the theory, both economic and philosophical, of how we should fund our government(6).

As a society, what should be the goals of our tax policy? How do we design the tax code to create the best outcome for the citizens, while still raising the revenue we need? I don’t claim to be able to ignore my cognitive biases and interests – in Volume 3, I stated the opposite. But I think the following is a list of worthy tax policy goals, in my rough order of importance:

  1. Progressivity: The wealthy should pay a higher percentage of their income in taxes. Sounds controversial – but the math makes it necessary. If everybo