Budget Deficits: Federal vs. Personal

Have you heard, or read the following (or something like it) before?

"Many Americans are very critical of how the federal government is handling the federal budget. Yet, many Americans have the same issues within their own household budgets. The problem with both is actually very simple. We are spending more than we are making.

"The federal government will take in $2.17 trillion in 2011. They will spend $3.82 trillion. This means they are spending $1.65 trillion more than they will make. On top of that, they owe $14.2 trillion in debt".

The preceding was taken from: http://debbiking.wordpress.com/2011/05/02/federal-budget-vs-household-budget/

Do you know what's wrong with it, how it's out of touch with reality? 

Well, as you might expect, we'll tell you, on the off chance you don't know.  That's what were here for.

In a sentence: There is a VERY BIG difference between the Federal Budget (or any government budget at the state, or local levels) and our personal budgets, which means deficits in each mean something very different.  

Here's why and how:

ONE WORD: Income.

Budgets involve income and expenses. Deficits arise when expenditures exceed income.  We all know this.

And government budgets and personal budgets are the same in that they both involve expenses. 

Where they are vastly different is their income, how they get the money they use to pay for expenses.

We earn income by having jobs.  The government's income is primarily from taxes, plus various fees. Okay, so here's a possible sticking point, the notion that somehow taxation can be overdone, etc.  For now, let's leave that for another discussion.

Why is the difference in the source of income so important?  Well...because it means that government income is pretty much tied to your income.  The more you earn and spend, the more tax income the government gets.  Of course, the government can also raise tax rates, especially the rates that apply to those with the highest income. 

Now, maybe this doesn't seem all that important, but there are a few very important consequences that merit mentioning:

1. Economic down-turns (aka recessions): It is NOT just a matter of rampant government spending that creates government budget deficits.  Yes, that can contribute, but equally important is the consequence of economic downturns.  In this latter case, the government hasn't budgeted to spend any more than in the past, but all of a sudden it has less income to meet its existing budget obligations.  So there is a deficit.

2. Economic growth: Since government income derives from taxes, its income goes UP during growth periods without any raise in taxes.  And, given there is no increase in expenditures and the growth is large enough, this can result in budget surpluses.

3. Government spending results in government income: Most folks either don't know about, or ignore this reality (fact).  As a result of income via taxation, when the government spends money that goes into the hands of the citizens, it creates taxable income (even those on social security now have to give some back in the form of taxes, when their total income exceeds certain amounts).  And when the citizens spend the money such that it goes into someone else's hands, that also produces tax income for the government.  Depending on what it is spent on, such as merchandise, it can return to local governments in the form of sales tax.

To make this clear, imagine the government gives Fred $100, which Fred spends by buying something from Bill.  Say the income tax rate is 10%, in which case Bill returns $10 of those $100 back to the government.  Then Bill buys something for $90 (what he has left of the original $100) from Sally, who then pays back $9 in taxes to the government.  She then buys something from Harry, who returns 10% in taxes, then Harry buys something from Mildred, who returns 10% of that income in taxes.  By the time that original $100 goes through the economy, it all gets returned to the government in taxes.  Of course, that is only if there is a good economy with money moving rapidly through the hands of the citizenry, a topic we discuss in our article about money and cash flow.