Twelve questions about the national debt, answered straight

Somewhere tonight, at a kitchen table or a diner counter or a family dinner that has gone on too long, two people are arguing about the national debt, and neither one will win, because they are using the same word to mean different things. One means the deficit. One means the debt held by the public. One means the whole pile, including what the government owes itself. They shout, they pass the potatoes, and nobody changes a mind.

That is not a failure of intelligence. It is a failure of vocabulary. The debt argument is crowded with words people use without defining them, and a conservative who wants to win it, or even to understand it, needs to start by naming the terms. So here are twelve questions, answered straight. I have left out every current dollar figure on purpose. Numbers go stale in a month, and the official ones are a click away at the Treasury Department's Fiscal Data site and at the Congressional Budget Office. What does not go stale is how the machine works.

The words

1. What is the difference between the deficit and the debt?

The deficit is one year's gap: the money the government spends in a fiscal year minus the money it collects. The debt is the running total of all the deficits, minus any surpluses, accumulated over the whole history of the country.

A household version helps. If you spend $52,000 in a year and earn $50,000, your deficit for the year is $2,000, which you cover by borrowing. If you do that three years in a row, you borrowed $6,000, which is your debt, plus whatever interest you owe. A surplus is the reverse: spending less than you take in, which lets you pay down some of the balance. The federal government ran surpluses in the fiscal years 1998 through 2001, four years in a row, and used the money to pay down debt held by the public. It has run deficits in almost every other year of the modern era.

Keep the two straight. "We cut the deficit" does not mean "we cut the debt." If a deficit shrinks but is still a deficit, the debt still grows, just more slowly.

2. What does the government actually sell when it borrows?

It sells Treasury securities, which are IOUs with different lengths. Treasury bills mature in a year or less. Treasury notes run from two to ten years. Treasury bonds run twenty and thirty years. There are also inflation-protected securities, whose principal rises with the consumer price index, and floating-rate notes.

The government sells them at auction, and investors bid. The yield, the interest rate, is set by what buyers demand. That is worth remembering. When we say "the rate on the debt," we are talking about a price set by a market, not a number picked by an official. The government can decide how much to borrow. It cannot decide what lenders will charge.

Who holds it

3. What is the difference between debt held by the public and intragovernmental holdings?

The total debt has two parts. Debt held by the public is what the Treasury owes to investors outside the federal government: individuals, banks, pension funds, state and local governments, foreign investors, and the Federal Reserve. Intragovernmental holdings are Treasury securities held by parts of the government itself, mostly trust funds such as Social Security's.

Here is how the second part comes about. Suppose Social Security collects more in payroll taxes than it pays out in a given year. The law says the extra must be invested in special Treasury securities. The cash goes into the general Treasury, where it is spent like any other money, and the trust fund gets a special bond in return. That bond is a legal claim of one part of the government on another. The details are in How Social Security works and the promise built into its 1935 design.

Add the two parts together and you have the gross debt, which is the figure behind the debt limit. Most economists focus on the public part, because that is what the government must refinance in the market. Both parts are real, though. Intragovernmental debt is a promise that Congress will have to honor by raising taxes, borrowing more, or cutting something else when the trust fund needs its cash.

4. Who owns the debt?

The honest answer is a long list. Americans own most of it, directly or through mutual funds, pensions, insurance companies, banks and state and local governments. The Federal Reserve holds a large block, which it acquired by buying securities on the open market. Foreign investors, including private firms and central banks, hold a share, and over the years that share has been a minority of the publicly held debt. The Treasury publishes its best estimates by country, and you should look at the latest table there rather than trusting anyone's talking point.

This is worth knowing because of the slogan that "China owns us." It is not accurate. No single foreign holder owns anything close to a majority, and the biggest holders of Treasuries are domestic.

5. Is it true we owe the debt to ourselves?

Partly. It is true for the portion held by Americans and by the government itself. It is not true for what is held abroad, and that part is a claim that can only be settled by sending dollars out of the country.

But "we owe it to ourselves" gets something wrong even when it is partly true. The people who hold the debt are not the same people who pay the taxes to service it. A retiree with a Treasury bond and a young worker who will pay the taxes are on opposite sides of the transaction. The debt moves money between different people at different times, and it raises the question of who has agreed to bear the cost. That is a moral question as well as an accounting one, and it is why A Balanced Budget Is a Moral Argument Before It Is an Accounting One makes the argument it does.

The limit and the cost

6. What does the debt limit actually do?

It is a ceiling on the total amount the Treasury may borrow. Congress first used the idea in the Second Liberty Bond Act of 1917 to give the Treasury flexibility in World War I borrowing, and the modern form, an aggregate cap on federal debt, dates from 1939.

The part that surprises people: the limit does not authorize any new spending. Congress has already passed the spending and tax laws that create the deficit. The limit only decides whether the Treasury is allowed to borrow to pay for what Congress has already ordered. That makes it an awkward lever. Refusing to raise it does not cancel past commitments. It decides whether the government can pay them.

When the limit is reached, the Treasury uses what it calls extraordinary measures, accounting maneuvers such as suspending certain investments in federal employee retirement funds, to keep paying bills for a while. Eventually the measures run out. Congress has dealt with the limit by raising it, suspending it for a period, or redefining it, many times. The fight over it in 2011 is the most consequential recent example, and it is told in the 2011 debt-limit fight that produced real spending caps.

7. What happens if the limit is not raised in time?

Nobody knows exactly, and that is the problem. The Treasury would have to choose among payments, and any missed payment on a Treasury security would be a default on the world's benchmark safe asset. Markets would likely react, and borrowing costs for the government, and through it for mortgages and business loans, could rise. The government has never defaulted on its debt in the modern era, and the argument over how close any past fight came is a live one.

The conservative case for using the limit as leverage is that it is the only moment when Congress is forced to look at the whole debt. The conservative case against is that it threatens damage to the country's credit and that spending is better controlled through the laws that create it. Both are serious points. Reasonable people pick sides, and the verdict depends on how much risk you are willing to take.

8. Why does interest cost crowd out other spending?

Interest is an obligation, not a choice. The government pays it before it pays for anything else it wants. It is the cost of the debt already accumulated, multiplied by the average rate on that debt.

Work through a hypothetical. Picture a government with $30 trillion in debt at an average interest rate of 2 percent. Interest is 30 trillion times 0.02, or $600 billion a year. Now suppose the average rate climbs to 4 percent as old low-rate debt is refinanced. Interest becomes 30 trillion times 0.04, which is $1.2 trillion. Same debt, double the bill. A family can see the same arithmetic on a smaller scale: a $300,000 balance at 2 percent costs $6,000 a year, and at 4 percent costs $12,000.

That is the crowding. Every dollar of interest is a dollar that cannot go to roads, defense, research, or a tax cut. And because the interest is automatic, it competes with the parts of the budget Congress votes on each year, which are explained in How a budget becomes law, from the President's request to the checks. When interest rises, the squeeze falls on whatever is left to fight over.

Printing and history

9. Can the government just print money to pay it off?

Not by itself, and not without a price. The Treasury borrows. The Federal Reserve creates money. The Fed can buy Treasury securities, paying with newly created reserves, but federal law bars it from buying new debt directly from the Treasury except in narrow cases, so it buys on the open market. The Fed is also meant to be independent of the political branches, so that it cannot be ordered to monetize whatever Congress spends.

More importantly, creating money to pay debts can cause inflation, because more dollars chase the same goods. That is the reason inflation has been called the tax that needs no vote, a case laid out in Inflation is the one tax that never needs a vote in Congress. The United States borrows in its own currency, which gives it options that countries borrowing in foreign money do not have. It does not give it a free lunch. The bill is paid in the value of your paycheck.

10. Where did all this start? What did Hamilton do in 1790?

The first Secretary of the Treasury, Alexander Hamilton, delivered his Report on Public Credit in January 1790. The country owed money from the Revolution, both the federal government and the states. Hamilton proposed that the federal government take over the states' war debts, and that all of it be paid at full value, so that the new nation would have credit and lenders would trust it.

It was a fight. James Madison objected that paying face value to speculators who had bought up old certificates cheaply was unfair to the soldiers who first held them. Southern states that had already paid down their debts did not want to subsidize those that had not. The impasse was broken in the summer of 1790 by a deal between Hamilton, Madison and Thomas Jefferson, in which the assumption plan passed and the permanent capital was placed on the Potomac. The Funding Act that August put the plan in law.

The lesson cuts two ways. Hamilton showed that a country that honors its debts earns the right to borrow cheaply for a long time. His critics showed that debt always carries a question about fairness between those who owe and those who are owed.

11. How do economists measure the size of the debt?

Not just in dollars. A bigger economy can carry a bigger debt, the same way a bigger paycheck supports a bigger mortgage. So analysts compare the debt to gross domestic product, the annual output of the whole economy.

That ratio rose sharply in wartime. By the end of World War II, debt held by the public was larger than the entire economy. It then fell for decades, not because the government paid down much principal but because the economy grew faster than the debt. Growth matters enormously. A debt that grows at 3 percent in an economy that grows at 4 percent shrinks as a share of the economy. The reverse is true, too.

This is the pro-growth conservative argument in one paragraph: the best way to shrink a ratio is to enlarge the denominator. It is an argument worth making, with a caution. Growth helps only when spending is not rising faster, and interest costs can grow faster than output when rates are high.

What moves the numbers

12. What would actually change the trajectory?

There are only three levers: spend less, collect more, or grow faster. Spending breaks into three kinds. Discretionary spending, voted every year, is the part Congress argues about most. Mandatory spending, such as Social Security and Medicare, runs on formulas in permanent law and does not need a yearly vote. Interest is set by the stock of debt and market rates.

An honest plan has to deal with all three. Cutting discretionary spending alone cannot close the gap, because mandatory spending and interest together have made up more than half of outlays for decades, as the Congressional Budget Office reports. Raising revenue alone runs into the limits of what taxpayers will bear and how the economy responds. Growth helps, but nobody can promise it. The history of attempts in How Washington learned to budget, from the 1921 act to the 1997 deal shows that rules help only when lawmakers keep them.

I think the strongest conservative position is not a slogan. It is this: set honest limits, in law, that hold in good years and bad, and apply them to every part of the budget, not only the part that is politically easy. The reasons are explained in Why Spending Restraint Keeps Losing in Washington, Whoever Is in Charge.

The bottom line

• The deficit is a year's gap. The debt is the accumulated total. Do not let anyone use one word for the other.
• Both debt held by the public and intragovernmental holdings are real obligations. The first is owed to investors, and the second is owed by one part of the government to another, to be settled by Congress.
• The debt limit does not authorize spending. It decides whether the Treasury can pay for spending Congress already approved.
• Interest is automatic, so a rising rate on a large debt pushes out everything else. Run the arithmetic yourself: debt times average rate.
• When a candidate offers a plan, ask which of the three levers it uses and what it does about mandatory spending. Then check the Congressional Budget Office and the Treasury's Fiscal Data site for the numbers.