Around tax day, I got serveral questions from users about taxes in America. You have to pay them, why not understand them? Thanks to Kate W. (via facebook) and Chris B. (via gmail) for submitting the most detailed questions I got. Hope this helps to answer them!
Getting into debt, in of itself, is not always a good or bad thing. You can end up $100,000 in the hole by going to med school and becoming a doctor. You can end up $100,000 in the hole by gambling at the horse track. So how can we tell a “good” debt from a “bad” one?
Getting into debt, in of itself, is not always a good or bad thing. You can end up $100,000 in the hole by going to med school and becoming a doctor. You can end up $100,000 in the hole by gambling at the horse track. So how can we tell a “good” debt from a “bad” one?
In mathematical economics, the symbol for “interest” is: “r.” This is because for economists, interest is considered “rent on capital” or for this discussion: “rent on money.”
If you borrow $1000 from me for a year, with 10% interest, 12 months from now you will owe me $1100. That extra $100 you pay back is the “rent” I’ve charged you for the right to use my money for one year.
Lenders (banks, creditors, etc.) charge rent for their money for all the same reasons that landlords charge rent on apartments. They have some cash lying around, abandoned; offering no additional value beyond just its nominal worth. They have no use for it themselves, so they rent it out.
The lender is actually losing money – or rather the opportunity to make money – every day that they aren’t collecting interest payments on that pile of bills wadded up on top of their dresser, just like a landlord with an empty apartment is losing money every day he has no tenant.
And what about the lender who is a bit timid to make a loan, frightened by the very real possibility of never seeing their money again? For them rent serves as an incentive, a reward for trusting their money in the hands of a stranger.
Borrowers are willing to pay interest for all the same reasons tenants are willing to pay rent. They need to make a purchase now, but in the short-term can’t put together enough funds to do so. I can’t write a $75,000 check for a house in this very instant. But I can come up with $500 every month to exchange with the owner for the right to make that house my home.
Keep this analogy in mind, and let’s turn to the National Debt.
Look at your pay stub. You’ll see taxes have been deducted for Medicare and Social Security. Those two programs are funded by their own specific taxes. Every time a paycheck is cut in America, a portion is deducted and paid directly into the funds for Medicare and SS.
The other major item you’ll see ‘Federal Deduction,” AKA Income Tax. That money funnels into Congress’s “Discretionary Spending,” or funds that can be spent, like the name would suggest, at Congress’ discretion. Every year, Congress hammers out a National Budget, a plan that spells out exactly how all this “discretionary” money is going to be spent (there’s a few additional intakes here as well, tariffs and some inheritance taxes and so on, but income taxes constitute the vast majority).
This spending funds everything else that the Fed contributes to, from NASA to the Peace Corps to the Dep’t of Transportation to the Armed Forces...and thousands more programs and items. Unlike Social Security and Medicare, these programs’ federal contribution is reviewed year to year, and can be altered on the whim of the Congress.
(By the way, more than half of all discretionary spending ends up going directly into our military.)
So what happens if the money collected in taxes can’t quite cover the year’s agreed upon expenditures? The Federal Government does exactly what anyone else does when their short on cash. They borrow enough to cover the year’s “Budget Deficit,” from banks and citizens, here and all over the world, as well as from other sovereign nations.
The sum total of debt we have outstanding as a result of all our past Budget Deficit loans is called the “National Debt.” So, every year that we don’t have a balanced budget, the National Debt piles a higher and higher. As of 2011, the National Debt was well over $10 trillion, with a yearly interest payment of $250 billion.
So the National Debt can be considered the money that our country is currently renting. Roughly $250 billion a year to rent out 10 trillion bucks.
Imagine this debt as a giant office building. Is it “ok” for the US to rent out the every room, on every floor of a such an enormous facility? Well, sure, as long as we’ve filled all the desks, manage it well, and don’t rent space we don’t need or use.
As long as our debt is being used sensibly and productively, to create things of value (or better yet, things that can generate value for a long time, like schools, technology or infrastructure), AND as long as we pay old debts off at the same rate that we take new ones on, than the debt is nothing to be ashamed of.
In fact, some of the wealthiest nations of the world, with the highest standards of living have huge national debts. Belgium’s outstanding national debt is valued at almost exactly the same amount of their GDP (it’s the nation equivalent of that recent college grad with a $30,000 a year salary who owes $30,000 in student loans. We all know one or two.) And still the Belgians have one of the strongest and most reliable economies in the world, with one of the world’s highest GDP per capita ranking.
They’re renting a damn sky scraper, but from it run an operation that generates spectacular income, value and wealth for their people.
Others, however (Portugal, Greece, Spain just to name a few) rented out the executive penthouse only to use it for a big party. They created little of lasting value, and paid the rent not with earned money, but with their credit cards. With no significantly large, steady income on the horizon, they may never manage to service the debt they’ve accumulated.
Also note that this is just the originally proposed budget. The one that will ultimately be passed will look very different, especially seeing how in a rougher economy, people will probably put up quite a fight over whatever funding there is available out there.
Want to play Where’s Waldo? I give you the challenge of finding: NASA, the Coast Guard, the Dep’t of State, and Highway Dep’t. Also, be sure to take a gander at that National Debt marker! Good Luck!
PS - Just in case you’re keeping score: since WWII, the US National Debt has risen with every Republican President and shrank with every Democratic one, with just three exceptions. We saw a decrease during both terms of Eisenhower and during Nixon’s 1st term (both Republicans). The third is the increase we’ve seen so far in each of the Obama years.
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