Debt vs. deficit

The distinction

In any fiscal year, the federal government collects revenue and pays out outlays. If outlays exceed revenue, the gap for that year is the deficit, and Treasury borrows to cover it.

The national debt is what all those past gaps add up to, net of any years with a surplus. The deficit is a rate; the debt is a level.

Why it matters for reading the news

“The deficit fell this year” and “the debt fell this year” are entirely different claims, and only the first is usually true. If the government still spent more than it took in, the debt grew — just more slowly than before.

The only thing that reduces the debt is a surplus. Those have been rare. A headline that treats a smaller gap as fiscal restraint has described the tap, not the tank.

How the gap is financed

A deficit is not automatically inflationary. Friedman drew the line that still applies: government spending financed by taxes or by borrowing from the public rearranges who spends; financed by creating money, it raises the quantity of money, and that is inflationary. See what causes inflation.

In the United States the usual sequence is the first of those: Treasury issues debt to the public, and the Federal Reserve may or may not buy a slice of it. When the Fed does buy in size — quantitative easing — the financing has crossed the line. The deficit did not have to be monetized. Someone chose to monetize it.

Interest on the existing stock is itself an outlay. It does not require a new program. It is the bill for every prior gap that was not closed with a surplus.

Which debt figure

There is a further split inside the debt itself. Debt held by the public is what is owed to outside holders — including the Federal Reserve. Gross federal debt also includes what the government owes its own trust funds, chiefly Social Security.

For questions about borrowing in financial markets, the public figure is the relevant one. For questions about the statutory limit, the gross figure is what binds. A headline number that does not say which one it means is not telling you enough.

Who pays

Bondholders are paid in dollars. Taxpayers, later, provide those dollars — or, if the real burden is reduced by a higher price level, households on fixed incomes provide them through inflation. Those are different distributions of the same stock. Neither is free, and neither is an accounting residual.

How to read the coverage

• “The deficit fell” — the gap is smaller. The debt still rose unless there was a surplus.
• “The debt hit a record” — true in nearly every year with a deficit. Ask the change relative to the economy, and how the gap was financed.
• “We owe it to ourselves” — some of the gross total is intragovernmental. Debt held by the public is owed to someone who can demand payment, including foreign holders and the Fed.
• “Deficits cause inflation” — only if they are financed by creating money, or if the central bank holds rates so as to accommodate them. The financing is the question.