So as of late, one of the refrains that one hears from the political Left is that "America is not broke." That all of the concern over the size of the debt is overblown and that the country is not collapsing, and it is just so that the Republicans in Congress and the states have an excuse to push through an ideologically-driven agenda to unnecessarilly cut spending (this is how the Left sees it).
Another concern is over the deficit as well. America in 2010 had a $1.2 trillion federal deficit, out of a federal budget of $3.5 trillion. This is a very large deficit. One of the immediate reactions over the size of the deficit from conservatives was how this type of deficit is dangerous and unsustainable. However, it has been a few years since President Obama got elected into office and the country has not collapsed or anything while running this enormous deficit, so as a result, some people have begun wondering, "IS the deficit really that big of a deal? Or is it a problem that is being blown way out of proportion by some on the political right?"
Let's look at them one at a time. Regarding the national debt, is that a major problem? Not yet. The national debt is currently about $14 trillion, which is equivalent about to the U.S. GDP. Now when a country runs a debt, it has to service the debt. How much money it takes to service the debt depends on the size of the debt and what the interest rate is set at. And whether or not the debt is a problem depends on how much of the federal revenues must go towards servicing the debt.
A country's national debt should not exceed 100% of GDP, as that is getting pretty high up there. The last time America had a national debt over 100% of GDP was during World War II. One of the reasons so many countries and institutions purchase America's debt is because it is AAA-rated. Because it is AAA-rated, a low interest rate is demanded.
Whether or not the interest rate demanded would have to be increase would depend on what the rating is of the country's bonds. If the bond rating goes down, say to AA-rated, this means that the ratings agencies have determined that the government is less likely to be able to continue to service the debt, and as a result, buyers of the debt will demand a higher interest rate as a result.
A major factor the ratings agencies look at in determining this is how much of the federal revenues must be devoted to servicing the debt. Not how much of the federal budget, but how much of the federal revenues. If a country gets to about 20% or more of the federal revenues having to go towards servicing the debt, this is a major red flag. It in particular is a major red flag if up to 20% of the federal revenues must go towards servicing the debt if it is with a low interest rate.
The danger of running an excessively large level of debt is that while the debt can remain manageable as long as interest rate is kept low, if the interest rate has to be increased, then the amount of money it takes to service the debt can increase by a massive amount. For example, Japan, with a national debt that is 230% of their GDP, has a debt so large that a one percentage point increase in their interest rate would literally wipe out the funding for whole sections of their government. Japan's bonds are rated now at AA, even though they are one of the world's leading economies. I believe Japan gets around having to raise their interest rate despite the lower bond rating because they themselves own most of their debt. A country like the United States, on the other hand, has a lot of foreign entities that hold portions of its debt. China holds roughly $900 billion of U.S. debt (they are the largest foreign holder of American debt). An oft-repeated myth is that China "owns all of U.S. debt." This is a myth. They are the largest foreign holder of U.S. debt however. Japan comes in second, holding roughly $700 billion. Various other countries and institutions own portions of U.S. debt as well. The entity that holds the largest chunk of U.S. debt, at roughly $5 to $6 trillion, is the U.S. Federal Reserve.
Going back to the original questions regarding the debt and deficit, I would thus say that, at the moment, while the debt is larger than what it should be (about 100% of GDP), it is not at a dangerous level. But it is getting to the point where too large a portion of the federal revenues will have to go towards servicing it (I think about 12% go towards servicing the debt at the moment). Furthermore, if excessive inflation were to occur and interest rates were to have to go up (in order to counter the inflation), this automatically would drive up the amount of the federal revenues going to service the debt, which could result in a disastrous viscious cycle, as then the bonds might get downgraded, which would then make investors likely to demand an even higher interest rate. Or, it would keep the interest rate permantly higher than it should be. High interest rates of course also make borrowing very expensive which of course hamstrings economic growth as well. A large national debt unto itself I believe can hamstring the growth of an economy as well.
Regarding the deficit, some have said, "This is not the largest deficit in America's history." Technically, that's correct. The problem is that the prior deficits were wartime deficits and were temporary. This is a structural deficit, a peacetime deficit. It's a deficit that will remain in place unless spending cuts are made or massive levels of economic growth occur (which is highly unrealistic). And what this massive deficit does is to increase the national debt by over a trillion and half a year. To stop the debt from growing massively as a percentage of the economy year-after-year, while running this deficit at the same time, would thus require the economy to grow at around $2 trillion a year (growing the debt by $1.6 trillion a year is okay if the GDP itself increases by $2 trillion a year). But even with a growth rate of 5%, which would be very healthy for the American economy, the U.S. economy is increasing in size at only $700 billion a year. The deficit for 2011 is projected to be about $1.645 trillion.
So to answer the question, will the country collapse any time in the next few years running a deficit like this? No. Does it mean that such a large deficit is thus not a problem? Absolutely not. The deficit is a very large problem and will create massive problems down the road if something is not done about it. If the debt becomes far too large, the U.S. will have to suffer through a painful trifecta of tax increases (which also likely will likely hamstring economic growth), entitlement cuts, and inflation. Inflation acts a tax, but politicians like it because it is a tax without "officially" being a tax. It garnishes the savings of ordinary people however.
What proponents of spending cuts should thus emphasize is that all of this will in particular hit the middle-income people and the poor. They will be hammered by this if something is not done about the deficit and the debt becomes too large. Significant cuts in national defense will end up being made as well, a danger as the United States acts a form of global peacekeeper. The U.S. keeps the sea lanes open, ensuring global trade, its presence kept the Soviet Union at bay during the Cold War, and likely continues to keep Russia at bay moreso than it would be to Europe if there was no U.S. in existence.
At the current rate, the problems of the deficit will probably begin to manifest themselves around a decade from now or so, if something is not done. Even assuming the U.S. economy returning to a healthy level of growth, spending cuts must be made to fix this deficit. As for the debt itself, it will not be a problem so long as it does not grow too large. If the U.S. can return to a balanced budget and say has a national debt at 120% of GDP, well we could pay some of it down, but otherwise, so long as the budget remains balanced, then year after year, as the economy continues to grow, the national debt will decline as a percentage of the GDP. So for example, if the country starts running a permanent balanced budget with a debt of 120% of GDP, then within a few years, it would decline to around say 115%, then 110%, then 105%, then 100%, then 95%, etc...maybe even moreso given healthy levels of economic growth and if the government was to use the surplus to pay down the debt.
On the issue of raising taxes to help balance the budget, one major problem with this is that what tends to happen is the government raises taxes, and assuming lots of additional revenue comes in (the tax increases work without hamstringing the economy), the budget crisis is then temporarily fixed, which then usually results in the government continuing to spend lots of money, or even increasing spending. California is a good example of this problem. This won't always occur, sometimes the government will see an increase in tax revenue and then continue to reduce spending, or not increase it, but this is rare. Both Democratic party-controlled governments and Republican party-controlled governments of the U.S. have shown themselves to be big spenders.
Personally, I would be okay with the implementation of a VAT tax if there was a strict requirement that spending must be cut in order to fix the federal deficit and maintain a permanent balanced budget. But I do not believe the government would cut spending with the implementation of a VAT tax, and even if they did, it would only be temporarily. Then another government would come in and begin spending a lot again. They would be especially emboldened to do this because once implemented, one can continually raise a VAT.
The major problem for excessive spending in America right now is Medicare, the single-payer health insurance program for the elderly. The program's costs are simply out-of-control and at some point, it will have to be reigned in if reforms are not made of some kind. What kind of reforms I am not really sure, but something will have to be done.
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