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National Debt: CNBC Explains

Anyone who has taken out a car loan or bought a house with a mortgage has taken on debt. It's the same for countries. They often need to borrow money to keep services going, with the promise to pay it back.

What is national debt and what is a deficit? How does debt get paid back? Here are the basics.

What is the National Debt?

National debt is the sum of all outstanding debt owed by the federal government. It includes not only the money the government has borrowed, but also the interest it must pay on the borrowed money. The government goes into debt when it doesn't collect enough revenue to cover the expenses it incurs from spending on programs such as the military, or building roads and bridges. The revenues come from corporate and income taxes, and the fees the government imposes, such as for visas and passports, student loans, and admission to national parks.

What is the Deficit?

The deficit refers to the difference, in a single year, between government receipts and spending. Those deficits become the national debt when they are added together. They're tied to each other, but they're different.

Deficit spending is sometimes viewed as temporary but necessary. For the government, that might be true if it needs to spend money to fight a war. For a person, it might be true if he or she wants to take out a loan to buy a car.

But over time, running large annual deficits is a bad thing, for the government and for the average person. Here's why: think of the government's annual deficit spending like a person using a credit card to spend above his or her means. If that type of spending continues year after year, the interest on the credit card builds up. The minimum payments become larger and larger. Eventually, the charges become so unwieldy that the card holder can't pay them off without making big sacrifices (say, selling the house and the car) or declaring bankruptcy.

It's also important to note that a government can still have a national debt even if there's no deficit in a specific year. Here's how that works.

In 2001, for instance, the government had a surplus of $127 billion. However, $127 billion was a surplus for that year alone and did not eliminate the national debt, which at that time was $5.9 trillion — from all the previous years of deficits.

What is the Debt Ceiling?

The debt ceiling is a cap, set by Congress, on how much debt the U.S. government can carry. The debt ceiling idea came about in 1917. Before then, Congress had to approve borrowing for each item when the government needed money.

But to have more flexibility as the U.S. entered World War I, lawmakers agreed to give the government approval for all borrowing — as long as the total was less than a specific number. That debt limit number — usually set at a high figure — would be set by Congress.

Whenever the government is going to exceed the debt limit, Congress has to vote its approval to raise it.

So looking at this in real money, the debt ceiling in 2011 is $14.294 trillion. The national debt is more than $14.5 trillion. Congress has to approve raising the debt limit. If it doesn't within a certain time frame, funds would not be available to pay bills.

The debt ceiling has frequently been raised — 74 times since March 1962 and 10 times since 2001.

History of U.S. National Debt

From its beginning as a nation, the U.S. has been in debt at one time or another, according to the Bureau of Public Debt. The country has usually spent more than it's taken in order to keep services going.

The Revolutionary War created a debt of $75 million. The fledgling government had to pay for its soldiers, along with food and supplies. To pay off the debt, the government sold bonds, which we'll see later is one way governments fund themselves.

It wasn't until 1835 — and after another war, the War of 1812 — that the U.S. was in the black.

The Civil War produced a massive round of debt, reaching a figure of $2.7 billion by 1864. After 1865, the U.S. ran deficits in 11 of the next 47 years, having surpluses in the other 36.

Jumping ahead to the 20th century, a major period of debt followed World War I and the build up for World War II, and social programs to fight the Great Depression caused a major increase in debt to $260 billion by 1950.

Over the years, government's role expanded with programs such as agricultural subsidies, highway construction, Medicare, Medicaid, public education, the federal courts, mail delivery, food and work safety inspectors, law protection agencies like the FBI, among others.

And of course there's defense — even with some cuts in the 1990s — leaving the U.S. still spending more for it that any other country.

The debt continued to grow from $260 billion in 1950 to $909 billion in 1980. Between 1980 and 1990, the debt more than tripled, according to the BPD.

How the Debt is Financed

If you've ever bought a savings bond, you've helped provide money to cover the debt. That money helps pay off the government's theoretical 'credit card.'

The government borrows money by selling Treasury Securities such as Treasury Bills or T-Bills— and bonds to the public and/or foreign countries.

US Capitol Building with cash
US Capitol Building with cash

These securities come with the promise of a payday with interest. They can be short-term payoff — say, three years — or they can be longer, up to 30 years.

Where Government Spends Money

In 1900, the government spent $332 million on defense, $297 million on domestic spending and other items such as interest on the debt for a total of $629 million in spending, according to the Treasury Department. But there was a surplus that year because the government took in $670 million in revenue.

Fast forward to 2010 and there's a change in spending and programs. The biggest cost was Medicare and Medicaid at $793 billion; and together they made up 23 percent of the budget, according to the Congressional Budget Office.

Next came Social Security at $701 billion or 20 percent, followed by defense spending at $698 billion and 20 percent of the budget.

Medicare, Medicaid and Social Security, along with such items as Congressional salaries, are considered mandatory payments—they have to be paid even if the money isn't in the government till.

And interest on the debt itself was $197 billion in 2010, or 6 percent of the budget.

Summing up 2010, the government had an annual deficit of $1.3 trillion, and the national debt at that time — the sum of all previous yearly deficits — was $13.1 trillion.

Before we move on, we need to note Social Security. Established in 1935, Social Security pays for itself through taxes collected on individuals and money it makes by investing in the government.

In 1968,it was included in the Federal budget.That changed in 1986 when it was taken 'off budget' — or not included as government spending — but has since been used in calculating total budget spending. So, while technically on the federal budget books, Social Security has its own source of revenue.

Who Owns the Debt

The U.S. government sells securities like bonds and T-Bills to finance its debt. Anyone can buy them, including other countries.

The U.S. is the biggest holder of its own debt, with institutions and investors holding 42.2 percent,according to the U.S. Treasury Department. Another holder of U.S. debt is the Social Security trust fund at 17.9 percent. The trust fund is the 'extra' or surplus that was set aside for deficits in payouts. The fund traditionally invests in U.S. securities.

Mike Kemp  | Getty Images

The U.S. Civil Service Retirement Fund and the U.S. Military Fund own a combined 8.1 percent. So, 68.2 percent of the debt is 'home'-owned.

The rest of the debt is owned by countriesincluding Japan, the United Kingdom, Brazil, Venezuela and Saudi Arabia. China owns 7.5 percent of the total U.S. debt, much less than popularly believed.

Why the Debt Matters

A high debt level affects the cost of living, interest rates to buy homes or cars, as well as the overall economy, say analysts.

Money owed to the people/countries/investors who subsidize the debt by buying debt instruments must be paid off.

If the investors and lenders believe the U.S. can't pay its national debt, they stop loaning the government money and the interest rates go up for banks and consumers.

Debt is repaid through higher taxes and/or spending cuts.

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