The U.S. government is living beyond its means – way beyond its means. As a result, we’ve built up a staggering amount of national debt—which is, essentially, the yearly loans the nation takes out to cover its budget shortfalls and pay its bills.

Worse yet, we have put ourselves in this fiscal hole at exactly the wrong time, because we are committed to paying enormous amounts in Social Security and Medicare as the huge baby boom generation starts to retire over the next few years. This means that the future of our economy and way of life may be dramatically affected by the choices we make today for managing the nation’s finances. And if we delay facing up to these choices, we will likely experience even more difficult economic conditions in the years to come.

To understand how we got into this mess—and what we’ll need to do to get out of it—we don’t need to understand the technical aspects of the federal budget. But it is extremely helpful to understand just a few key points.

The Deficit and the Debt

We are really talking about two tightly interrelated problems here, the deficit and the debt. The short-term problem we face is that the federal government routinely runs a deficit – that is, in most years the government is spending much more than it takes in.

Historical trend of federal deficit/surplus

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Federal deficit/surplus: Federal deficit or surplus, in billions of current dollars and constant FY 2000 dollars, fiscal years 1970-2006

Source: Budget of the United States Government, fiscal year 2008

And this leads us to a second and much bigger problem. Every time there’s a deficit, the government borrows money to cover its bills, often from foreign banks and governments. This adds to the long-term problem, the national debt, which is the total amount owed by the federal government.

Historical trend of national debt

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Federal debt : Total federal debt held by the public, in billions of dollars at the end of year, fiscal years 1970-2006

Source: Budget of the United States Government, fiscal year 2008

So if the government can’t cover its bills it runs a deficit. And every time it does this, it increases the national debt, which is like having a huge balance on your credit card. It just sits there charging you interest while you scramble to try to catch up. (Find out about the two kinds of federal debt [0]).

GDP

One of the key concepts economists use when they’re talking about the federal deficit and the national debt is how big these numbers are in relation to GDP – gross domestic product, or the total amount of goods and services produced in the United States. In effect, this means the size of our deficit [0] or debt [0] in relation to the total U.S. economy.

Most economists say this is an important benchmark and the best measure of how the deficit and debt are affecting the rest of the economy. The larger these are in proportion to GDP, the greater the impact they’re likely to have. The national debt, for example, could start taking up too much investment cash that could otherwise be put into private industry, pushing up interest rates for everybody.

Current projections by the White House budget office and the Congressional Budget Office show the deficit and the debt both declining in relation to GDP over the next few years. Those projections, however, make some major assumptions, such as that there will be no new spending programs over the next few years. The projections also largely ignore one looming problem, which is the next concept you need to know.

Fiscal Exposure

The third term that gets thrown around is fiscal exposure, or sometimes unfunded liability, to distinguish it from the national debt. Whereas debt is money we’ve already borrowed, fiscal exposure is how much we’ll need to spend in the future to keep the promises we’ve made, such as Social Security and Medicare.

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Fiscal exposures: Long-term fiscal exposures, in trillions of dollars, as of fiscal year 2006

Source: David Walker, "Saving Our Future Requires Tough Choices Today," Fiscal Wake-up Tour [1].

In this chart, fiscal exposure dwarfs the national debt, $38.8 trillion to $8.8 trillion. Combine the exposure, the debt and various other liabilities, and the Government Accountability Office estimates we face $50.5 trillion in liabilities over the next 40 years. If you consider this in relation to GDP [1], future spending on Social Security, Medicare and interest outstrips all other discretionary spending, not to mention further worsening the gap between spending and how much revenue is coming in. This is what’s really threatening our nation’s future, not the deficit or the official debt.

In sum, because we fail to live within our means we’re mortgaging our future and preparing to leave a big mess to our children. That’s why its vital to face up to the nation’s finances and do something while we still have time. These are daunting problems – but fortunately, as anyone who has ever dug him or herself out of debt knows, they’re not impossible.