The federal government is on track to run a budget deficit of almost $900 billion in fiscal year 2019, which ends on September 30, according to the Congressional Budget Office (CBO). This would be the largest deficit since 2012, when the United States was coming out of the Great Recession.
What’s more worrisome is that the budget deficit is expected to continue to increase over the long run, according to the latest projections from the CBO, adding to the national debt. Large, consistent budget deficits, at a time when the economy is expanding, could slow economic growth over the longer run, making it more difficult for the U.S. to address its priorities.
What Are Budget Deficits and Why Do They Matter?
Budget deficits are an imbalance between government spending and revenues (primarily taxes). If the government is spending more than it’s taking in it runs a deficit.
Budget deficits are not necessarily a problem, and can benefit the economy in certain circumstances.
During a recession, when demand from the private sector is weak, the federal government can step in and stimulate demand, either directly, through government purchases of goods and services, or indirectly, by cutting taxes, giving households and businesses more money to spend. That’s what happened during the Great Recession, when various stimulus efforts—investment in infrastructure, aid to state and local governments, a temporary cut to the Social Security payroll tax—helped support economic growth, lessen the severity of the recession, and bring about an earlier recovery.
Budget deficits can also be positive for the economy if they finance spending that makes the economy larger over the long run. Projects like investment in infrastructure or education, or tax cuts that stimulate private investment, can boost the economy’s potential. If the rate of return on a project is greater than the cost—the interest the federal government pays on the borrowing to fund it—than it makes sense to undertake it.
How We Got Here
Absent Big Policy Changes, CBO Forecasts Growing Long-Run Budget Deficits
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As a result of efforts to combat the Great Recession, the federal government’s budget deficit increased from 1.1% of GDP in fiscal year 2007 to 9.8% of GDP in fiscal year 2009. (Measuring the budget deficit as a share of the size of the economy, rather than in dollars, provides greater context.) Over the next 6 years the budget deficit declined as the economy expanded, temporary spending increases and tax cuts ended, the federal government raised taxes, and federal spending grew more slowly. The deficit fell to 2.5% of GDP in fiscal year 2015.
Since then budget deficits have been increasing as a share of the economy. Some of it has come from more spending, but the main driver has been the big cut to corporate and personal income taxes that Congress passed in late 2017. Revenues as a share of GDP have fallen dramatically and the budget deficit has widened; the CBO estimates that it will be 4.2% of GDP in the current fiscal year. Outside of the Great Recession and early recovery, this is the largest budget deficit as a share of the economy since 1992.
Budget deficits are projected to increase in the future, with the retirement of the baby boomers leading to greater outlays on Social Security and especially Medicare. The CBO estimates that under current policies, given demographic trends, the budget deficit will rise to almost 9% of GDP by 2049 (see chart).
Consequences of Large Structural Budget Deficits
Large structural budget deficits—that is, deficits due to a long-running imbalance between spending and taxes, and not due to temporary economic factors like recession—can cause problems for the economy for a number of reasons.
- Structural budget deficits may make it more difficult to respond to the next recession, whenever it comes. If the budget deficit is already large heading into a recession, policymakers may be reluctant to undertake stimulus, concerned about causing a fiscal crisis.
- Large federal borrowing year after year may crowd out private investment, making it more difficult for businesses to find the capital they need to expand, weighing on long-run economic growth.
- Big budget deficits may reduce spending on federal programs that can boost economic growth over the long term. If deficits are due to income transfer programs, like those for retirees, or due to greater interest spending as the national debt rises, they may crowd out spending on more productive activities, like investment in basic research or transportation infrastructure. This could slow economic growth over the longer run, making it more difficult for Americans to enjoy rising living standards and for the nation to fund government programs that our citizens find worthwhile.
Is a Fiscal Crisis Likely?
That being said, even if budget deficits are set to increase as a share of the economy over the long run, they are unlikely to lead to a fiscal crisis in the United States. The U.S. is not Greece.
Our nation benefits from:
- Control over its own currency, which serves as the global reserve currency
- An independent central bank in the Federal Reserve
- A long history of responsible policymaking that has created strong domestic and foreign demand for U.S. Treasuries
- Very deep capital markets
- A remarkable record of innovation and economic growth
Current extremely low interest rates on government debt—the federal government can now borrow for 10 years at an interest rate of just over 2%—demonstrate that investors are not terribly concerned about the U.S. not meeting its financial obligations over the long run.
The Impact on Long-Run Economic Growth
Big long-run budget deficits can impinge on long-run economic growth, and it makes sense for the United States to address this sooner rather than later. The key question for policymakers, and Americans as a whole, is how much our nation should provide the baby boomers in retirement, and how much we are willing to pay for that.
Accessible Version of the Chart