This paper examines historical and contemporary trends in the U.S. federal budget deficit, arguing that the raw deficit figure is an insufficient measure of fiscal health. Drawing on economic research and federal budget data from the early twentieth century through FY 2006, the paper traces the near-continuous growth of the deficit since World War I, surveys the brief surplus period of the late 1990s, and explains why the ratio of deficit to gross domestic product (GDP) is a far more meaningful analytical tool. By applying this framework to the FY 2004 and FY 2006 budgets, the paper demonstrates that rising nominal deficits do not necessarily indicate deteriorating government performance, and that debt held by the public as a percentage of GDP offers a more accurate picture of fiscal effectiveness.
Political pundits and armchair economists alike decry the state of the nation's budget. They point to growing deficits, spending on a plethora of social programs, and taxes on everything from gasoline to bottled water as being detrimental to the overall economic health of the nation. The budget deficit, defined as the amount the government must borrow in order to fulfill its budgetary allocations, is at an all-time high. Although this figure can serve as a useful talking point for pundits and critics, it does not actually carry significant economic meaning when taken by itself. This paper examines the trends in the federal budget, compares these historical trends with the current federal budget, and explores what those trends mean from an economic perspective — as opposed to an armchair economist's opinion.
Experts have noted that since World War I, the deficit has risen "almost continually" (Cogan 1991). This can be significantly attributed to increasing demands on government by various groups: there are agricultural subsidies, welfare programs for the poor, unemployed, or disabled, highways to be built, environmental standards to be upheld, and literally thousands of other programs that the public expects the government to fund. Ideally, this funding would come from revenues collected by the government, but years of fiscal deficits prove that government income will usually not exceed government spending.
Until a brief period in the late 1990s, the federal government consistently outspent its revenues. As one source notes, "in every year between FY1969 and FY1998, the federal budget was in deficit… beginning in 1929 and extending through 1969, the budget was in surplus for a total of nine years, and during that time was never in surplus for more than three years in a row" (Cashell 2005, p. 2). What, then, are economists to make of budget deficits? They seem undesirable, and yet pervasive. Is greater expenditure than revenue simply a fact of modern governmental life? And if so, is it necessarily detrimental to fiscal health? Historical trends demonstrate that deficits are significantly more prevalent than surpluses, which were the luxury of government only during a brief window in the late 1990s. More often, expenditures exceed revenues, and bridging the gap requires government borrowing from foreign or private entities.
Reducing the discussion to whether government revenues are larger than expenditures is too simplistic a measure, however. Economist Laurence Kotlikoff has argued that deficits are "not a well-defined economic concept" and that there is actually "very little correlation between budget deficits and interest rates," another commonly cited economic factor (Kotlikoff 1993). Perhaps most relevant in determining the true state of the federal budget is the ratio of the amount borrowed — the deficit — to the gross domestic product (GDP), rather than a simple comparison of borrowing against income. Cashell has noted that although the deficit, even when adjusted for inflation, may have grown, its relationship to GDP is far more important than whether it is increasing year to year (2005).
For example, if the deficit increases 2.5% in one year but GDP also increases by the same amount, the deficit as a proportion of the federal budget has remained unchanged. This approach leads many economists to observe that although the nominal deficit is increasing, as a portion of GDP it has actually declined in some years. This method of analyzing the federal budget is significantly more accurate than simply expressing alarm over the fact that the budget remains in deficit.
With these criteria in mind, attention turns to the current federal budget, which has been in deficit status since 2002 and seems destined to remain so for the next several years. The FY2006 proposed budget includes a $390 billion deficit — not including potential expenditures in Iraq and Afghanistan or any Social Security reform measures — a seemingly large discrepancy between government revenue and spending (Cashell 2005, p. 1). President Bush vowed to reduce deficit spending by half within five years, and appeared to be holding to that promise, as the 2006 deficit was smaller than the $427 billion deficit recorded in the FY2005 budget. However, these figures are not a true reflection of the government's fiscal condition when they do not account for the deficit as a ratio to revenue or as a percentage of total spending.
The Office of Management and Budget data from this period reinforces the importance of applying a GDP-relative lens. When evaluated against the broader economy, the deficit figures look considerably less alarming than raw totals suggest, supporting the argument that nominal deficit numbers alone are a poor basis for fiscal judgment.
Examining the latest federal budget data available at the time of writing, the aggregate deficit between government program outlays and government income grew in nominal terms but remained a steady percentage of GDP (Budget of the US Government, 2004). Other specific figures from the federal budget demonstrate that expecting the government to operate on a for-profit basis — as a business would — simply ignores the primary function of government, which is to distribute federal revenues among the public.
"FY2004 data shows debt-to-GDP declining despite rising deficits"
Again, these kinds of relationships in the federal budget and in the broader discussion about government deficits and spending abound. To explore every instance in which the deficit proves to be a poor indicator of government performance would be redundant, and is also limited by space. Economists — both professional and casual observers alike — should let the brief examples above speak for the vast majority of current federal budget programs: increased operating deficits do not necessarily indicate poorer performance. In fact, the percentage of debt as a proportion of GDP is a far better predictor of effectiveness in the federal budget mechanism than the raw deficit figure alone.
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