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Two-Minute Take: The Federal Deficit

Economic growth expert Cullum Clark explains the national deficit and its impact.

Article by J.H. Cullum Clark June 28, 2018

With the federal deficit expected to be the largest in history within 16 years, economic growth expert Cullum Clark explains the national deficit and its impact.

Explain the federal deficit for us. How does it impact the economy?

The federal government has run a budget deficit in all but three of the last 50 years, meaning that it consistently spends more than it takes in from taxes. The U.S. Treasury finances its deficits by borrowing money from the public through bond issuance. The sum of all the outstanding Treasury bonds is the national debt. Over the past 40 years, the federal budget deficit has generally amounted to two or three percent of gross domestic product (GDP); in fiscal year 2018, it was 3.9 percent. As of the end of fiscal year 2018, the national debt stood at $15.6 trillion, or 78 percent of GDP, fast approaching a level we have not seen since World War II.

A small deficit is not a problem for the economy, as the U.S. government is the world’s most creditworthy borrower and can easily fund small deficits through bond issuance. Today, however, a combination of recent tax cuts, spending increases, and the accelerating retirement of the Baby Boomer generation is pushing the federal deficit to uncomfortably high levels. The government’s spending and tax revenues this year will amount to 21 percent and 17 percent of our economy, respectively, implying a deficit at four percent of GDP. This is a larger share than the U.S. has ever experienced when the economy is booming. 

Looking ahead, government accountants project that the government’s deficits will exceed five percent of GDP within three years, and as much as nine percent within a decade. The national debt will grow explosively absent a policy shift, from 78 percent of GDP now to over 105 percent by 2028 and 150 percent by 2048.

This path is not sustainable. Growing federal spending on the big three entitlement programs – Social Security, Medicare, and Medicaid – will increasingly crowd out all other national priorities. Soaring bond issuance will bid up interest rates in the economy as a whole, choking off private sector capital investment and research. Or, in the event that the Federal Reserve lets itself be bullied into acquiescing, soaring bond issuance could result in higher inflation, which reduces the value of savings and destabilizes the economy. The debt burden will become a millstone weighing down America’s economic growth.

What does it mean that we will soon surpass the deficits of the immediate post-World War II years?

The U.S. government ran huge deficits to fund the war effort from 1941 to 1945, in the context of a global war against existential threat to our nation. But the deficit quickly fell back below 10 percent of GDP after the war’s conclusion. In the immediate postwar years, we continued to pay for an enormous military presence around the world for several years.  It is remarkable that, within a decade, the federal government will incur deficits even larger as a share of the economy than it incurred in those years, even as the national defense has become a far smaller part of government spending.