Budget Deficits

Federal Budget, Budget Deficits and the National Debt

The government runs a budget deficit when tax collections are less than total spending. The government borrows to finance the deficit by selling government bonds. The federal debt is the total amount of outstanding loans owed by the federal government.

Click here to see the national debt calculated up to the minute.

A large national debt causes a drag on U.S. productivity through higher tax rates to pay the interest on that debt. 60% of GDP x 2.5% real interest rate means that 1.5% of U.S. real GDP is taxed just to be transferred.

National Debt in Historical Perspective

In the old days, little debt. In fact, in the old days, little federal government. Debt-to-GDP ratio up to perhaps 30% of National Product in a war, but little outside of a war.

Notice that spending returned to a very low level after the Civil War and previous wars. This was part of a pattern of running up debt to finance the war, but then run your national debt/GDP ratio down to zero after a war. Andrew Jackson paid off the national debt in the 1830s. This hasn't happened folowing our 20th century wars. In 1913 debt was 3% of GDP; 1930 debt of 20% of GDP; 1975 debt of 25% of GDP.

With the end of World War I, however, government spending did not go all the way back down to its pre-war share of GDP. Whether it would eventually have done so or not in the absence of a Great Depression is unclear--but with the Great Depression, the movement of the federal government into infrastructure spending in a big way for the first time, and so forth (Social Security system) civilian spending bounced up to nearly ten percent of GDP.

And then came World War II, the Korean War, and the postwar military-industrial buildup associated with the Cold War.

Taxes kept pace--and the underlying growth of the American economy steadily reduced the outstanding national debt as a share of GDP. (The debt to GDP ratio went down from 112% at the end of WWII to perhaps 25% in the mid-1970s.)

Since the end of the 1970s things have turned very strange: doubling of debt-to-GDP; first-time emergence of large persistent peacetime budget deficits. Steady walking away of expenditures from revenues (which have been relatively constant as a share of GDP).

Three reasons for persistent budget deficits in the 1980s and 1990s:

• • the post-1973 productivity slowdown

  • the Reagan tax cuts (the Laffer Curve; too small by a factor of three or more; not to say that there aren't lots of times and places where Laffer Curve effects are important)

  • loss of political immunity against budget deficits as a result of "Keynesian" expenditure policies. Cyclical deficit--good; structural deficit--bad seems just a little bit too hard a lesson for American politics to keep in its small collective brain.

Deficits and the Business Cycle

The budget deficit automatically changes over the business cycle: towards deficit during recessions and toward surplus during expansions. Balancing the budget every year would lead to a procyclical policy which makes recessions worse and expansions more inflationary. A better policy would be to look at what the deficit would be if real GDP were equal to potential GDP and to balance this structural deficit.

Laffer Curve