A federal deficit occurs when the government's expenditures for the year exceed its income. The government then pays for those excess expenditures by borrowing money, adding to the national debt. With so much stimulus money being spent to prod the economy out of recession, the federal deficit will reach record levels this year. According to the Congressional Budget Office, the federal deficit will quadruple in 2009, from $459 billion last year to $1.845 trillion this year (Source: The Economist, June 10, 2009). While the president vows to slash the deficit in half within four years, the Congressional Budget Office estimates the deficit will still total more than $1 trillion per year by 2019. Are these huge deficits cause for concern? It's tough to decide, since opinions range from "deficits don't matter at all," to "deficits will ultimately result in federal bankruptcy." It might help to put the federal deficits in perspective.
In 1998, for the first time in 28 years, the federal government ran a budget surplus. Those surpluses lasted four years. During that time, concerns about the viability of the Social Security system seemed less urgent, and there was talk about what would happen to the bond market if the federal government paid off all its debt. These discussions were short lived. Following two tax cuts, the September 11 terrorist attacks, the Afghanistan and Iraqi wars, and a recession, the federal deficits were back and have not gone away since.
Of course, a federal deficit results in an increase in the national debt. Currently, the gross national debt is approximately $11 trillion. A significant portion of that debt is owed to the Federal Reserve and other government accounts. But the public holds $6.8 trillion, or 62%, of the total debt (Source: Region Focus, Winter 2009). China and Japan are the largest foreign holders of this publicly held debt.
While the dollar amounts of the deficits and national debt are enormous, these numbers are often presented as a percentage of gross domestic product (GDP) to compare to past deficits and debt levels. The 2009 deficit of $1.8 trillion is 13.1% of GDP, twice the post-World War II record of 6% set in 1983 (Source: Fortune, June 22, 2009). The Congressional Budget Office's estimate of a $1.2 trillion deficit for 2019 would represent 5.7% of GDP, an extremely high number for a healthy economy.
In 2008, federal borrowing totaled 42% of GDP, about average for post-war years. By 2019, it could reach 82% of GDP, close to double the current level. At that point, one out of every six dollars the government spends will go to interest payments (Source: Fortune, June 22, 2009).
The general consensus is that the government needs to spend money now to stimulate the economy out of the current downturn. Without running deficits, the recession is likely to last longer and become more severe. When recessions cause a rise in unemployment rates, people spend less, which causes more people to lose their jobs, precipitating a downward spiral in the economy. Using short-term deficits to stimulate the economy helps reverse this cycle.
The problem is that even if the short-term deficits lift the economy out of recession, projected increases in Social Security, Medicare, and Medicaid expenditures make it difficult to envision a scenario where the government can operate without deficits. Spending is growing astronomically, while revenues as a percentage of GDP are basically flat. Spending is primarily driven by entitlements such as Social Security, which are projected to grow enormously as the population ages. Revenues, on the other hand, are based heavily on the individual income tax, which typically rises and falls with GDP.
What impact will these huge deficits have on the economy if they continue? No one knows for sure. But perhaps the federal government should pay special heed to what got us into the current recession in the first place - consumers living beyond their means, incurring debt to support a lifestyle they couldn't afford. Will the government be next?