[A Citizen's Guide to the Federal Budget]
[4. Deficits and the Debt]
[From the U.S. Government Printing Office, www.gpo.gov]
You've probably heard a lot about the Federal budget deficit and debt
in recent years, primarily because both exploded in size in the 1980s.
Put simply, a deficit occurs when spending exceeds revenues in
any year--just as a surplus occurs when revenues exceed spending.
Generally, to finance our deficits, the Treasury borrows money. The
debt is the sum total of our deficits, minus our surpluses, over the
years.
The deficit is not a new phenomenon; the Government incurred its first
in 1792, and it generated 68 annual deficits between 1900 and 1995.
Chart 4-1 provides the history of budget surpluses and deficits since 1940.
Chart 4-1. Past and Future Budget Deficits or Surpluses
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For most of the Nation's history, deficits were the result of either
wars or recessions. Wars necessitated major increases in military
spending, while recessions reduced Federal tax revenues from
businesses and individuals.
The Government generated deficits during the War of 1812, the
recession of 1837, the Civil War, the depression of the 1890s, and
World War I. Once the war ended or the economy began to grow, the
Government followed its deficits with budget surpluses, with which it
paid down the debt.
Deficits returned in 1931 and remained for the rest of the decade_due
to the Great Depression and the spending associated with President
Roosevelt�s New Deal. Then, World War II forced the Nation to spend
unprecedented amounts on defense and to incur unprecedented deficits.
Since then--with Democratic and Republican Presidents, Democratic and
Republican Congresses--the Government has balanced its books only eight
times, most recently in 1969.
Why have deficits become such a perennial problem for budget
decisionmakers? Because spending has been growing faster than
revenues.
Chart 4-2. Outlays as a Percent of GDP
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Revenues have stayed relatively constant, at around 19 percent of GDP,
since the 1960s. In that time, however, outlays have grown from below
18 percent of GDP in 1965 to up to 24 percent in 1983 before falling
to 21 percent today. Much of the spending growth has come in Social
Security, Medicare, Medicaid, and interest payments (see Chart 4�2).
Nevertheless, the deficits before 1981 paled in comparison to what
followed. That year, the Government cut income tax rates and greatly
increased defense spending, but it did not cut non-defense programs
enough to make up the difference. Also, the recession of the early
1980s reduced Federal revenues, increased Federal outlays for
unemployment insurance and similar programs that are closely tied to
economic conditions, and forced the Government to pay interest on more
national debt at a time when interest rates were high. As a result,
the deficit soared.
Why the Deficit is a Problem
The United States is not alone in struggling with budget deficits. As
Chart 4�3 illustrates, this Nation has an average record when compared
to the recent history of six other major developed economies. (To make
accurate comparisons with the governments of other nations, the U.S.
data include the activities of State and local governments).
If budget deficits occur so frequently, here and abroad, should we
worry about them?
The short answer is, yes. The deficit forces the Government to borrow
money in the private capital markets. That borrowing competes with (1)
borrowing by businesses that want to build factories and machines that
make workers more productive and raise incomes, and (2) borrowing by
families who hope to buy new homes, cars, and other goods. The
competition for funds tends to produce higher interest rates.
Deficits increase the Federal debt and, with it, the Government's
obligation to pay interest. The more it must pay in interest, the less
it has available to spend on education, law enforcement, and other
important services, or the more it must collect in taxes--forever
after. Today, the Government spends 15 percent of its budget to pay
interest.
As shown in Chart 4-4, the Federal interest burden grew substantially
in the 1980s. By 1997, net interest spending will be nearly as much as
the Government will spend on national defense.
In the end, the deficit is a decision about our future. We can provide
a solid foundation for future generations, just as parents try to do
within a family by
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limiting the amount of debt that they pass on; or we can generate
large deficits and debt for those who come after us.
Deficits and Debt
If the Government incurs a deficit, it must borrow from the public.
Table 4-1 summarizes the relationship between the budget deficit and
Federal borrowing.
Federal borrowing involves the sale, to the public, of notes and bonds
of varying sizes and time periods. The cumulative amount of borrowing
from the public--i.e., the debt held by the public--is the most
important measure of Federal debt because it is what the Government
has borrowed in the private markets over the years, and it determines
how much the Government pays in interest to the public.
Chart 4-3. Total Government Surplus or Deficit as a Percent of GDP
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Table 4-1. Federal Government Financing and Debt
(In billions of dollars)
------------------------------------------------------------------------------
1995 Estimate
Function Actual 1996 1997 1998 1999 2000 2001 2002
------------------------------------------------------------------------------
Federal Government financing:
Budget deficit (-) or
surplus -164 -146 -140 -98 -64 -28 8 44
Other means of financing -7 -20 -24 -27 -29 -29 -28 -27
-------------------------------------------------
Borrowing from the public 171 165 164 124 93 57 20 -17
Federal Government debt:
Debt held by the public 3,603 3,769 3,933 4,057 4,151 4,207 4,227 4,210
Debt held by government
accounts 1,318 1,439 1,566 1,693 1,828 1,978 2,133 2,297
-------------------------------------------------
Gross Federal debt 4,921 5,207 5,499 5,750 5,979 6,185 6,360 6,506
Debt subject to legal limit 4,885 5,163 5,456 5,711 5,939 6,145 6,321 6,468
Note: Numbers may not add to the totals due to rounding.
Debt held by the public was $3.6 trillion at the end of 1995--roughly
the net effect of deficits and surpluses over the last 200 years. Debt
held by the
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public does not include debt the Government owes itself--the total of
all trust fund surpluses and deficits over the years, like the Social
Security surpluses, that the law says must be invested in Federal securities.
The sum of debt held by the public and debt the Government owes itself
is called Gross Federal Debt. At the end of 1995, it totaled $4.9 trillion.
Another measure of Federal debt is debt subject to legal limit, which
is similar to Gross Federal Debt. When the Government reaches the
limit, it loses its authority to borrow more to finance its spending;
then, the President and Congress must enact a law to increase the
limit.
The Government's ability to finance its debt is tied to the size and
strength of the economy, or GDP. Debt held by the public exceeded 50
percent of GDP at the end of 1996. As a share of GDP, debt held by the
public was highest at the end of World War II, at 114 percent, then
fell to 24 percent in 1974 before gradually rising to current levels.
That decline, from 114 to 24 percent, occurred because the economy
grew faster than the debt accumulated; debt held by the public rose
from $242 billion to $344 billion in those years, but the economy grew
faster.
Individuals and institutions in the United States hold over 75 percent
of debt held by the public. The rest is held in foreign countries.
Deficit Reduction Efforts
Ever since the deficit soared in the early 1980s, successive
Presidents and Congresses have tried to cut it. Until recently, they
met with only limited success.
In the early 1980s, President Reagan and Congress agreed on a large
tax cut, but could not agree about cutting spending; the President
wanted to cut domestic spending more than Congress, while Congress
sought fewer defense funds than the President wanted. They wound up
spending more on domestic programs than the President wanted, and more
on defense than Congress wanted. At the same time, a recession led to
more spending to aid those affected by the recession, and reductions
in tax revenues due to lower incomes and corporate profits.
By 1985, both sides were ready for drastic measures. That year, they
enacted the Balanced Budget and Emergency Deficit Control Act, better
known as Gramm-Rudman-Hollings (GRH). It set annual deficit targets
for five years, declining to a balanced budget in 1991. If necessary,
GRH required across-the-board cuts in programs to comply with the
deficit targets.
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Faced with the prospect of huge spending cuts in 1987, however, the
President and Congress amended the law, postponing a balanced budget
until 1993. The President and Congress never achieved those revised
targets, in part because of the extraordinary costs of returning the
Nation's savings and loan industry to a sound financial footing.
By 1990, President Bush and Congress enacted spending cuts and tax
increases that were designed to cut the accumulated deficits by about
$500 billion over five years. They also enacted the Budget Enforcement
Act (BEA)�rather than set annual deficit targets, the BEA was designed
to limit discretionary spending while ensuring that any new
entitlement programs or tax cuts did not make the deficit worse.
First, the BEA set annual limits on total discretionary spending for
defense, international affairs, and domestic programs. Second, it
created ``pay-as- you-go'' rules for entitlements and taxes: those who
proposed new spending on entitlements or lower taxes were forced to
offset the costs by cutting other entitlements or raising other taxes.
For what it was designed to do, the law worked. It did, in fact, limit
discretionary spending and force proponents of new entitlements and
tax cuts to find ways to finance them. But the deficit, which
Government and private experts said would fall, actually rose.
Why? Because the recession of the early 1990s reduced individual and
corporate tax revenues and increased spending that is tied to economic
fluctuations. Federal health care spending also continued to grow
rapidly.
In 1993, President Clinton and the Congress made another effort to cut
the deficit. They enacted a five-year deficit reduction package of
spending cuts and higher revenues. The law was designed to cut the
accumulated deficits from 1994 to 1998 by about $500 billion. The new
law extended the limits on discretionary spending and the ``pay-as-you-go'' rules.
Clearly, the President's deficit reduction efforts have paid off. The
deficit fell from $290 billion in 1992 to $164 billion in 1995, and by
over half as a share of GDP, to 2.3 percent. Now, as you will see in
the next chapter, the President wants to finish the job by balancing
the budget over the next seven years.