[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 69 annual deficits between 1900 and 1996.
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 17 to 19 percent of
GDP, since the 1960s. In that time, however, outlays have grown from
about 17 percent of GDP in 1965 to up to nearly 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 a good 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.
The Federal interest burden grew substantially in the 1980s, both in actual
dollars and as a percentage of Federal income tax revenues (see Chart 4-4).
By 1998, net interest spending will be nearly as much as the Government
will spend on national defense.
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Chart 4-3. Total Government Surplus or Deficit as a Percent of GDP
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 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
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Chart 4-4. Interest Costs as a Percent of Income Tax Revenues
private markets over the years, and it determines how much the
Government pays in interest to the public.
Table 4-1. Federal Government Financing and Debt
(In billions of dollars)
-----------------------------------------------------------------------------
1996 Estimate
Actual 1997 1998 1999 2000 2001 2002
-----------------------------------------------------------------------------
Federal Government financing:
Budget deficit (-) or
surplus -107 -126 -121 -117 -87 -36 17
Other means of financing -22 -17 -25 -21 -22 -23 -22
-----------------------------------------------
Borrowing from the public 130 143 146 138 110 59 5
Federal Government debt:
Debt held by the public 3,733 3,876 4,021 4,159 4,269 4,328 4,333
Debt held by government
accounts 1,449 1,578 1,715 1,853 2,003 2,157 2,319
-----------------------------------------------
Gross Federal debt 5,182 5,454 5,736 6,013 6,272 6,485 6,653
Debt subject to legal limit 5,137 5,411 5,697 5,973 6,233 6,447 6,615
----------------------------------------------------------------------------
Note: Numbers may not add to the totals due to rounding.
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Debt held by the public was $3.7 trillion at the end of ~1996--roughly the net
effect of deficits and surpluses over the last 200 years. Debt held by the
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 1996, it totaled $5.2 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 was 50 percent of GDP at the
end of 1996. As a percentage of GDP, debt held by the public was highest at
the end of World War II, at 111 percent, then fell to 24 percent in 1974
before gradually rising to current levels.
That decline, from 111 to 24 percent, occurred because the economy grew
faster than the debt accumulated; debt held by the public rose by amounts
ranging from $242 billion to $344 billion in those years, but the economy
grew faster.
Individuals and institutions in the United States hold over 70 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
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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.
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 $107 billion in 1996, and by two-thirds as
a share of GDP, to 1.4 percent. Now, as you will see in the next chapter, the
President wants to finish the job by balancing the budget over the next five
years.