The Budget Deficit is Dropping

What Does This Mean for America?

The Budget Deficit is Dropping
November 4, 2014

Do you need some economic good news? Try this – the budget deficit is dropping.

In a recent speech, President Obama claimed to have cut the budget deficit in half. Indeed, his claim is true, although he may not deserve the credit. Whether measured as a percentage of the Gross Domestic Product (GDP) or in raw dollar values, the deficit has decreased by half during President Obama’s time in office.

From a 2009 high (or low, if you prefer) of 9.8% of GDP, the deficit shrank to 6.8% of GDP in 2012 and 4.1% in 2013. The August CBO estimate for 2014 is 2.9% of GDP, continuing the trend.

Why is the budget deficit dropping? For one reason, it was almost inconceivable that it could get worse. To find a deficit that was higher than any one of the budget deficits from 2009-2012 as a percentage of GDP, you have to go back to 1946. It is a bit like gaining 100 pounds in a year and being proud that you lost 70 pounds in the next five. It’s still progress in the right direction, but we still have a long way to go.

Legislative efforts and curbs in government spending account for much of the improvement. The 2011 Budget Control Act capped discretionary spending, starting the more significant decreases. The effects of sequestration and the subsequent agreement continued the overall spending reductions, along with the 2013 Bipartisan Budget Act and the 2014 Farm bill.

A continued drop of the deficit reduction must be a good thing… right? That depends on your political and/or economic philosophy.

Consider that the deficit can drop through two mechanisms – an increase in revenue or a decrease in spending. Revenues have been increasing slowly each year since 2009, as our economy slowly recovers. Meanwhile, the bulk of the improvements have come through decreases in spending.

One camp argues that economic growth is being hampered by government restrictions and tax policies, and that if the restrictions were released, that the economy would grow enough to increase the overall tax revenue even with lower tax rates. Deficits would shrink and eventually turn into surpluses.

Another camp argues that the economy needs significant government spending to provide economic stimulus, and that we would be wise to invest in the infrastructure while money is still cheap. Balance this approach with more progressive tax brackets for personal income taxes and closing of loopholes, and again the result is higher income, shrinking deficits, and an eventual budget surplus.

Who is correct? We don’t know. Highly intelligent people have been debating this for years, and will continue to do so regardless of the results. But we do know this: the budget deficits are approaching normal historical averages (around 3.1% from 1974 to 2013, according to the CBO), and are projected to fall slightly beneath them. Some sense of normalcy is returning, which is good.

However, before we celebrate too much, consider the following:

Social Security still counts “off budget”, and is in essence a big fat IOU that is not being taken into account with the deficit.

The CBO projects deficits to rise again in 2016 and shows continued increases from that point. 2014-2015 may be as good as it gets.

Most importantly, this is a shrinking deficit, not shrinking debt. Remember the 100-pound analogy? A better analogy is that we gained 100 pounds in a year and we have improved to only gaining 20 pounds a year. We cannot run perpetual deficits as a country any more than we can perpetually gain weight and survive as a person. Eventually, systems shut down.

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