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The federal deficit, part II

Federal responses to economic shocks have driven higher spending


When it comes to the massive annual U.S. deficit and the growing national debt, it’s worth considering that 23 years ago, under the second term of President Bill Clinton, the U.S. ran a budget surplus three years in a row. That proved that, in modern times, we could still balance the budget. Unfortunately, it’s been downhill ever since until we reached the highest annual deficit in U.S. history—$3.132 trillion— in the final year under President Donald Trump.
Last week, we considered how tax cuts for the wealthy and corporations implemented by Presidents George W. Bush and Trump, contributed to the growing deficits by substantially reducing federal revenues.
This week, as promised, we’ll explore what areas of spending are driving our deficits higher, and the results may surprise you. We examined several resources, including Wikipedia and publications of the Congressional Budget Office for this information.
There are three primary factors that have increased government spending in the years since our last surplus budget in 2001, and by far the most significant are the two severe economic shocks that the country has experienced since then— the 2008 financial crash and the 2020 COVID pandemic. The federal response to each of these events pushed federal spending far higher as the government sought to soften the impact of the economic dislocations for businesses and individuals, mostly through direct payments in one form or another. The cumulative effects of these two shocks, have conservatively added $10 trillion to the national debt.
Outside of stimulus related to these two shocks, growth in government spending has actually been surprisingly modest, particularly during the Obama administration. After spending jumped in response to the financial crash, it virtually flat-lined from 2010 to 2017, growing by less than the rate of inflation. In real terms, government spending actually shrank during seven of the eight years of the Obama administration.
Deficits during that period weren’t so much the result of higher spending as they were a result of the economic crash and the slow recovery, which significantly impacted federal tax revenues. The federal government took in $2.67 trillion in 2007 and didn’t return to that level of revenue until 2012. The growth in federal revenues continued to lag in the subsequent years, increasing by an average of just 2.3 percent (or about at the rate of inflation) from 2013-2020.
Many economists now believe that the federal response to the 2008 crash was too modest and that the relative lack of stimulus contributed to a years-long period of steady but slow economic growth. The federal response to COVID was far more robust (a lesson learned from 2008) and it sparked much faster growth once the lockdown was over. That has sparked a significant jump in federal revenues, which have climbed faster in the last two years than at any time in modern history, helping to reduce the deficit.
At the same time, federal spending dropped by $1 trillion in 2022 over 2021 levels and was budgeted to drop another $100 billion this year, leaving a projected deficit of $1.154 trillion. That’s an improvement on the $3.3 trillion deficit in the final year of the Trump administration, but it’s a long way from a balanced budget. And, unfortunately, the latest budget projections from the White House show spending and deficits beginning to increase slowly again next year. And that assumes we have no more economic shocks, which is no guarantee.
Underlying much of the spending growth looking forward is the rising cost of major entitlement programs, primarily Social Security, Medicare, and Medicaid.
The cost of these programs has increased from $606 billion in 2000 (equivalent to 5.95 percent of the nation’s gross domestic product, or GDP) to $2.53 trillion (or 10.2 percent of GDP) as of 2022. Back in 2000 these programs occupied 34 percent of the total federal budget, but that’s over 40 percent today and rising. The steady increase in healthcare costs, which has fueled Medicare and Medicaid spending, as well as the aging of our population, which has increased the draw on Social Security, are the primary contributors to this growth.
Defense spending has also grown— we spent 2.8 percent of GDP on the Pentagon in 2000 and 2.9 percent in 2022. The cost of wars in Iraq and Afghanistan, which are typically funded outside the Pentagon budget, have also added to the debt because we didn’t raise taxes to pay for them. The immediate direct cost of the wars was approximately $1.6 trillion although the long-term cost is estimated at closer to $6 trillion once all the indirect costs, including the cost of caring for thousands of badly injured servicemen and women, are included.
Interest on the debt, which had been quite modest for years thanks to low interest rates, has spiked considerably as the Federal Reserve has raised rates and that’s pushing spending higher.
Most other types of federal spending, such as the income supports we think of as “welfare” have been flat for years as a percentage of GDP and account for less than ten percent of the total budget in either case. The cost of running the rest of government, including all the federal agencies, airports, courts, national parks, etc. has actually declined in real terms in recent years. Back in 2000, the federal budget included $600 billion in spending on general government operations, which equaled about 5.8 percent of the GDP. Today, the federal government is spending about $910 billion (3.6 percent of GDP) on these same operations, which is well under the rate of general inflation over that period. In real terms, spending on general government has declined over the past 20 years. It clearly isn’t driving our debt problem.
If we really want to address the factors driving our rising debt, we need better ways to respond to economic shocks, since it is those shocks that have pushed our deficits and debt out of control. Classic Keynesian economics advocates using the government’s spending power to bolster the economy during downturns and its taxing authority to recoup the debts incurred once the economy recovers. We’ve become devoted to the first half of Keynes’ equation, but we ignore the second part. We’ve come to rely on monetary policy, i.e. higher interest rates, to address the economy when it overheats, rather than fiscal policy, i.e higher taxes on those at the top. Both approaches serve the same purpose of restricting the money supply, only higher interest rates put the squeeze on those who need to borrow (i.e. lower and middle income Americans), while higher upper end taxes put the pinch on those who can most easily afford it.
That’s the discussion we need in Washington. We have a debt problem, and we have solutions available to us. All it takes is the political will.