November 11, 2019
Do Deficits Matter?
Please read important disclosures and index definitions HERE
November 11, 2019
Please read important disclosures and index definitions HERE
SPECIAL SECTION: This is a new section of Perspectives intended to encourage a discussion and dialogue.
The U.S. federal government just announced it ran a deficit of $984 billion for the 2019 fiscal year ended September 30, as spending grew twice as fast as revenues. In order to pay for this excess spending, the U.S. government borrowed from savers both here and abroad. With annual deficits now expected to continue at the trillion dollar mark over the next decade, should we be worried? Do these deficits matter or are they just a normal part of how the largest economy in the world functions? If we look at current fiscal budgets and expected trends, it’s hard not to conclude that we could be paying for this profligacy for generations unless we make changes soon.
To understand how the federal government finances itself, let’s take a look at some budget data.
CBO U.S Federal Budget Projections: 2019-20291
CBO update: August 2019
|Publicly Held Debt||$16.685||$29.322|
According to the latest projections for fiscal year 2019 from the Congressional Budget Office (CBO), total spending was projected to be $4.4 trillion dollars, while total revenues were projected to come in at approximately $3.4 trillion. Of the total spending, 61.4% is mandatory (benefits payments such as food stamps, Social Security, and Medicare, etc.), and 8.4% is the net interest payment on the national debt, leaving about 30.2% (about $1.3 trillion) for all discretionary spending (defense, housing, highways, clean water, etc.) — the only portion Congress really debates and sets. Breaking discretionary spending down further, roughly half is spent on defense ($670 billion), leaving $662 billion to cover all other discretionary items.
What does the CBO project over the next 10 years for the federal budget? With the aging U.S. population (the share of the population that is age 65 or over) projected to expand by around one-third by 2029, mandatory spending is expected to increase by over 64% to around $4.4 trillion dollars alone — mainly due to increased outlays for Social Security and Medicare benefits. Also, with the accumulation of an additional $12.2 trillion of national debt over the next decade, net interest payments will more than double to approximately $807 billion. In fact, Social Security, Medicare, and interest on the debt will account for about two-thirds of the increased spending over the decade.
Based on these estimates, accumulated national debt will rise to $29.3 trillion in 2029 from $16.7 trillion today, causing interest costs to rise to 11.6% of the total budget, up from 8.4% today. That giant sucking sound you hear isn’t the noise from our jobs heading to Mexico, as former presidential candidate Ross Perot once famously predicted, but rather our federal government sucking up more and more dollars from all over the world in order to cover these huge deficits.
But that’s not all. The federal budget doesn’t include many of the pending liabilities not fully funded at the public (federal and state) level. In addition to Social Security and Medicare, the federal student loan program is now expected to cost taxpayers an additional $31.5 billion over the next decade due to escalating defaults (last year the government was still expecting a profit of $8.7 billion!). Moreover, current estimates from the Pew Charitable Trusts indicate that U.S. states have a cumulative pension funding gap of $1.5 trillion2, in addition to a shortfall of $600 billion for other retiree benefits (mainly health care), while the Federal Reserve puts the total shortfall for all public pension systems across the U.S. at $4.2 trillion. These are staggering figures that can only be made up by exceedingly good investment returns or higher taxes.
In addition, many of the 2020 presidential candidates have proposed expensive new programs, most of them in the mandatory spending category, along with some recommended new taxes to pay for them. Ignoring the fact that many economists doubt whether these new taxes would actually raise the projected revenue, or even whether the programs or taxes are good policy, none of the candidates or political parties are addressing our current trillion dollar deficits or how we might manage the huge projected growth in the national debt already built in over the next decade.
The U.S. budget deficit reached 4.6% of gross domestic product (GDP) in 2019, higher than the 50-year average of 2.6%. On the surface, this still may seem to be within reasonable levels. However, there are three key assumptions within the CBO’s projection for the next decade that hide some important risks of this trend. First, the CBO assumes that real GDP growth remains positive throughout the next decade, averaging around 1.8%. If, however, a recession were to hit within the next few years, revenues would likely be dramatically lower and spending dramatically higher (especially for unemployment benefits and other special programs), exacerbating the deficit problem.
Second, the CBO assumes that the interest rate on the national debt, which averaged 2.3% in 2018, climbs to only 3% by 2029. Even with this modest assumption, the near doubling of the national debt over the next 10 years jumps the proportion of the national budget dedicated to interest payments dramatically. If interest rates were to rise even by 1% more than projected, net interest costs would exceed $1 trillion annually, further crimping Congress’s ability to fund discretionary items.
Finally, the CBO assumes no new spending programs over the next decade, including those proposed by the 2020 presidential candidates or currently under consideration in Congress. Most of those that have been in the headlines recently fall into the category of mandatory spending (“Medicare For All,” etc.), and so would affect outlays no matter what the revenue collections actually are. If new taxes underfund these programs, it would accelerate the increase in our debt even more.
One of the buzz words of the moment is “sustainable,” as in sustainable agriculture or sustainable energy production. When we think about the above trends, it’s doubtful that this level of spending is sustainable without significant changes or painful repercussions. At the projected rate of economic growth, even without new programs, the ability to borrow at cheap rates is likely to be tested. Some economists, including a few advising current presidential candidates, expect that growth will benefit from the new spending and that proposed taxes will pay for all of the costs of the new programs (although some, such as Bernie Sander’s “Medicare For All” are assumed to create additional “cost savings” from the adoption of the program itself). In regard to deficits and the growing national debt, these economists argue that larger economies such as the U.S.’s, which issue debt in their own currencies, can always print more money to cover deficits or create desired inflation. However, this presumes the continued existence of willing lenders and the ability to pull back printing to keep inflation controlled — and both an ability and a willingness to pay on the part of the borrower. If borrowing becomes too elevated, lenders may become more reluctant to continue to roll over U.S. debt, never mind lend for new spending. This scenario is especially true if a recession hits and savers need the funds to cover their own expenses or if the government is on a clear path to inflate the debt problem away.
We need only think back to past U.S. government shutdowns, combined with the inability of Congress to compromise on a budget or a new debt ceiling, that led to the first ever credit downgrade of U.S. government debt below AAA in 2011 (as interest payments on Treasury debt were threatened). The projected accumulation of another $12+ trillion of debt over the next decade combined with any other negative change from CBO projections (e.g., a recession) could bring into question our ability to pay, on top of Congress’s seeming periodic unwillingness to do so. When debt grows faster than the economy, history shows that a country’s citizens soon end up facing economic misery.
There are some steps that could be taken now to address this situation. For example, Social Security is expected to begin running deficits (taking in less in tax payments than is spent for the program’s benefits) in 2020, and Medicare is already running one. The trust funds for each would be entirely depleted within the decade. However, with modest adjustments, each program could be made sustainable (solvent for the next 75 years). For example, subjecting more income to Social Security taxation (it is currently limited to income only up to $132,900 in 2019), along with a modest increase in the eligibility age for obtaining benefits (to account for longer expected life spans) could achieve this goal.
Also, in our current world of low interest rates and willing lenders, we could take this opportunity to refinance some of our debt to lock in low interest rates using longer-term rather than shorter-term bonds (i.e., 20- or 30-year bonds rather than 2- or 5-year notes).
Usually our government tends to run deficits when the economy is doing poorly, especially during recessions when unemployment benefits escalate while revenues decline. When the economy is at full employment and inflation is low as they are today, we’d typically expect to see balanced budgets, if not surpluses. In this regard, Congress currently acts like Wimpy from the old Popeye cartoons: “I’d gladly pay you Tuesday for a hamburger today.” But instead, Tuesday only seems to bring a request for another hamburger, with the promise to pay kicked down the road.
Let’s hope we never have to face a world of rising debt and unwilling lenders. In any case, you may want to watch your pocketbook because taxes — and maybe inflation — are most likely going up to pay for all of those hamburgers we are consuming today.
1. Congressional Budget Office; ‘An Update to the Budget and Economic Outlook: 2019 to 2029’; August 21, 2019. https://www.cbo.gov/publication/55551
2. Pew Charitable Trusts; ‘The State Pension Funding Gap: 2017’; June 27, 2019; https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2019/06/the-state-pension-funding-gap-2017