Why the National Deficit Matters to Businesses and Beyond
Jul 05, 2018 12:08PM
By Kathleen Maris
By Mike and Blake DuBose
On the surface, the current U.S. economy looks rosy. However, recent Congressional Budget Office (CBO) predictions that the federal deficit will reach $1 trillion by 2020 have alarmed many economists, business leaders, and ordinary citizens…and rightly so. As Thomas Kaplan of the New York Times wrote in April 2018, “The fear among some economists is that rising deficits will drive up interest rates, raise borrowing costs for the private sector, tank stock prices, and slow the economy, which would only drive the deficit higher.” From there, the likeliness rises that the U.S. will face a fiscal crisis such as the Great Recession…or worse. If so, everyone—businesses, families, and individuals—will suffer!
As of April 2018, unemployment in America is low (3.9 percent), consumer confidence is high, and business investment is up. So why are economic experts worried? Typically, the federal government borrows less money during a good economy in preparation for harder times. However, even though Republican tax cuts are projected to grow the economy by 0.7 percent per year from 2018-2028, decreased tax revenues and increased interest payments will add nearly $2 trillion to deficits during that period. If tax cuts for individuals are made permanent rather than expiring in 2025, the debt will soar! In addition, Congress recently approved a $1.3 trillion spending bill.
It may seem astonishing that a powerful nation would carry such large debt, but the U.S. has run deficits throughout its history. In fact, since 1970, the federal government has only had one balanced budget for four years—1998 to 2001—due to cooperation between President Clinton and a Republican-dominated Congress.
Many individuals wonder, “Why doesn’t Congress learn from successful businesses and households, only spending money that they have available?” Some politicians say they support a “balanced-budget amendment,” but have no concrete ideas for action. An April 2018 USA Today article quoted Maya MacGuineas, president of the Committee for a Responsible Federal Budget, who said, “Anyone supporting a balanced budget amendment should also have a plan to achieve a balanced budget and support efforts to implement such a plan; otherwise, it is not a serious proposal.”
Most politicians’ goals are re-election, which means keeping constituents happy. However, to balance the budget, spending would need to decrease and taxes increase. Some programs would have to be cut, upsetting voters. For example, raising the full Social Security retirement age from 66 to 70 could save the government $30 billion per year, but would be unpopular with older constituents. Individuals also become angry when their taxes increase, hence why politicians avoid it.
There are three major categories of government spending:
Mandatory interest payments on our debt will be an estimated $310 billion in fiscal year (FY) 2018. At more than 7 percent of the budget, interest is the fourth-largest spending category. The Office of Management and Budget (OMB) projects that by 2028, interest payments will account for 12 percent of government spending.
Mandatory spending covers several well-known programs that Congress is required by law to fund. Social Security and Medicare, the two largest, account for a whopping 62 percent of all federal spending, according to nonpartisan finance website TheBalance.com. Other mandatory spending programs include welfare and unemployment insurance, although these represent a much smaller portion of spending than Social Security ($1.1 trillion in FY 2019) and Medicare ($625 billion in FY 2019).
Discretionary spending allows Congress some say in how much is appropriated for certain departments and programs. At $886 billion, military spending (including funding for the Defense Department, State Department, and FBI) is the largest discretionary budget item, and the third largest spending category overall.
Congress could raise taxes to increase revenue, but many members are resistant, concerned about voter reactions. To compound the problem, the recent tax cuts will likely represent an overall loss. Although the administration has targeted economic growth of 3 percent, in a recent Wall Street Journal piece, William Galston painted a less optimistic picture: “In the short term, [the CBO] estimates that growth will surge to 3.3 percent in 2018 and a respectable 2.4 percent in 2019. In 2020, however, growth is expected to subside to just 1.8 percent with no significant rise thereafter. Average growth in that coming decade is projected at a mere 1.9 percent per year.”
Spending for FY 2018 is projected to exceed $4 trillion. The OMB projects that the federal government will gain about $3.4 trillion in revenue, roughly half of which will come from income taxes. Payroll taxes will raise $1.2 trillion, and corporate taxation will account for $218 billion, or 7 percent of the budget. According to IRS figures, the government loses about half a trillion dollars annually from unreported income by both businesses and individuals (for example, a plumber who gets paid in cash and doesn’t report that income on state and federal tax returns to avoid paying taxes).
Running a deficit doesn’t necessarily signal that a nation is failing; in fact, it can promote economic growth by distributing money to the people, who then spend it. However, most experts agree that too much national debt is dangerous. The World Bank said that the “tipping point” occurs when the ratio of debt to the amount of goods a country produces (GDP) reaches 77 percent; if it stays that way for an extended period, economic growth will suffer. If the debt-to-GDP ratio hits 100 percent, owners of the debt will avoid buying bonds and notes.
Fortunately, the U.S., which is at a 104 percent debt-to-GDP ratio, owns much of the federal debt and is still considered a safe investment. Areas of the government—the three biggest are Social Security, the Office of Personnel Management Retirement Fund, and the Military Retirement Fund—own about $6 trillion, or nearly 30 percent. These agencies receive more tax money than they immediately need, so they buy U.S. Treasury bonds with it. This frees up the money for use by the federal government, but it will need to repay the agencies one day. Overall, foreign investors (mostly China) own about 43 percent of the U.S. debt, according to a Wall Street Journal article by Daniel Kruger.
The bottom line: In the short-term, business owners and individuals benefit from the recent tax cuts. Looking to the future, however, the government must decrease the federal deficit, especially as the American population ages and fewer workers generate taxes. As Washington Post economics correspondent Heather Long wrote in April 2018, “A day of reckoning is likely to come at some point where the United States will have to raise taxes or cut benefits and programs that many people have come to rely on—or some combination of both.” Let’s hope that Congress chooses wisely!