The Federal Budget Deficit is the Worst it’s Ever Been

Two articles I read today struck me. The first was a report on CNBC that noted the federal budget deficit in fiscal year 2018 (FY 2018) reached $779 billion dollars.[1] The second was an article in Vox that covered a Pew Survey of American attitudes toward major issues. Of the 18 issues surveyed, there were only four issues that both Republicans and Democrats agreed were a “very big problem” for our country. One of those issues was the federal budget deficit, with 56% of Democrats and 61% of Republicans prioritizing it.

That led me back to the CNBC article, and I read a few others (Business Insider, The Blaze, New York Times). All of these articles noted that the deficit is the biggest it’s been since 2012, but they all fundamentally missed how big a deficit we have this year. Our deficit is HHHHUUUUGGGGEEEE and growing. Here’s why that’s the case.

Our federal budget is really a function of two things: policy choices and our economy. When the economy is in recession, the deficit grows naturally even if we don’t make any policy changes. Why? Because of both revenue and spending. When the economy is doing poorly, corporate profits are lower and fewer people have jobs. Since the federal government’s revenue comes from taxes on corporate profits and individual incomes, federal revenues go down in a recession. At the same time, with fewer people having jobs, government spending on safety net programs like food stamps increases. These factors combine to naturally increase budget deficits when the economy is doing poorly and reduce deficits when the economy is doing well.

Below I’ve taken data on US budget deficits and unemployment rates for the past 50 years. The Y-axis is the budget deficit as a percent of Gross Domestic Product (to normalize for inflation and economic growth). Higher numbers are bad, as they mean we have bigger deficits. Lower numbers are good. Numbers below zero mean we ran a budget surplus that year. The X-axis is the unemployment rate, which is pretty good statistic for the overall state of the economy. The further to the right a point is, the worse the economy is.

Chart 1: US Federal Budget Deficits and Unemployment Rates (1970 to 2019)

You’ll notice both blue dots and orange dots. The blue dots represent actual data — 50 blue dots represent the last 50 years. You’ll see the blue dot in the bottom left labeled “2000”. The year 2000 was a great year — the unemployment rate was below 4%, and we ran a budget surplus of over 2%. The orange dots are predictions of what the deficit would have been each year if we saw the average relationship between deficits and unemployment rates we had across the last 50 years.[2] You can see the orange line goes up because the higher the unemployment rate, the higher we’d predict the budget deficit to be. Blue dots below the orange line are success stories — whatever the economic conditions, we managed to have lower than predicted budget deficits those years. Blue dots above the orange line are the problems — for some reason we’re running much higher deficits than normal, even after accounting for economic conditions.

Which brings us to why our current deficits are such a big problem. The 2018 deficit is WAY above the orange line. How bad is it? Well, we could look at it in two ways. One way would be to say, when we have an unemployment rate of 4%, we should have virtually no budget deficit (which is why the orange line is crossing the X-axis just below 4% unemployment). Another way would be to say that, a budget deficit of 4% of GDP, which is what we had in FY 2018, is consistent with a 7% unemployment rate (note the orange line crossing 4% deficit at 7% unemployment). Either way, this is not good!

Here’s some more color. In the past 50 years, the actual budget deficit has only been further above the predicted deficit one time, in 2009. And that was an extraordinarily unique situation — combating a potential economic meltdown, the Bush administration enacted the TARP program, costing $275 billion and the Obama administration signed the stimulus bill, costing $200 billion. Both of those major expenditures were realized in the 2009 fiscal year budget.

But wait — it gets worse! The White House has projected that next year’s budget deficit will be even higher: 5.1% of GDP. That deficit would be a full 5% higher than the orange line, higher than any other year in the past 50. In fact, there have only been 5 years in the past 50 that had higher budget deficits period, and they were all during terrible recessions.

Why is all this so bad? We need to be using times of economic prosperity to whittle down our debt so that when the next recession comes — and it will come — we’ll be able to cover the down times. But today we’re in the process of maxing out our nation’s credit card during the good times, and we don’t seem to be in any hurry to behave better.

[1] The US government fiscal year runs from October to September. So FY 2018 ran from October 2017 to September 2018.

[2] Simple regression analysis for the statistics nerds.

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Thanks !

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