At This Point, Do Deficits Matter?
Last week, the Congressional Budget Office (CBO) – the nonpartisan federal agency within Congress that provides budget and economic information to lawmakers and is tasked with providing an analysis of the impact of every bill Congress enacts on the national budget – released a report that projects the U.S. annual budget deficit will exceed $3.3 trillion by the end of fiscal year 2020. That’s the end of this month.
Unsurprisingly, the CBO said the deficit explosion was largely due to the “economic disruption caused by the 2020 coronavirus pandemic and the enactment of legislation in response.”
Still, that’s a huge number. The 2020 deficit is triple the 2019 gap and, as Politico reported, is the highest level seen since the end of World War II as compared to U.S. gross domestic product (GDP).
The average deficit-to-gross domestic product (GDP) ratio over the last 50 years is three percent. A $3.3 trillion annual budget shortfall for 2020 would equal a staggering 16.1 percent of the size of the total U.S. economy. The last time the deficit-to-GDP rate hit a level higher than that was 1945.
The deficit-to-GDP measurement is expected to improve next year, falling to a projected 8.6 percent (still nearly three times the 50-year average), but the CBO predicts the country will feel the budgetary fallout of the coronavirus pandemic for some time. Indeed, the deficit-to-GDP ratio will exceed the 50-year average of three percent until at least 2030, the CBO estimates.
The nation also is breaking records when it comes to the national debt. (Quick reminder: the deficit describes an annual sum – the total amount the federal government spends during the current fiscal year versus what it receives in revenue. The national debt is the cumulative total of those yearly deficits, plus interest.)
The national debt currently stands at $26.7 trillion. By the end of this month, according to the CBO, the national debt will total 98 percent of GDP – that is compared to 79 percent at the end of 2019 and 35 percent in 2007, before the start of the Great Recession. Based on the CBO’s analysis, the debt-to-GDP ratio would “exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.”
By 2030, that measurement would be at 109 percent.
What could this flurry of numbers mean for the economy, and for federal spending, both in the near term and over the next decade?
First, let’s tackle the economic implications. After the CBO released its projections, Michael R. Strain, director of economic policy studies at the right-leaning American Enterprise Institute (AEI), summarized the potential fallout. He explained, “Deficits reduce national savings, shrinking the pool of funds available for private-sector investment.” Reduced investment then would lead “to lower productivity and slower wage growth, reducing living standards and economic output.”
Strain noted, “Inflows of foreign capital can make up for” those losses, but also could “lead to increases in payments to foreign investors and reductions in domestic income.”
Finally, going back to CBO data from 2014, Strain explained that a “one-dollar increase in the budget deficit reduces national savings by 57 cents and domestic investment by 33 cents.” Additionally, Strain notes, “A 2019 CBO working paper found that a one-percentage-point increase in the ratio of debt to annual GDP increases [interest] rates by two to three basis points.”
When it comes to long-term spending obligations, Politico explains rising debt and deficits mean “trust funds for federal entitlement programs are expected to run dry faster than previously estimated.” Indeed, “If Congress doesn't change spending or policy to fix the imbalance, three trust funds will be depleted within the next 10 years.” The Highway Trust Fund, which provides revenue for surface transportation projects, would run dry next year, in fiscal year 2021. The Medicare Hospital Insurance Trust Fund, which finances health care services related to stays in hospitals, skilled nursing facilities, and hospices, would be depleted in fiscal year 2024 and the Social Security Disability Trust Fund, which pays benefits to disabled workers, their spouses, and dependents, would be out of money in fiscal 2026. Obviously, that’s troubling. But in Washington, which operates from crisis to crisis, these can be thought of as long-term problems.
In the near term, concerns about long-term obligations and implications of higher debt and deficits already have impacted the debate over the next COVID relief bill, the current crisis du jour in D.C.
Back in July, Sen. Ted Cruz (R-Texas), who famously (or infamously) led the filibuster that led to the 2013 government shutdown, said, “Simply shoveling cash from Washington is not going to solve the problem. And right now, all the Democrats and too many Republicans are contemplating doing just that. Massive spending and pork and ballooning deficits and debt are bipartisan problems.” (Sen. Cruz announced this morning he would support the Republican’s $1 trillion “skinny” COVID bill, scheduled for a vote tomorrow.)
In reality, the differences between the two parties and the White House when it comes to the cost of the next COVID package are small relative to the total federal deficit and national debt.
On May 15, House Speaker Nancy Pelosi (D-Calif.) and her caucus approved a $3 trillion COVID relief bill. The Senate refused to consider that legislation, and offered a $1.1 trillion package of its own. President Donald Trump and White House officials originally said they wanted a bill in the $1 trillion range as well.
According to a Politico report yesterday, however, the White House now says the president is willing to spend up to $1.5 trillion. House Democrats also have come off their opening bid and now say they will accept spending in the $2.2 trillion range.
So now there is a $700 billion gap in what Democrats say they are willing to vote for and what the president says he is willing to sign into law.
Under normal circumstances, $700 billion is an enormous amount. In fact, according to The Washington Examiner, President Franklin Roosevelt’s New Deal – the entire package of Great Depression-era legislation – cost about $700 billion in today’s dollars. That’s also the original price tag for the universally maligned – but, in the end, wildly financially successful – TARP, better known as the government financial bailout of 2008.
But if Republicans and Democrats met in the middle and agreed to bill that cost somewhere in the $1.85 trillion range, the impact on the federal deficit and that cumulative national debt is not much more than if Congress passed legislation totaling $1.5 trillion – particularly since interest rates are low. And here is another nugget from CBO’s report last week: As former CBO director Douglas Holtz-Eakin pointed out, the CBO actually lowered its outlook for interest rates, and the budget savings, about $2.4 trillion, “are bigger than the budget impact” of Congress’ largest COVID stimulus bill to date, the CARES Act, Holtz-Eakin. The former CBO director noted, “[T]he interest savings are so significant that once one gets past the impact of the pandemic response, the budget deficit is modestly smaller than CBO previously projected.” This is precisely why some former Federal Reserve chairs, including Janet Yellen, have encouraged elected officials to think big when it comes to COVID stimulus spending.
Americans also don’t seem inclined to prioritize deficit and debt reduction over dealing with the pandemic or its economic fallout. Though the survey was taken before the latest CBO report, a June 2020 Pew Research poll found only 47 percent of Americans see the deficit as a “big problem.” That figure is down eight percentage points from 2018 even though, by June of this year, most Americans knew the annual budget gap would be much higher than in either of the two previous years.
What do all of these factors, including the potential economic fallout of rising debt and deficits, indicate policymakers should do?
Here is former CBO director Holtz-Eakin: “You will hear that the United States needs to spend trillions more to avert economic calamity and that because of the lower interest rates this will be no problem. I would say instead that the United States should spend what is needed to spur the recovery, and that, if not targeted on the actual impediments to growth, additional trillions will do no good.”
Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, took a slightly different approach. She told MarketWatch, “This pandemic is tragic on so many fronts and today’s massive borrowing is a cost of mitigating this pain. The warning bells [the CBO] report contains should not cause a premature end to borrowing, but a commitment to dealing with the debt at the appropriate time.” MacGuineas said, for example, “whomever is sworn in as president next year” will “need a plan to dig us out of this hole once the economy is stronger.”
And while he outlined a host of negative economic impacts to rising debt and deficits, AEI’s Strain seemed to agree with MacGuineas. He said that while “debt and deficits matter … The economic damage they cause is more akin to slow rot in the foundation of a house than a tornado suddenly blowing it down.”
Strain concluded, “This year’s enormous deficit was justified. The economic emergency facing the U.S. requires additional deficit-financed spending, as well.”