Deficits and Debt

Deficits and Debt

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Updated March 6, 2017
Deficits and Debt
Net deficits and debt are the primary short- and long-term
As deficits have historically been the largest contributor to
measurements of federal budget performance, which
debt, the deficit improvements experienced in expansions
represents a critical congressional responsibility. This In
indirectly reduce debt levels relative to poor economic
Focus summarizes debt, deficits, and their interaction at the
periods. However, because debt is largely dependent on
federal level; analyzes recent outcomes and their interaction
past federal fiscal outcomes, there may be a lag between a
with the economy; and discusses Congressional options for
change in economic outcomes and changes in debt levels.
debt and deficit management.
Net deficit and debt levels may in turn affect economic
Fundamental Properties
outcomes. Many economists support the use of budget
The federal government incurs a budget deficit when total
deficits as an economic stimulant during an economic
outgoing payments (outlays) exceed monies collected
downturn. Though deficit outcomes increase federal debt
(revenues). If instead revenues are greater than outlays, the
levels, they may also mitigate downward shocks in demand
government incurs a surplus. Deficits are measured over the
and employment in such periods.
course of the fiscal year, which runs from October 1
through September 30. Net interest payments, which
However, economic experts caution that structural deficits,
measure inflows and outflows on interest from the federal
which describe budget conditions that produce deficits in all
debt, are included in deficit and surplus outcomes.
economic conditions, may lead to adverse outcomes. Large
and persistent deficit or debt levels may reduce public
Federal debt represents the accumulation of government
confidence in the government’s ability to fulfill its
borrowing activity from private citizens, institutions, and
borrowing obligations, which could increase federal
domestic and foreign governments. Debt levels increase
borrowing costs and have implications for financial
when there are budget deficits, net outflows for federal
markets. There are past examples of foreign governments
credit programs, or increases in intragovernmental debt
experiencing the adverse effects of a deteriorated fiscal
(debt that is held in federal government accounts). The
position. There are, however, no examples of such an
Department of the Treasury is tasked with managing debt
occurrence taking place in modern U.S. history.
levels, with the stated intent of doing so in a manner that
maximizes transparency and minimizes interest costs.
Historical Outcomes
Policymakers monitor budget and debt outcomes for a
Figure 1. Federal Debt, FY1940-FY2016
number of reasons. Deficits and debt provide measurements
(As a % of GDP)
of intergenerational equity, or how public goods and
services and related payments are assigned across
generations. Increases in debt and deficit levels in one time
period may constrain the choices available to other periods.
Budget and debt outcomes may have ramifications on
performance in financial markets, as market exchanges may
depend on the perceived credit risk of federal debt. Deficits
and debt can also affect economic growth. In prosperous
economic periods, deficit spending may replace private
investment and, as those deficits will incur borrowing costs,
can lower long-run economic potential.
Economic Interaction
Economic expansions are generally correlated with
improvements in budget and debt outcomes. Net deficits

typically experience a structural decline in periods of high
Source: OMB, Historical Tables, Table 7.1
economic growth due to both increased revenues (through a
Notes: Shaded areas represent years with economic recessions.
rise in earnings and subsequent tax payments) and reduced
outlays (through a decline in demand for unemployment
Figure 1 shows debt outcomes from FY1947 through
benefits and other income security programs). Reductions
FY2016. Deficits and federal debt levels reached their
in outlays in an expansion may be mitigated by increases in
historical peak during World War II, as deficits as high as
net interest payments if the expansion is characterized by a
29.6% of gross domestic product during the war caused
rise in interest rates. When interest rates are low, net
federal debt to rise to 120% of GDP at the end of FY1946.
interest payments decline, and vice versa.
(When comparing deficit and debt totals over time,
measuring values as a percentage of GDP helps to account
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for the effects of inflation.) In the ensuing decades, a
Table 1. Recent and Projected Federal Fiscal
combination of either budget surpluses or small deficits and
Outcomes, FY2016-FY2046
robust economic growth caused real debt to steadily
(All figures as a % of GDP)
decline, reaching a low of 32% of GDP in FY1981.

FY2016
FY2026
FY2046
Real debt levels grew in the following three decades. The
federal budget recorded consistent deficits in that time
Outlays
20.9
23.1
28.2
period, except for budget surpluses from FY1998 to
Revenues
17.8
18.3
19.4
FY2001 (caused by economic growth and fiscal restraint).
Reduced revenues, increased defense commitments, and
Deficit
3.2
4.8
8.8
gradually increasing mandatory spending contributed to the
Debt Held by
77.0
87.0
141.1
rise in debt after FY2001. Debt levels then grew sharply in
the Public
the Great Recession, as deficits from FY2008 through
FY2010 were higher than in any other postwar year.
Source: CBO, The Budget and Economic Outlook: 2017 to 2027,
January 2017, and The 2016 Long-Term Budget Outlook, July 2016.
Real deficits have declined steadily in the past few years,
Note: Debt held by the public equals total federal debt less
reaching a value of 3.2% of GDP in FY2016, though
intragovernmental debt.
remained higher than the average deficit value of 2.0% of
GDP in the postwar period. Large declines in discretionary
Congressional Management
spending and depressed net interest payments (attributable
Perhaps the most significant law modifying budget
to low interest rates) have contributed to the decline.
outcomes at the start of the 115th Congress is the Budget
Federal debt is estimated to have reached 105% of GDP at
Control Act (BCA; P.L. 112-25). Signed into law in 2011,
the end of FY2016, the highest value since FY1947.
the BCA was originally estimated to reduce deficits by $2.1
trillion from FY2013 to FY2021, primarily through caps on
Current Outlook
discretionary budget authority.
The January 2017 Congressional Budget Office (CBO)
forecast projects deficit increases in the 10-year budget
Subsequent legislation raised the caps in FY2013 through
window. Increases in real outlays (through rising mandatory
FY2017. FY2017 cap levels are set at a combined value of
spending commitments) and net interest obligations
$1.070 trillion, a small increase from the $1.066 trillion
(through increased real interest rates) more than offset
level in FY2016; that value is scheduled to decrease to
continued inflation-adjusted declines in discretionary
$1.064 trillion in FY2018. Other options to modify budget
spending and relatively steady revenue projections.
outcomes introduced in recent Congresses include pay-as-
you-go requirements for new legislation, mandatory
Overall, the forecast projected budget deficits of 3.2% of
spending reform efforts, and tax reform proposals.
GDP in FY2016 and 4.8% of GDP in 2026. Debt held by
the public—all federal debt less intragovernmental debt—is
Federal debt levels are managed through the statutory debt
projected to equal 87.0% of GDP in FY2026, which is
limit, which places a nominal (dollar) cap on the
larger than any historical value since FY1947. (CBO and
permissible level of federal borrowing. The federal debt
other agencies often project debt held by the public instead
limit acts as a check to ensure that recent revenue and
of total federal debt, as the former measures the borrowing
expenditure trends meet the approval of Congress.
that directly affects credit markets.) CBO's July 2016 Long-
However, federal obligations affecting debt levels may have
Term Budget Outlook projects government activity over a
been agreed to well in advance of a nearly binding debt
longer time horizon and estimates publicly held federal debt
limit. In the past, Congress has linked debt limit increases
to be 141% of GDP in FY2046 under present law. Table 1
with legislation that seeks to improve future budget
shows the latest projected values of federal outlays,
outcomes.
revenues, deficits, and debt held by the public.
The Bipartisan Budget Agreement of 2015 (BBA 2015;
Current economic conditions offer mixed signals for federal
P.L. 114-74) suspended the debt limit through March 15,
activity. Most economists agree that the economy is close to
2017. That law calls for the debt limit to be increased upon
full employment, with a national unemployment rate of
reinstatement to exactly accommodate any increases in
4.7% as of February 2017. However, the labor force
federal borrowing undertaken during the suspension period.
participation rate (measuring the percentage of the
If Congress is faced with a nearly binding debt limit upon
population that is either employed or looking for a job)
its reinstatement, it may choose to (1) leave the debt limit in
remains lower than expectations. The current economic
place; (2) authorize the invocation of “extraordinary
expansion is the fourth longest in the postwar area, although
measures” to postpone a binding debt limit; or (3) increase
the growth rate has been lower than in previous expansions.
or suspend the debt limit. Possible consequences of a
Additional debt financing in expansions may reduce the
binding debt limit include increased future borrowing costs,
“fiscal space” available to address future recessions. Fiscal
financial market shocks, and reduced economic growth.
space may be particularly important if a recession takes
effect when traditional monetary responses are weakened.
Grant A. Driessen, Analyst in Public Finance
IF10549

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Deficits and Debt

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