Last year, the federal government’s deficit was the smallest since 2007. Doesn’t $3 trillion in revenue and $3.5 trillion in spending represent a government that’s out of control? Isn’t the deficit only okay because the Federal Reserve has pinned interest rates so low? What will happen when rates go back to normal? How can the total national debt rise faster than the deficit?
These are all questions readers posed in response to our latest story on the deficit.
“Isn’t the bigger issue, that 15 years ago ( and two recessions) we were spending $1.2T. Now we are collecting $3T and still running a $0.5T deficit?”
The Treasury Department. Congressional Budget Office and the White House all default to reporting the budget in plain old dollars. The raw numbers of the U.S. budget are, of course, enormous. How can the U.S. possibly sustain annual spending that’s gone from under $1 trillion in 1985 to over $3.5 trillion now?
But adjusted for the size of the economy, the U.S. budget isn’t unusually large. The U.S. has over 320 million residents now, an increase of nearly 100 million since the early 1980s. The country is richer than in the early 1980s, and there’s been a significant amount of inflation, too. Prices have more than doubled since the early 1980s–$1 trillion isn’t what it used to be. Put it all together and, as a share of the economy, today’s spending and expenses are not unusually high or low.
In recent decades, spending and revenue have almost always been between 14% and 24% of gross domestic product (hence the range displayed in the chart). That doesn’t mean bridging the gap would be easy. Boosting revenue by 2% of GDP would be more than most Republicans could stomach, ditto cutting spending by 2% of GDP for Democrats. And most budget experts agree that without legislative changes, the deficit will widen again in coming years.
“If rates were normalized, what would this gap have looked like?”
The Federal Reserve has held its target interest rate near zero since December 2008. The yield on the 10-year Treasury bond is currently about 1.8%. So the government’s deficits really are cheaper to finance right now. If interest rates were higher and everything else in the world were the same, then, yes, the deficit would be larger.
Interest rates won’t instantly return to normal, but the Congressional Budget Office has run the numbers on what interest expense will look like if rates rise. The CBO forecasts that three-month interest rates will average 3.4% from 2018 to 2024 and that the 10-year Treasury will average 4.7%.
That causes net interest to rise to 3% of GDP in 2024, up from 1.3% now. The CBO projects that mandatory spending (which includes Social Security and Medicare) will also rise over this period to around 13.6% of spending from about 12.2% now. Defense spending and nondefense spending will decline by about 1 percentage point each over this period. If policy makers want to hold total spending at its current level, then the rise of interest rates will cause a
squeeze. But the deficit is not so large that normal interest rates would lead to catastrophe.
“Many articles on this topic ignore the large differences between reported deficits and changes in total debt outstanding.”
“How can Treasury claim a $2 billion surplus in December and yet need to borrow $101 billion from the public in December?”
We saved the best and most complex question for last. Several astute readers noticed that the government’s reported deficits do not align with the total amount of debt outstanding. (The Treasury reports the total debt to the penny daily on its website.) For the month of December, the government borrowed $101 billion from the public, but reported a $2 billion surplus.
It might seem that the deficit ought to equal to the change in outstanding debt. The explanation is wonky and a bit long, but there’s nothing sinister about the deficit not adding up the same as the debt from one month to the next.
First, the Treasury doesn’t spend every dollar it borrows. It also maintains an operating cash account. This alone explains most of December’s apparent discrepancy. The Treasury started with about $108 billion in cash. Over December it ran a $2 billion surplus and borrowed $101 billion from the public. That extra money didn’t disappear through accounting shenanigans. The Treasury just held onto the extra cash. At the end of December, the Treasury had $223 billion in cash.
The federal government’s finances are complicated. Getty Images
After accounting for cash, the discrepancy in December was small, and is explained by little changes across Treasury’s several dozen other financial accounts, which include obscure assets like securities in the National Railroad Retirement Investment Fund. accounts at the International Monetary Fund. Special Drawing Rights. etc.
What about the change over all of calendar year 2014? The Treasury reported deficits of $488 billion but borrowed $668 billion. What happened with the other $180 billion? Again, cash explains part of it. Cash rose from $162 billion to $223 billion. That’s $61 billion accounted for and $119 billion unexplained.
What else does the government do in addition to spending and accumulating cash? It issues loans. The government’s loan financing climbed by $118 billion over the course of 2014. With lending programs, the government borrows from the public and turns around and lends out that money. (Most direct lending from the government is for student loans, but the departments of transportation, agriculture and energy, the Small Business Administration and the Export-Import bank all have significant lending programs too.)
Lending is not spending. If the government spends $1 million the money is gone. If the government makes $1 million in loans to lots of different borrowers, the odds are that most of the loans will be paid back. To be sure, these programs carry credit risk and can cost the taxpayer money when loans aren’t repaid. The solar-energy company Solyndra famously defaulted on a $535 million loan from the Energy Department. for example. But even Solyndra was part of a much bigger energy lending program that has an overall loss ratio of about 2%.