Federal Budget Deficit Explained

The Federal Budget Deficit Explained

The federal budget deficit has been one of the most contentious political issues of the last few years and figures to be a main topic of discussion in Washington during President Obama's second term. The current national debt is somewhere around $16 trillion dollars, a figure that will grow at around $1-2 trillion dollars a year if government spending and tax revenues remain at current levels. In 2011, the rating agency Standard and Poor's downgraded U.S. government debt from its highest AAA rating to AA+, and many politicians and economists have of more dire consequences if the deficit remains and the national debt continues to grow. However, many other politicians and economists have also argued that federal debt levels are nowhere near dangerous level, and that, if anything, the government should increase spending in the short-term in order to avoid another recession. This hub will attempt to cut through the political junk in order to take an unbiased look at government spending in order to explain the causes, effects, and possible solutions to our federal budget deficit and rapidly increasing national debt levels. Will Congress finally be able to come to an agreement on a long term solution to the budget deficit?

Government Debt - an Overview

There are two main forces driving the federal deficit:

Government Spending: The dollars the government spends on programs. This includes things like the salaries of soldiers in the armed forces, grants to the states to fund public schools, road building and infrastructure projects, medicare for seniors, and many others.

Government Revenue: The amount of money the government takes in. Revenue comes primarily from taxes, however, other revenue streams such as customs duties, the sale of resource rights and leases (such as oil drilling rights on government owned lands), and the sale of government property also help bring in revenue.

Therefore, to reduce the national debt, the federal government must either reduce the amount of money it spends (through cutting programs or reducing costs) or increase the amount of money it takes in (through increased taxes or other revenue streams).

Not as Simple as it Seems

So, if the two factors impacting debt are spending and revenue, it seems that easiest solution would be to either

A. Cut government spending to match government revenue

B. Raise taxes to match projected government spending

C. Some combination of the two to meet in the middle and balance the budget.

Unfortunately, these seemingly solutions are not entirely independent of one another. Tax revenues are highly dependent on the economy: if its going well, people are employed, companies are making money, and the government is receiving increased tax revenues (as we saw during the 1990s, when the government consistently ran budget surpluses). However, when the economy is going poorly, tax revenues will go down even if tax rates remain the same.

This extra layer of complication is hugely important in our current economy, with high unemployment and many Americans relying on the government for support through unemployment insurance and other assistance programs. Many economists believe that increased government spending has helped lessen the effects of the economic downturn, and that cutting government spending, while it will reduce that side of the debt equation, will also depress tax revenues further (the unemployed still spend money at supermarkets, which in turn are taxed by the government). So, while cutting government spending might reduce that side of the deficit equation, it will also decrease the amount of tax revenues the government takes in.

Okay, you might ask, so if we can't cut government spending without reducing revenue, why not raise revenue through increased tax rates? If we're currently taxing most Americans at 25% (in a hypothetical example), why not raise it to whatever % is needed to cover the deficit?

Similarly to government spending, government revenues are sensitive to tax rates: if employees and companies are going to be taxed at higher levels, they might be less willing to work hard in order to make money (since more dollars are going to the government). Again, economists disagree on the effect this has, since the magnitude of the effect changes depending on the rate being taxed (going from 25% to 26% might not change your habits much, but being taxed at 80% when you are used to being taxed at 30% would probably make you much less likely to put in overtime to earn extra income).

Short Term Solution - Increase Spending, No Tax Increase

The solution that President Obama has adopted for most of his first term is one of slightly increased government spending (through the American Recovery and Reinvestment Act and increased spending on unemployment insurance) along with continued low tax rates, as the Bush tax cuts have remained in effect. For those economists who believe that increased taxes hurt growth, this is a good thing, as that extra money will hopefully be spent, stimulating the economy and increasing government revenues down the road. In effect, the government is increasing the deficit in the short-term with the hope of decreasing the deficit down the road through increased economic growth (which in turn will lead to increased tax revenues even if tax rates remain the same).

The Future Reckoning

The jury is still out on whether or not this short-term approach will work over the next few years: if it does help economic recovery, than it should help increase government revenues in the next 3-10 years, even if tax and spending rates remain the same. However, almost all forecasters predict that, in the long-term, the federal government will have to make fundamental changes to its spending and tax dollars if it is to remain solvent, as future spending and tax revenues are going to be impacted greatly by the effects of an aging population on health care and social security. Almost all economists agree that some long-term adjustments are necessary in order to solve our budget deficit problem, and the solutions are not as simple as many politicians would like us to think.

The government currently spends around 74% of its revenue on three things: defense, social security, and Medicare, 8% is devoted to interest payments, and 18% is devoted to all other programs. That includes everything from scientific and medical research to education to environmental protection to building roads, bridges, and subways. While defense spending should be reduced with the end of the war in Iraq (and potentially the end of the war in Afghanistan in the next few years), social security and health care spending could skyrocket as many baby boomers retire, making them eligible to receive social security benefits and receive health coverage through Medicare. This means that any realistic attempt to balance the budget:

A. Dramatically cut defense spending, Medicare Spending, or reduce Social Security Benefits.

B. Increase taxes to raise revenue to pay for the increased costs of these entitlements

There is no other way to balance the budget. Anyone who tells you that it is possible to solve the budget gap through "eliminating pork projects" is speaking nonsense: earmarks account for less than 1% of the current federal deficit. A serious attempt to reduce the deficit will have to either increase taxes or dramatically reduce the money the government spends on popular programs like Medicare, Medicaid, Social Security, or the money the government spends on Defense.


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Comments 12 comments

scheng1 5 years ago

Instead of raising tax, why dont they work to improve the economy? Once the economy is in full swing, and everyone is gainfully employed, they will get more money from corporate and income tax.


Dark Liberty 4 years ago

Regulate taxes and meet at the bottom. Accept your faults of this frivioulous war of terrorism. To balance budget is to balanace balance or audit. To terrorize is to go to war of an act. Too much blood shed! Consistution was not met for that! Get ourselves in all countries and go back to the bottom of the matter our home! Minumum wage is not really minumum wage what I find out. Its a joke and that's why many people are not employed not just because they are picky but they have no choice of your own budget you are auditing in different words to get your way. The national minumum hourly wage does not match up with the annual minumum wage which many people in my opinion I believe gets confused. If you want to protect America and the America people's assests of life, liberty, and property then I suggest you get your act to together and protect our shores at the country we are really protecting. Think before you act when ones considering the globe.


Dark Liberty 4 years ago

What are our Christian morals? Accepting faults? The president that I forsee of the chances of what is happening up that is a Christian. Unless something totally happens outragously unexpected. What I am getting at, is that our war of this age of terror is inhumane! It needs to stop! Its wasting our money to ending up auditing and taking our rights of insurance like Medicare and SS. What the?! Christ wouldn't want that for his people. What you do for me, you unto others and vice versa? Do you understand that? With this war, its sucide. Even the big shots are putting themselves in trouble with everyone else getting mad like a domino effect. No one has no one's back. What happen someone or everyone's back and front?


mateo 4 years ago

am not clear on at mathmatical equations but would appreciate more info on how lower expenses do not equal a budget within your income?

thank you


federalWhat? 4 years ago

I thought your article clearly explained the facts and put them into a current context. I would like to point out that the federal deficit is annual and it's effect on the national debt could be offset by an annual surplus. The president and congress can balance their annual budgets by raising taxes and cutting annual spending. The only difference between Dems and the GOP from a budget standpoint, is deciding who's taxes will be raised and which government programs to cut. But, that's assuming both parties want to get the country out of debt.


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conradofontanilla 4 years ago from Philippines

Nice post. Government budget is not like personal budget. To simplify, this discussion did not include one implication of the deficit or debt, that it also means an expansion of the economy, if handled properly. The difficult task is the calculation of the budget deficit.


Carlos Sepulveda 4 years ago

Much is said about the present budget deficit. Which budget are we talking about since Congress has not passed a budget since 2009?


conradofontanilla profile image

conradofontanilla 4 years ago from Philippines

In the Philippines, if no budget for 2013 were passed this year, the budget for 2012 turns the budget for 2013.


bambi 4 years ago

No one here understands Monetary Sovereignty. Don't feel bad, it appears our politicians don't either. Here is a litte tidbit from 1941 when I guess they actually understood deficits.

The national debt can be a good thing. As Federal Reserve Board Chairman Marriner Eccles testified in hearings before the House Committee on Banking and Currency in 1941, government credit (or debt) “is what our money system is. If there were no debts in our money system, there wouldn’t be any money.”

Properly directed, the national debt becomes the spending money of the people. It stimulates demand, stimulating productivity. To keep the system stable and sustainable, the money just needs to come from the nation’s own government and its own people, and needs to return to the government and people.

It’s the federal deficit spending for things like "the war machine" that stimulates the economy. The federal purchase of all those bullets, tanks and bombs, plus the massive salary total for all the soldiers, pumps huge numbers of dollars into the economy, and those additional dollars stimulate the economy. This same principle can be applied to INCREASES in Medicare, Medicaid, Social Security, infrastructure and a never ending list of other things.

There are many ways to measure economic growth, but Gross Domestic Product (GDP) may be the most popular, and here is how GDP is calculated.

Gross Domestic Product = Federal Spending + Non-federal Spending – Net Imports

If you have even a smidgeon of algebraic knowledge, you will recognize that increasing GDP without increasing Federal Spending would be quite difficult, and in a practical sense, well nigh impossible (because Federal Spending also boosts Non-federal Spending). This is why the “small government” preachers either are ignorant, intentionally trying to sabotage the economy or merely are kissing up to rich people. There are no other alternatives.

The wealthiest among us are only too happy to see the economy tank, because during recessions and depressions, the gap between the rich and the others, WIDENS.


bambi 4 years ago

My sincere apologies to "conradofontanilla." He actually pretty much gets it, way more than the author of this article. The author apparently has no clue that reduction in the Federal Debt means REDUCTION in the public hold, which I explained above. If the government were to “balance” its books or eliminate its debt, it would have to take back, probably through taxation or some other confiscatory measure, those $16 trillion that the public holds. That would reduce the public’s wealth by $16 trillion. That is the ONLY way that the government can eliminate its debt. Would that be a good thing? Hard to see how it would, yet that’s what people are calling for.

The next time someone tries to scare you about this or point to that Debt Clock in Times Square, you ask them where the Asset Clock is. There is none, but there should be, because for every liability there is an asset. It’s just basic accounting. The fact that there is never a discussion of the asset side of the balance sheet is proof that the fear mongers who talk about the debt are either ignorant or intentionally trying to manipulate you into believing something that is not true.


carolkim 3 years ago

I am currently working on a writing assignment and I argue that the national debt isn't necessarily a bad thing, kudo's kudo's bambi on ur input/comment. I 100% agree with you. Please let me know how I can read any other articles you have written. Your economic way of thinking is not only educative but also entertaining well done!


dickens 3 years ago

this answer and articles is very very helpful for my research. the depcition of budget deficit has continued to be a chronic politicla factor and has also impacted on the peformance of the general economy. i agree with the factions proposing chang eof policy.....http://academic-hub.blogspot.com

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