U.S. Federal Budget Deficit

Economics for Strategic Decisions

U.S. Federal Budget Deficit

Introduction and History

The U.S. Federal Budget deficit is the fiscal year difference between what the United States Government takes in from taxes and other revenues, called receipts, and the amount of money the government spends, called outlays. The items included in the deficit are considered either on budget or off budget. Generally, on-budget outlays tend to exceed on-budget receipts, while off-budget receipts tend to exceed off-budget outlays. The United States public debt, commonly called the national debt, gross federal debt or U.S. government debt, grows as the U.S. Federal Budget remains in deficit and is the amount of money owed by the United States government to creditors who hold US securities like T-bills, notes and bonds. This does not include the money owed by states, corporations, or individuals, nor does it include the money owed to Social Security beneficiaries in the future. As of April 18th, 2006, the total U.S. government debt was $8.395724 trillion. The United States has had public debt since its inception. Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly reported value of $75,463,476.52 on January 1, 1791. Over the following 45 years, the debt grew and then contracted to nearly zero in late 1834. On January 1, 1835, the national debt was only $33,733.05, but it quickly grew into the millions again. The first dramatic growth spurt of the debt occurred because of the Civil War. The debt was just $65 million dollars in 1860, but passed $1 billion in 1863 and had reached $2.7 billion following the war. The debt slowly fluctuated for the rest of the century, finally growing steadily in the 1910s and early 1920s to roughly $22 billion as the country paid for involvement in World War I. The buildup and involvement in World War II brought the debt up another order of magnitude from $43 billion in 1940 to $260 billion following the war. After this period, the debt's growth closely matched the rate of inflation until the 1980s, when it again began to skyrocket. The public debt briefly started to go down in 2000 when the country had a substantial budget surplus, but began growing again after budget deficits grew large beginning in 2002.

At any given time, at least in recent decades, there is a debt ceiling in effect. If the debt grows to this ceiling level, many branches of government are shut down or only provide extremely limited service. However, the ceiling is routinely raised by passage of new laws by the United States Congress every year or so. The most recent example of this occurred in March of 2006, when the U.S. Congress agreed to raise the National Debt Ceiling to just under $9.000 trillion. Viewed alternately as a percentage of the GDP, the national debt rose sharply during World War II, reaching about 122% of GDP in 1946. As soon as the conflict ended, the debt began declining, reaching a postwar low of 32.6% of GDP in 1981. The debt then started rising again and peaked at 67.3% of GDP in 1996. It then dropped to 57.4% of GDP by 2001. The debt of the United States is on par with the debt of other developed countries, such as Germany and France.

Causes Opinions on the causes of the U.S. Federal Budget deficit vary greatly. The three that I have chosen to highlight are a decrease in the private saving rates of Americans, productivity growth and a slump in foreign domestic demand. Proponents of a decline in saving rate are also mainly supporters of the belief in American over-indulgence. Since the mid-1990s, the personal saving rate has declined from roughly 5 percent of disposable income to less than 2 percent, and gross private saving (which includes corporate saving) has edged down from about 16 percent of GDP to less than 15 percent.

The decline in saving rates could reflect a structural shift in household saving and spending behavior. Continued financial liberalization and innovation have made it easier for Americans to borrow, particularly against their real estate wealth, and this easing may have led to greater consumption.

An impressive achievement of the U.S. economy which has contributed to its skyrocketing budget deficit is the surge in labor productivity growth from about 1-1/2 percent annually in the two decades preceding 1995 to roughly 3 percent in the period since then. This surge is viewed as having several important consequences. First, higher productivity growth boosted perceived rates of return on U.S. investments, thereby generating capital inflows that boosted the dollar. Second, these higher rates of return also led to a rise in domestic investment. Finally, expectations of higher returns boosted equity prices, household wealth, and perceived long-run income, and so consumption rose and saving rates declined. Under this explanation, all of these factors helped to widen the current account deficit.

Lastly, domestic demand growth has slumped in many foreign economies because of varying combinations of an increase in saving rates and a decline in investment. This weakening of foreign spending has enhanced the supply of capital available to the United States, put downward pressure on U.S. interest rates, and put upward pressure on the dollar.

Some of the largest industrial economies in the world, Japan and Western Europe, have been running current account surpluses while experiencing very subdued growth. In the developing world, the East Asian economies that went through financial crises in the late 1990s have seen a plunge in their investment rates even as their saving rates have remained extremely high; the weakness in domestic demand has likely motivated the authorities in these countries to keep their exchange rates competitive to promote export-led growth, a strategy that has also contributed to the U.S. deficit. In general, since 1999, the developing countries as a whole have been running current account surpluses, with the industrial countries, mainly the United States, necessarily running current account deficits.

The federal budget and the economy are closely interrelated. The strength or

weakness of the overall economy affects the levels of outlays and receipts

substantially. The budget also has significant effects on the economy, both in terms

of how fast the economy grows, and also in