Revenue, Spending, Deficit, and Debt (Educational)

In advance of the budget battles this fall, here is an introductory guide to the history (and future projections) of the federal budget. To make sure I’m keeping this basic, let’s start with a few informal definitions. The revenue of the government refers to the money the government takes in, mainly through taxation. Spending covers all forms of government spending. The difference in any given year between revenue and spending is the deficit (if spending exceeds revenue) or the surplus (if revenue exceeds spending). The debt is the accumulated deficit over several years.

Here’s federal revenue and spending since 1947, from the Federal Reserve Economic Data:

Excel spending and RevenueAs you can see, there was a brief surplus in the 1990s, but other than that the federal government had tended to run small deficits until 2008, when revenue dropped dramatically and spending rose quickly, resulting in a large budget deficit. Here’s a look at the deficit from 1947 on:

FRED deficitYou’ll note that the federal reserve graph highlights recessions automatically. Like most economic statistics, the deficit is at least somewhat dependent on the business cycle. In 2008 it wasn’t that revenue fell because of a new tax cut, instead revenue fell because income fell, and so the same tax rates brought in less money. Spending decisions aren’t directly tied to the business cycle, but in this case the business cycle was behind the decision to spend on stimulus (and cut taxes as part of the stimulus package as well), as well as the increase in spending on safety net programs like SNAP (food stamps).

Deficits that are related to the business cycle are called cyclical deficits, while deficits that would exist independently of the business cycle are called structural. Figuring out how much of the current deficit is structural and how much is cyclical is not an easy question. I’ll discuss it a little more when we get into projecting future debt and deficits.

When looking at a countries overall level of debt, economists normally use a debt to GDP ratio. The reason for this is fairly straightforward, the bigger your economy, as measured by GDP, the more debt you can safely take on. The debt to GDP ratio also lets us look at debt over time without worrying about inflation, population growth, and economic growth, because those are all accounted for by comparing debt to GDP. Here is debt to GDP since 1966:

FRED debt to GDPDebt to GDP came down after WWII until about 1975, and then took off in the 1980s, slowed and even reversed during the late 1990s, grew a little in the early 2000s and then took off when the 2008 recession hit. It is worth noting that for debt to GDP to decline, the government does not need to run a surplus, all that needs to happen is that the GDP grows faster than the debt. While it is theoretically possible to grow the economy fast enough that the debt becomes insignificant compared to the size of the economy, it is unlikely that the economy will grow that quickly.

In order to get the full picture, we also need some projections for the future. Here’s the Congressional Budget Office projections for revenue and spending (outlays) for the next 10 years:

CBO revenue and spending projections 2013And this is what would happen to the deficit based on that forecast (remember, deficit is the yearly difference between revenue and spending, we’ll cover the overall debt level next):

CBO deficit projections positive axisNote that the deficit goes down until 2015, and then starts to grow again. Past 2015 the big drivers of the deficit are public health care expenditures (Medicare, Medicaid, Obamacare) and Social Security. Assuming the economy continues to grow, even at its current anemic pace, revenues will be back to close to historically normal levels (perhaps slightly under due to the continuation of middle class tax cuts enacted in 2001 and 2003) and discretionary spending will be well below historically norms.

Next are Congressional Budget Office projections for the debt (accumulated deficit), over the next 10 years:

CBO debt to GDP 2013 projectionsHaving presented the information as neutrally as possible, I will now do a little editorializing. While the budget picture isn’t pretty, it’s also not exactly the disaster you might hear from some news outlets. Long term medical costs and demographic change drive the long-term debt projections, and the short-term deficits, while huge, were mainly driven by the recession. Since 2010, projections of the long-term debt levels have gotten significantly less dire. The Center on Budget and Policy Priorities shows their old 2010 projections next to their new ones (last chart, I promise):

CBPP debt projections 2010 comparisonTheir projections mostly match the CBOs, but extend out to 2040, and you can see where the 2010 projections reflected an exponential growth in health care costs. Health care costs are still growing too rapidly, but they’ve actually slowed down a lot compared to their previous rate of growth. No one can be too sure what’s causing this slow-down, but I was always a little skeptical of the claim that health costs could continue to grow at the rate they did in the late 90s and 2000s. As essential as health care is, and as messed up as the health care market is, at some point people are simply going to refuse to pay so much for it. That might happen because people will forgo needed care, or start getting help informally, or the slow-down might happen because market-based reform forces insurers to compete for customers, driving down insurance prices which in turn drive down the amount insurers are willing to pay for medical procedures.

The general point of my health care reflections in the context of the budget is that 30 year projections are incredibly difficult to make. Think about what the world was like 30 years ago (this could be difficult, if, like me, you weren’t even alive 30 years ago). I’m not suggesting we ignore long-term budget projections, but I am suggesting that we think very carefully before making changes in the present that could hurt people in order to improve a 30 year budget window. Continuing to work on controlling health care costs and making some tweaks on either the tax or benefit side (for the record, I prefer the tax side) of social security in order to account for changing demographics would be a good start to putting us at a sustainable debt to GDP ratio. Past that, choices about the level of taxation v. the level of public service provision will have to be openly debated; but once one accounts for the recession, health care costs, and demographics, the questions about the rest of the budget are much less daunting.

Comments, questions, slanders, and slurs are welcome in the comment section. Although I guess if you write your slander down it becomes libel. But hey, you’re anonymous, so you might as well go for it.

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