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What's So Bad About a $1.4 Trillion Deficit?

5 years ago
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The Obama administration recently trumpeted the fact that the federal government spent only $1.4 trillion dollars more than it took in during the last fiscal year. In a joint statement issued with Peter Orszag, the director of the Office of Management and Budget, Treasury Secretary Timothy Geithner said, "This year's deficit is lower than we had projected . . . in part because we are managing to repair the financial system at a lower cost to taxpayers." Just one month earlier, the administration had forecast a $1.8 trillion deficit. That's a $400 billion shrinkage, which is definitely good news.

But before getting too excited about that, stop and think about why the United States is adding nearly $1.4 trillion to the nation's $12 trillion national debt.

Consider first how the government is helping those who have been most hurt by the economic downturn. Relative to a year earlier, the federal government is spending an additional $70.5 billion on the unemployment trust fund, $18 billion more on food stamps and child nutrition programs, and $93 billion more on Medicare and Medicaid. This spending is essential to help the neediest sector of the population.

Other expenditures have gone to save the financial system. The government spent $154 billion on the Troubled Asset Relief Program and $96 billion on the takeover of Fannie Mae and Freddie Mac. These programs, of course, did not exist the previous year.

The recession has also affected the amount of taxes the government collects, and government receipts have plummeted as a result. Individuals paid $230 billion less in taxes to the federal government this year, while corporations paid $166 billion less.
The best news in the federal budget comes from an unlikely source. Due to record low-interest rates, interest payments on the federal debt fell by $68 billion last year.

Many of the expenditures, of course, are needed to pull the economy out of recession. In light of that, let's consider what is so bad about a $1.4 trillion deficit.

When asked this question, Maya C. MacGuineas, president of the Committee for a Responsible Federal Budget (CRFB), said, "Nothing for one year." However, as a committed deficit hawk, she warned that "if deficits even close to that large last over the next years, it is very likely creditors will demand higher interest rates, which in turn could derail the economic recovery." While justifying deficit spending during a recession, the CRFB has routinely argued that the U.S. government is on an unsustainable deficit path. It has projected that the ongoing deficit spending, largely on Medicare and Medicaid, will push public debt to 300 percent of national income in just three generations.

Other budget experts, however, are even less forgiving of short-term deficits.

Concord Coalition chief economist Diane Lim Rogers, who blogs on EconomistMom, regularly argues about their dangers. As she said during a Concord Coalition conference in Denver, "I think the effects of short-term deficit spending as stimulus often 'linger' as longer-term policy in a harmful way. "

Rogers cited the Obama administration's proposal to give senior citizens a $250 check to offset the lack of a cost-of-living increase in Social Security payments this year as an example. If the government starts giving these payments in the name of stimulus rather than in the name of policy, then there will be no end to the amount of "political pandering" that the government will do to obtain votes today "at the expense of higher deficits tomorrow,"
Rogers wrote on her blog.

This year's $1.4 trillion deficit, which equals 10 percent of gross domestic product, is hampered by large, temporary federal spending programs. Some of these, such as the extension of unemployment benefits, seem justified. However, the federal government regularly funds other budget-busting programs. One example is the temporary first-time home buyers' tax credit that added $9.4 billion to the deficit. Despite the fraud found in this program, Congress hopes to extend it. (Treasury Department Inspector General J. Russell George told the House Ways and Means committee that the IRS has already found nearly 74,000 fraudulent claims, including several made by 4-year-old children among the 1.2 million borrowers who have claimed $8.5 billion of the $13.6 billion in refundable credits allocated for this program.)

Congress doesn't limit its tax breaks to individuals. The corporate sector is a frequent target of congressional generosity. Although corporate tax revenues are down by more than 50 percent this year due to significant losses in the financial sector, it is not just current-year revenues that fall when a corporation loses money. U.S. law allows corporations to obtain tax refunds from earlier years by applying this year's losses to previous years' income. Congress is considering becoming even more generous in this area. This year, as part of the American Recovery and Reinvestment Act, the provision was modified to allow small businesses to claim refunds from five earlier years.

The Car Allowance Rebate System, popularly known as "cash for clunkers," is another initiative that further drained the federal coffers. Congress allocated $3 billion for the program, which started on July 24 and ended one month later. The program gave up to $4,500 to those who traded in an old car for a more fuel-efficient one and led to more than 360,000 sales of new cars. But as we later learned, many of those sales represented shifts from future months. General Motors sales fell 45 percent in September compared with a year earlier, while Chrysler's fell 41 percent.

With a $1.4 trillion budget deficit, these stimulus gimmicks may have a detrimental impact on the budget much sooner than expected. As MacGuineas said, "
The path we are on is unsustainable over a much shorter time period [than earlier believed]. Change needs to happen in the next few years."

The Tax Foundation has simulated exactly how much change is needed to fund these deficits. In a report released Oct. 22, it estimates that if the administration and Congress wished to eliminate the current deficit, it would have to raise tax rates to unprecedented levels. Assuming no other changes in the tax law, the minimum tax rate would increase from 10 percent to 27.2 percent while the maximum tax rate would rise from 35 percent to 95.2 percent.

While no one believes that Congress would actually try to close the deficit in one year, these figures show in stark terms what is so bad about amassing such debt.
Filed Under: Economy

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