Budget Deficit Rising: What Does It Mean?

On Monday (July 28), the White House Office of Management and Budget released its “Mid-Session Review” of the federal budget.

The headline news focused on the current FY2008 budget deficit being projected at $389 billion, with next year’s deficit rising to a projected $482 billion. This has drawn the usual gasps and cries of horror from various camps, such as the media and deficit hawks. For good measure, accusations fly between Democrats and Republicans over who is more fiscally irresponsible.

But a few things should be kept in mind.

First, budget deficits by themselves do not necessarily have a major impact on the economy. No economic magic is unlocked if at the end of the fiscal year, federal outlays and receipts come out equal, or close to it.

The usual assertion is that U.S. federal deficits raise interest rates, and thereby serve as a drag on economic growth. But the idea that deficits ranging in size between 2.4% and 3.3% of U.S. GDP could have a substantive impact on interest rates with trillions of dollars in capital sloshing around the global economy is rather preposterous. And when you look at the historical data, we have had periods with budget deficits when interest rates have risen and, at other times, have fallen.

Second, the causes of widening deficits should be noted. The budget deficits projected for this year and next are mainly the result of poor revenue growth due to a slow-growth or no-growth economy, and rising federal spending.

Consider, for example, that while total federal revenues are projected to actually decline in FY2008, and then rise by 3.8% in FY2009, the government’s spending juggernaut just keeps rolling along, with outlays expected to increase by 7.8% in FY2008 and by 6.5% in FY2009.

So, the current deficits serve as spotlights on the negatives of rapid increases in the size of government.

Third, and finally, the ultimate threat that these deficits present to the economy is that they increase the chances of major tax increases. The 2001 and 2003 tax relief measures, of course, are temporary, with most of the tax relief measures set to expire at the end of 2010. That means the economy is staring at a huge, costly tax increase. These deficits make those tax hikes even more likely to occur.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council