November 14, 2013

Why We Have Federal Deficits

Charles Blahous

J. Fish and Lillian F. Smith Chair
Summary

The federal deficit is a huge public policy problem that must be understood, confronted, and solved. Federal deficits run in these last five years dwarf any precedent in U.S. post-world-war history. The Congressional Budget Office (CBO)’s latest projections warn that without legislative corrections, deficits will rise to untenable levels with severe consequences for our economic well-being. There is widespread agreement among non-partisan analysts that the deficit problem is a serious one.

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The federal deficit is a huge public policy problem that must be understood, confronted, and solved. Federal deficits run in these last five years dwarf any precedent in U.S. post-world-war history. The Congressional Budget Office (CBO)’s latest projections warn that without legislative corrections, deficits will rise to untenable levels with severe consequences for our economic well-being. There is widespread agreement among non-partisan analysts that the deficit problem is a serious one.

About the causes of deficits, however, there is much less agreement. This is partially because partisan advocates cannot resist the temptation to blame these deficits on leading figures from across the political aisle. There is practically a cottage industry of “analyses” purporting to show why a particular individual (often President Obama for conservatives, President George W. Bush for the left) is the one to blame for the deficit problem. These studies are usually meaningless because they exclude from view any policy decisions made before their targeted political figure entered office.

If we want to understand and solve the deficit problem, we need to go about our analysis in a better way. Today the Mercatus Center is releasing a comprehensive study I completed earlier this year that does just that. Instead of focusing on policy decisions made during an arbitrarily-assigned time frame, I analyzed the sources of deficits by dissecting the budget itself, identifying deficit-driving policy decisions regardless of when they were made. The study was a mammoth undertaking; it required the digestion of practically every CBO and Office of Management and Budget (OMB) budget report published over the past forty years.

The striking finding of this analysis is that more than three-quarters of our long-term fiscal problem derives from a set of policy decisions made over a period of just seven years, 1965 to 1972. 1965 saw the establishment of Medicare and Medicaid, advocated for and signed by President Lyndon B. Johnson. Both of these programs were later expanded in 1972 during the Nixon administration, as was Social Security. Thus one Democratic and later one Republican President each worked with a unified Democratic Congress to enact a fundamental worsening of our long-term budget outlook. Nothing done by any recent President or Congress carries long-term fiscal consequences as daunting as those arising from these 1965-72 decisions. Details follow.

Defining the Question: The study examined deficits from three different vantage points. The first was to analyze the specific policy decisions that led to current projections of untenable long-term deficits. The second was to analyze the policy decisions that led to the current 2013 deficit. The third analyzed which office holders ran the largest deficits in fiscal years during which they were responsible for federal budget policy.

Each of these perspectives is useful and none is inherently superior to the others. The first two perspectives track specific policy changes, assigning responsibility to those who enacted them. The third perspective evaluates general records of fiscal stewardship. This perspective is also important, to recognize that that later federal officials bear responsibility for correcting fiscally problematic practices regardless of when they were originally adopted, and that they often possess updated information that earlier officeholders lacked. 

When undertaking such an analysis, it quickly becomes apparent that misleading, trivial and/or often bizarre results will arise unless reasonable methodological solutions are found. For example, consider that lawmakers must enact appropriations legislation anew each year (unlike mandatory spending, appropriations do not carry over automatically from one year to the next) and are thus responsible for current appropriations levels. Now, consider also that appropriations spending moves separately from revenue measures; it is spending without a specific revenue source. Going about this the wrong way, one could easily stumble into a framework in which one finds that Congress is always adding immensely to the deficit unless it ceases all appropriations and shuts down the government altogether. Such a method would nearly always find that current officeholders caused the current deficit, even if they had actually cut appropriations relative to previous levels, and even if there were more than enough incoming tax revenue to finance all such appropriations. The results of such an analysis would be uninformative and potentially very misleading.

These problems can be avoided by employing the technique of norming relative to historical practices. I pulled these historical norms from data published by CBO on revenue collections and spending category totals stretching back over the 1973-2012 period. As I demonstrate in the longer study, these forty years are a very good time span for establishing representative norms of federal budget behavior.  These historical norms illuminate the policy changes that caused our current deficit problem.

Specifically, federal tax revenues have consistently averaged 17.9 percent of GDP over the historical period. Only rarely has this level varied by even two percentage points (on the low side during the recent recession, and on the high side during the dot-com bubble and Clinton-era tax rates). Similar averages are seen over even longer spans of time. Hypothetically, if today we spent less than 17.9 percent of GDP, we could fairly say that our current deficit problem was not being driven by recent spending growth. The long-term data enable us to determine whether our deficits arise because of spending exceeding sustainable historical norms, or are due to tax collections falling short, or both. 

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