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Making Sense of Government Deficits and Debt

Both the federal government’s budget deficit and total indebtedness are at or near record highs in terms of their dollar amounts. Quite a few people confuse the federal deficit with the federal debt, so first let’s establish what’s what and then seek some historical and economic perspective on both.

Definitions

The word deficit applies to a budget condition, while debt refers to how much an entity owes. A budget can be balanced, run a surplus, or run a deficit, depending on whether the    entity ─ the government, a business, or a household ─ spends the same amount as its revenue over the budget period, spends less, or spends more.

The federal government’s fiscal year runs from October 1through September 30 of the following year. But just because the government spends more than its revenue one year doesn’t lock it into the same situation the following year, because it is relatively free to raise or lower its spending and raise or lower its tax rates from one year to the next.

But when a government spends more than it earns in a given fiscal year, it must make up the shortfall either by using savings or borrowing (incurring debt). Sometimes the shortfall is caused by tax revenues falling short of projections or obligations (like unemployment insurance) being higher than expected. Other times, a government incurs debt to pay for a capital project ─ like building a highway or a bridge.

The federal government projects that as of the end of September 2013; it ran a deficit of approximately $973 billion dollars. That’s less than recent years ($1.09 trillion in 2012, $1.30 trillion in 2011, and $1.29 trillion in 2010). The record was set in 2009, when the federal government ran a deficit of $1.41 trillion.

The federal government borrows by selling Treasury securities with maturities that range from 30 days to 20 years. As of the end of March 2014, the federal government had total debt of $17.5 trillion. In dollar terms, that’s the largest amount of debt in U.S. history.

Deficits: The Dollars Alone Don’t Tell the Whole Story

It’s important to understand, however, that the total dollar value of the deficit is relatively meaning-less when taken out of context of the size of the economy and the fluctuating history of U.S. government debt. Economists recognize that the real measure of both the deficit and the debt is how large they are compared to the size of the U.S. economy and historic context.

Since 1900, a budget surplus has been run by the federal government 33 times and a budget deficit 80 times. The last string of surpluses was from 1998 through 2001. The 2013 deficit will be the 81st since 1900 and the 12th in a row. However, when compared to the size of the economy, these deficits are by no means the largest. That record was set in the war year of 1943, when the deficit reached 28.1% of gross domestic product (GDP). In 2009, the largest year for a federal budget deficit since World War II, the deficit equaled 10.1% of GDP; the 2013 deficit is an estimated 6% of GDP.

Federal Debt: It Fluctuates

Just as with federal deficits, the true significance of government debt lies not in the number of dollars, but in the ratio of dollars of debt to the U.S. GDP. While the current federal debt level of $17.5 trillion is the highest on record in dollar terms, at about 107% of estimated GDP for 2013, it’s still far off the record of nearly 122% in 1946, the year after World War II ended.

Since 1900, federal debt as a percentage of GDP has fluctuated in three great pendulum swings. In 1900, it stood at 20.4% but then fell to a low of 7.3%, only to rise to a peak of nearly 35% by 1919, the year after the end of World War I. In the next swing, the debt to GDP ratio fell to low of 16.3% in 1929 then rose to its all-time high of 122% in 1946. It took 35 years for the ratio to reach its next low of 31.8% of GDP in 1981. Since then, it took four years to climb above 40%, a total of 10 years to reach above 60% in 1991, and a total of 32 years to reach its current level.

A quick review of the last 113 years of federal deficits and debt levels reveals a number of patterns:

  • While deficits are more common then surpluses, they spike in response to national emergencies, specifically wars and severe economic contractions.
  • Deficits were twice as common as surpluses until the administration of Franklin Delano Roosevelt; since then, deficit years have outnumbered surplus years by more than four to one.

In spite of these patterns ─ or perhaps even because of them ─ the U.S. economy experienced its greatest growth after World War II. In neither the relative size of deficits nor debt has the U.S. touched previous highs and economists have no answer to the question of how much debt is too much for a country like the U.S.

The political consensus among both Democrats and Republicans is the federal debt and deficits cannot continue to grow at their recent rates without doing harm to the economy. The difference between the two parties is whether to prioritize job creation (perhaps financed by more government debt) and wait to rein in the deficit and debt until after the economy is stronger, or to start slashing government spending now, even at the cost of higher unemployment.

Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

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