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Understanding the U.S. Federal Budget Deficit – Definition & History

By Michael Lewis

us treasury department buildingAs we wrestle with the economic problems facing the country, it is important to understand the reality of budget surpluses and deficits, their relationship to national debt, and how the level of national debt affects average Americans and the economy in general.

However, few discussions generate as much heat or confusion as those dealing with the annual federal budget deficit – and it is often a single misunderstanding of the budget that drives most misinformation.

Why a Balanced Budget Doesn’t Make Sense

In a misguided effort to promote further understanding of the budget, many analysts describe the revenues and expenditures of the Federal Government as if our government were a typical family arguing about stretching their monthly paychecks to cover expenses. This analogy, however, contributes to unfounded fears and public calls for unwise, draconian steps to impose and enforce a “balanced budget” solution upon federal lawmakers and executives.

The analogy is false for several reasons:

  • Debt Is Never-Ending. Unlike humans, whose lives eventually end, the government goes on from one century to the next. As a consequence, the debts owed by the government can be transferred to future generations, never to be totally amortized, by paying interest on the outstanding balance and reissuing new debt instruments as older obligations come due.
  • Income Is Flexible. While families and individuals have a fixed amount of income to cover their obligations, the Federal Government can rapidly increase income through its tax policies, regulations, and collection efforts.
  • Expenses Are Flexible. Individual government programs can be modified or even eliminated to reduce or delay expenditures. For example, simply raising the retirement age for Social Security recipients or transferring executive responsibility for specific federal programs to state governments will reduce federal expenditures.

According to Norman Ornstein, resident scholar at the conservative American Enterprise Institute, a balanced budget amendment “is about the most irresponsible action imaginable,” and would eliminate the flexibility of the government to respond to the needs of the public, whether it be an emergency such as a hurricane, or financial assistance to the unemployed during recessions. This is because a balanced budget by definition eliminates the possibility of running a deficit or a surplus, and emergencies, by definition, are unplanned and cannot be quantified prior to the actual event. In such an event, the Federal Government would be forced to either not act or to transfer funds from approved programs in order to respond, potentially defunding critical programs.

Calls for a balanced budget more likely reflect the country’s general distrust of elected officials, as well as the belief that the privileged receive special benefits.

The Budget Process

Simply stated, the budget is a pre-authorized spending plan approved by Congress to be implemented by the president. The budget is developed and approved by following several steps:

  1. The president submits his budget request for the following fiscal year each February. The president’s current budget is typical of previous budgets in length, explanation, comprehensiveness, and complexity.
  2. Congress reviews, amends, and passes resolutions to approve the budget in each House. Historically, conflicts between the respective versions of the budget are resolved in a joint conference committee and subsequently approved by the full House and Senate, respectively.
  3. Congress authorizes the budget expenditures by continuing previous laws where necessary and/or writing new laws.
  4. The appropriations committees and subcommittees of both Houses determine the actual funds that can be spent for the authorized programs. Some programs are authorized, but never funded, and vice-versa.

money

The Budget’s Impact on the Federal Debt Limit

The amount of federal debt outstanding at any time is established and controlled by Congress – currently, the debt limit is $16.39 trillion. The U.S. Treasury, using the proposed spending authorization as a basis, determines whether the limit imposed by Congress will allow the Federal Government to meet its obligations.

Budget deficits increase the amount of federal debt outstanding, while surpluses decrease the debt. When a projected budget deficit will increase the amount of debt over the legal limit, the Treasury requests Congress to either raise the limit or reverse prior authorization of existing programs to avoid exceeding the limit.

Congress has raised the debt limit 11 times since 2001. In each instance, the process has stimulated intense political pressure and in-fighting, as a failure to raise the debt limit might cause the government to cease Social Security payments, interest payments, or employee salaries.

Factors to Consider About the Federal Budget

While the importance of the process and the necessity of a realistic budget cannot be overstated, the process and calculations supporting the budget have become excessively complex and, sometimes, intentionally misleading to serve political purposes of the president, Congress, and their respective political parties.

Keep in mind the following as you consider the effects of the budget on the economy and the level of our national debt:

1. Expenditures “On” and “Off” the Books

Some expenditures are “off the books” and not reflected in the “official” deficit number, but added to the national debt nevertheless. For example, the expenses of various agencies are not part of the budget process and are isolated from normal public scrutiny. The costs of the Strategic Petroleum Reserve, the Pension Guaranty Corporation, and the Postal Service Fund are just a few of such agencies. Neither the Iraq War nor the war in Afghanistan were reflected in budget computations prior to 2009.

There have been various legislative efforts to eliminate “off the books” funding, but it continues to survive. As a consequence, budget deficits or surpluses are misleading and do not reflect the true cost of  government operations.

2. Budget Surplus or Deficit Definition

Technically, the budget surplus or deficit is the difference between actual cash collections from taxes and “budgeted” spending, not the actual spending that occurs during the fiscal year. Since the difference between collections and expenditures are projected, rather than actual, the first analysis of deficit or surplus should always be considered suspect, since reality generally produces a different result.

For example, President Bush’s budget to Congress for 2008 reflected a projected $240 billion deficit – but the actual deficit reported by the U.S. Treasury using the rules then in effect was a $454 billion deficit. The increase in federal debt for the year was an astounding $1.9 trillion due in large part to off-the-books expenditures, or almost eight times greater than the president’s projection for the year.

3. Loan Guarantees

Various federal agencies issue debt guarantees for products and services ranging from college education and home ownership, to small business finance. These guarantees are not reflected in the federal budget, but represent huge potential liabilities that may require payment in the event of default.

Since 2008, taxpayers have been forced to invest almost $200 billion in the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), having guaranteed the mortgages issued by these two quasi-federal agencies. The guarantees are not included in budget calculations, since it is impossible to know whether or when they might be called upon in the future.

4. Social Security and Medicare

Many contend that the Federal Insurance Contributions Act (FICA) tax used to fund Social Security and Medicare (programs for retirement and healthcare for older Americans) is “social insurance,” and was never intended to be part of general government expenses. FICA revenues in 2011 were approximately $819 billion with expenditures of $835 billion, an imbalance that is bound to grow if steps are not taken to increase payments from, or reduce benefits for, future beneficiaries.

social programs often require increased taxes

The Outlook for the Future Budget Deficit

According to the Office of Management and Budget, only four annual budget surpluses have been recorded since the election of Ronald Reagan in 1980: The last three years of Bill Clinton’s term (1998, 1999, 2000) and the first year of George W. Bush’s term (2001). At the same time, however, the U.S. Treasury Department reports that federal debt has grown every year since 1969, illustrating the difficulty of obtaining and translating financial data provided by different government departments and agencies into a meaningful figure.

It is very likely that we will continue to run significant annual deficits in the future, even if we have a robust gross domestic product (GDP) due to several factors:

  • Limited Tax Revenue Growth. If tax revenues remain at current levels of 15.5% GDP and the economy expands at a healthy 3% per year, federal revenues in 2016 will be approximately $2.68 trillion, insufficient to cover the expenditures of this past year. Taxes are unlikely to be increased, as every Congressional member of the Republican Party has publicly pledged to Grover Norquist’s Americans for Tax Reform “to oppose and vote against tax increases.”
  • Inability to Cut Federal Expenditures. The economic dislocations of the past four years and reduced worldwide demand for products and services will leave a significant number of citizens in need of financial assistance for years to come. Democrats are unwilling to cut social programs without a corresponding increase in taxes paid by the highest-bracket taxpayers. Political and religious terrorism may lessen the country’s ability to cut defense expenditures. Disasters both man-made (the Deepwater Horizon oil spill) and natural (Hurricane Sandy) are likely to continue, forcing the Federal Government to intervene for humanitarian and practical reasons. As a consequence, federal expenditures are likely to grow, not decline.
  • Continued Political Deadlocks. Despite the poor public opinion and lack of respect for elected officials, pols on both sides of the aisle continue to engage in “brinksmanship,” pandering to the most extreme elements of their respective parties. This behavior is likely to continue until one party wins a clear-cut majority of both houses, as well as the presidency, which is unlikely until the next presidential election in 2016. As a consequence, the country will continue to lurch from one disaster to the next led by a do-nothing Congress and an ineffectual president.
  • Higher Interest Rates Paid on Federal Debt. Historically, American debt has been considered the safest investment in the world. This status encouraged foreign ownership, specifically the governments and citizens of China and Japan to invest and accept a low interest rate in return for the exceptional safety of our debt. Both countries are facing internal economic stress today, and are unlikely to remain eager buyers as they have been in the past. In addition, America’s own economic malaise and the inability of Congressional members to work together have marred our financial reputation. It is likely that we will be required to pay higher interest on our outstanding debt over the next four years as a result.

Final Word

The federal budget reflects the nation’s priorities and the importance of each program within that list of priorities. At the same time, the history of continued budget deficits – clockwork additions to the national debt – illustrates our unwillingness or inability to agree on which programs should be continued, increased, or eliminated, or to make the requisite sacrifices by raising taxes to fund programs we do agree on.

Despite the inaction of elected representatives, we can solve our financial and economic problems with a combination of tax and entitlement reform, a stable economy, and a willingness to cover the deficits and eliminate national debt incrementally. Our problems did not arise over a year or two, but over decades – and our solutions will require a similar period of time to implement.

Michael Lewis
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike's articles on personal investments, business management, and the economy are available on several online publications. He's a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas - including The Storm.

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  • John@TheMoneyPrinciple

    A fascinating review of the US federal budget. It’s all smoke and mirrors really, money is counted or not, created or not but what we do know is that money is always being wasted – read destroyed. Creation is therefore necessary or there would be a massive increase in entropy ie disorder. . It seems to me that as the family budget idea is not appropriate for nations (well, currencies really), there should be a better way of counting it but this has yet to be seen.

    Over in the UK our present government seems intent on treating the nation as a family. Hence we will remain in recession for some time. The lessons of Roosevelt and Keynes seem to have been forgotten!

    • Mlewis

      John,
      Thanks for your comment. it’s always interesting to get the perspective of someone slightly removed from the problem and able to bring a more objective perspective.

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