Budget and the Economy

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Budgets play many roles in policymaking: They allocate resources to public purposes, reflect the government’s priorities, and redistribute income through the government’s power to tax and spend. In addition, government activity represents a significant share of the overall economy. Thus, it is critical to promoting economic stability and growth. Decisions made during each budget cycle affect current spending and shape the government’s ability to address future demands.

Many believe that the long-term future of the federal budget is unsustainable. After the Great Recession, publicly held debt soared to the highest levels since the 1940s. While recent annual budget deficits fell dramatically from the peak of 10 percent of gross domestic product (GDP) in 2009 to below 3 percent in 2015, this improvement is not sufficient to solve the long-term problems. According to projections, the debt will continue to increase under the pressure of demographic changes, growing health care costs, and higher interest payments. Currently, the Congressional Budget Office (CBO) projects the debt to reach 141 percent of GDP in 2046. Over time, national debt of this magnitude may bankrupt the country.

Large budget deficits have persisted ever since the beginning of the 21st century. They were the result of high outlays, such as those for health care or national security, and historically low revenues (below the 50-year average of 17.4 percent of GDP). CBO projects revenues to grow somewhat, but stay at about 19 percent through 2046. Outlays were well above the long-term average (20.2 percent of GDP) in the wake of the 2008 recession. They are projected to stay well above that average going forward, exceeding 27 percent in the out-years.

Debates continue about the relative importance of short- versus long-term deficit reduction and about the appropriate role of tax increases and spending reductions in achieving long-term fiscal sustainability. Deficits may be necessary, even prudent, in times of recession to counteract otherwise weak private-sector demand and to spur economic growth. Reducing the federal deficit prematurely can hamper or stall any nascent economic recovery.

Over the long term, however, large deficits can pressure governments to cut spending and limit their ability to react to future economic crises. Deficits may absorb available capital, drive up interest rates, discourage investments, and hamper economic growth. Reducing the federal deficit to a manageable level, while preserving programs that support vulnerable Americans, is a challenge for policymakers. All aspects of the federal budget deserve examination. Spending on defense, intelligence, and national security warrant particular scrutiny, as do various revenue-reducing tax provisions.

In recent years measures affecting the federal budget responded to immediate crises and lacked long-term perspective. The Budget Control Act of 2011 instituted discretionary spending caps leading to automatic across-the-board spending reductions (“sequestration”) beginning in 2013. Also in 2013 policymakers permanently extended the broad tax cuts first enacted in 2001. This increased deficits by a total of nearly $4 trillion over the 2013–2022 period. The debates focused on whether cuts for the top 2 percent or 3 percent of taxpayers would be extended in full or in part, rather than on whether the extension was affordable at all.

Over the years, efforts to address the long-term federal fiscal challenges have examined different approaches. Some proposals have focused on major spending programs such as Social Security, Medicare, and Medicaid. Others looked to save money at the federal level by capping the amount of federal funds used for different programs and devolving power to the state level to structure and administer programs, a strategy often referred to as block-granting. In 2010 a number of policy groups presented alternative plans designed to put the federal budget on a sustainable path through reducing spending and increasing revenue. The proposals generated much interest in policymaking circles but did not gain traction in Congress.

At the state level, where most governments are ostensibly precluded from running deficits, policymakers face the task of balancing the budget in every budget cycle. Their challenge has been heightened after the Recession of 2008, since recessions have reduced state and local government revenues while increasing necessary expenditures for vulnerable populations and the unemployed. In recent years national economic conditions improved, but the positive effects varied state by state. Some states have attempted to balance their budget through tax reforms that lower taxes on businesses, hoping to spur economic growth. In many cases, this approach has not produced the desired results.

Found in Budget and the Economy