The Danger of Deficits To Our Economy

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Recently the White House Office of Management and Budget released its Midsession Review, an update and review of the budget that President Obama submitted to Congress. The document extols the virtues of the administration's economic policies, noting that a combination of economic growth, discretionary budget cuts and the reversal of the Bush tax cuts has halved the federal deficit. Moving forward, the administration hopes to further the economic recovery through additional budgetary savings from health-care reforms, closing tax loopholes for the wealthy and sensible immigration reform. What the Mid-Session Review does not discuss, however, is the mounting federal debt - and the dangers it poses to the economy.

The Congressional Budget Office's 2014 Long-Term Budget Outlook provides a more accurate picture of the challenges facing the economy. While the deficit may have fallen in recent years, CBO identifies a triple threat to long-term economic growth: an aging population, increased per capita federal spending on health care, and expanding federal health-care programs. Together, these trends ensure the return of higher deficits and increasing federal debt. According to the CBO, by the year 2039, federal debt will be greater than the nation's output, reaching 106 percent of GDP. This level of debt has not been seen since World War II. Prior to the 2008 economic crisis, federal debt was 39 percent of GDP, but the structural imbalance between revenues collected and federal spending is steadily pushing the federal debt to unsustainable levels.

The CBO report makes clear that entitlement spending is the primary driver of the rising debt levels and a major concern to the economy. In fact, its projection suggests that discretionary spending as a percentage of GDP actually falls over the long run; it is the substantial increases in health-care spending and social security spending that are problematic. As the CBO study demonstrates, "Most of the growth in mandatory spending has involved the three largest programs - Social Security, Medicare, and Medicaid. Federal outlays for those programs together made up more than 40 percent of the government's noninterest spending, on average, during the past 10 years, compared with less than 30 percent four decades ago."

Perhaps one of the most important conclusions from the CBO study is the fact that the budget problems are structural, not cyclical. That is, perpetual deficits are a function of unsustainable federal spending patterns, not ups and downs in the economy. If the federal government consistently spends more than it collects in revenues, the resulting deficits will exacerbate the nation's debt problems. In turn, the increasing debt burden has a direct impact on economic growth: "the projected amount of debt would reduce the total amount of national saving and income in the long term; increase the government's interest payments, thereby putting more pressure on the rest of the budget; limit lawmakers' flexibility to respond to unforeseen events; and increase the likelihood of a fiscal crisis."

The contrast between the administration's Mid-Session Review and the CBO's 2014 Budget Outlook highlights a constant tension between economic policies and politics. Sound economic policy requires a long-term outlook, creating institutions that promote economic growth. Politics, on the other hand, has a very short time horizon, with incentives to adopt policies that focus on the issue that drive election cycles. While politically appealing and popular with constituents, this approach to policy is counterproductive and may actually sow the seeds for the next economic calamity.

Expanding entitlement programs and perfunctory increases in the debt ceiling without a willingness to address what the CBO views as an obvious and mounting federal debt problem leave little in the way of long run economic success stories for the Obama administration. Yes, the deficit may have declined from its peak during the heady days of the stimulus package, but this is just a lull that does not alter the long run's untenable growth path.

Moving forward, fundamental reforms will be required to address the ongoing fiscal imbalances that only will be exacerbated by current demographic trends. Rather than the current obsession on boosting aggregate demand, Obama would do well to revisit economic chokepoints emanating from Washington, D.C., including the rising regulatory state that hampers small businesses and thwarts economic activity in some of the most dynamic sectors of the economy, the inefficient and unfathomable tax code that distorts investment decisions and drives investments elsewhere, and fiscal policies that consistently increase the federal debt.


Wayne Brough, Ph.D is Chief Economist and Vice President of Research at FreedomWorks.  

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