Where Deficits Come From

Since the 2008 election much more attention has been paid to the problem of federal budget deficits and the national debt. The GOP, in particular, has rediscovered its purported passion for fiscal conservatism. They apparently, lost this passion during the Bush administration when they cut taxes substantially and increased spending considerably. They even added an expensive benefit to Medicare. They voted in an expensive drug benefit to the program just prior to the 2004 election which did not hurt their chances to win votes from the elderly. In any case, we do have to bring spending and tax revenues into greater alignment after we recover from our current downturn. The Congressional Budget Office has provided an analysis of the major sources of budget deficits, and their implication for the national debt projected into 2020. Their analysis assumes no changes to current law. This enables Congress to assess the impact of changes in policy against their benchmark. I have provided a graph of the CBO projection to help with our analysis.

The first thing to notice is the impact of lost tax revenues in 2009 and 20010 on the federal budget deficits. The loss of tax revenues due to the recession and the loss of tax revenues as a result of the Bush tax cuts are, by far, the major cause of these deficits. The economic recovery act also had an impact. The act increased spending but it also cut taxes by over $200 billion. Spending on TARP to deal with the financial crisis and the wars in the mid-east also contributed to the deficits. We should recall, however, that TARP was enacted in the Bush administration. These data indicate that lost tax revenue from multiple sources have had a far greater impact on the budget deficits than increases in federal spending. There is little support for the ranting and raving coming from politically motivated sources that the deficits are due to "out of control spending" from tax and spend liberals. In fact, to the extent that increased spending mitigated the loss of jobs, and even greater loss of tax revenue from the recession, the deficits might have been greater without the stimulus.

It also important to look out to 2020. This analysis assumes that the Bush tax cuts will not be allowed to expire as called for under current law. The loss of tax revenue from the Bush tax cuts will add $4 trillion to the national debt in 2020. It is clear that cuts in spending alone cannot restore balance to the federal budget. It seems, however, that we are in for two more years of political gridlock. The GOP will not accept changes to current law that eliminate the tax cuts to the wealthiest Americans and Democrats do not want to eliminate the tax cuts to the middle class during an economic downturn.