What have budget trends been over the short and long term?
Federal budget deficits are largely driven by external events—war, recession—in the near term and by demography in the long run. When events conspire to drive revenues above the trend, tax cuts usually bring them down with alacrity.
The budget deficit has been on a roller coaster in recent years because of the Great Recession and the subsequent recovery. (The federal budget deficit measures the amount by which total government outlays exceed total revenues in a given year.) In 2007, prior to the recession, the deficit had fallen to 1.1 percent of gross domestic product (GDP) despite the Afghan and Iraq wars and significant tax cuts earlier in the decade. Then the recession hit and the deficit soared to 9.8 percent of GDP by 2009, as tax revenues fell, automatic safety net programs kicked in, and hundreds of billions were appropriated for fiscal stimulus. But the economic recovery quickly lowered the deficit again; by 2014 it was 2.8 percent of GDP.
The recovery has not been as kind to the debt-GDP ratio. (The federal debt is the total value of outstanding Treasury securities and measures how much the government owes.) Very large deficits during the recession caused it to double from 35.2 percent of GDP in 2007 to 74.1 percent at the end of 2014. It is not expected to decline substantially over the next few years, and will start rising thereafter as outlays for health and retirement programs expand.
The rapid rise in the debt-GDP ratio has had remarkably little impact on the interest bill facing the government. In fact, interest payments relative to GDP actually fell while the debt-GDP doubled because interest rates plunged extraordinarily.
The recession-induced increase in safety net spending and the fiscal stimulus package caused total spending to soar from 19.1 percent of GDP in 2007 to 24.4 percent in 2009, while revenues fell from 17.9 to 14.6 percent. Spending then fell in relative terms as the stimulus wound down and safety net and interest spending fell. By 2014, it was back down to 20.3 percent of GDP.
The slowdown in total spending growth was aided by an unusual slowdown in health cost growth. The total cost of Medicare and Medicaid relative to GDP was no greater in 2014 than in 2009 despite aging of the baby boomers and effects of the Affordable Care Act on Medicaid.
Over the longer run, however, health costs will certainly create a major budget problem. They are being pushed upward by an aging population and by increasing health costs per enrollee in government programs.
The two largest health programs, Medicare and Medicaid, were created in 1965. Five years later their spending amounted to less than 1 percent of GDP. But by 2014 their spending had grown to 5.2 percent of GDP. A cumbersome price control system is in place to limit Medicare cost growth. But it has been far from successful, as the health sector tends to respond to limits on prices by prescribing more treatments.
Social Security spending has also been affected by aging of the population. Retirement spending relative to GDP rose from 2.8 percent in 1970 to 4.9 percent in 2014. Yet total government spending rose only from 18.7 to 20.3 percent over the same period. The total did not rise in proportion to health outlays and Social Security because defense and nondefense discretionary spending shrank in relative terms.
Defense spending was still being affected by the Vietnam War back in 1970, when it represented 7.8 percent of the GDP. In 2014 defense spending only amounted to 3.5 percent. Nondefense discretionary spending fell from 3.7 to 3.4 percent over the same period, but it had been as high as 5.0 percent in 1978. It is clear that rising health and Social Security spending combined with a strong aversion to raising taxes is putting a severe squeeze on the rest of the government.
There seems to be a law of nature (or at least Washington political nature) that significant tax cuts follow whenever total revenues exceed 19 percent of GDP. The total tax burden reached this benchmark during World War II, the Korean War, and the Vietnam War, but in each case was quickly lowered after the war’s end—or with Vietnam, after defense spending began to fall.
The inflation of the late 1970s again raised the total burden above 19 percent in 1981 as people were pushed into higher tax brackets. President Ronald Reagan enacted large tax cuts that year. The longest period with a tax burden above 19 percent was from 1998 through 2000. The 2003 and 2004 Bush tax cuts then lowered the burden in several steps to less than 16 percent.
Over the past 40 years the composition of receipts has not changed radically. The relative importance of income and payroll taxes has fluctuated over the decades, but both are only slightly more important now than they were in the mid-1970s. The importance of corporate, excise, and estate and gift taxes has declined over the same period.
Office of Management and Budget. Historical Tables.