That Makes Cents: What's the Federal Deficit?

by Patrick Gleeson, Ph. D., Registered Investment Adv ; Updated December 30, 2017
That Makes Cents: What's the Federal Deficit?

Two terms are often used interchangeably: the Federal Deficit and The National Debt. But the Federal Deficit is the difference in a given year between U.S. government income and U.S. government spending. The National Debt is the accumulated result of all prior deficits. The Federal Deficit has ardent believers who profess that it's a positive influence on economic activity and equally determined critics who profess that it creates an unsupportable National Debt that weakens the economy.

The Federal Deficit and Its Relation to the Budget

The Federal Deficit is the difference between the federal government's annual budgetwhat the government agrees to spend in certain budget categories in a given yearand its revenuesor the amount it takes in.

Since the Constitution doesn't provide an actual budget process, but only the somewhat vague determination that Congress has "the power of the purse," the budget process has evolved (and continues to evolve) in ways that assign responsibility for budget formation to several different governmental entities and at several different several stages of the budget process.

The annual budget process begins with the President, who makes a budget request to Congress. In practice, this never includes all the details of an actual budget. Instead, it's a policy statement, an overall expression of the President's spending priorities. It doesn't violate the Congress's power to control the budget because this initial document is a request, not a command.

Following receipt of the President's budget request, the Senate and the House draw up separate budget "resolutions," or plans. These are not automatically approved as they're drawn up. There's a complicated process leading to approval. Different Congressional committees consider in detail specific budget areas and then may suggest changes in earlier budget proposals. Often small groups within each branch of Congress will make demands that a particular item or items in the resolution be modified before they'll agree to vote in favor of it. Congressmen and Senators from specific geographic areas may want spending increased in those areas, even at the expense of reduced spending in other areas. Congressional parties often liken budget formation to a "horse-trading" activity.

The process also includes some back and forth bickering between Congress and the President's Office. Once both branches of Congress have approved their own budget through the appropriation of specific funding amounts, Congressional committees meet to "reconcile" the differences between the Senate and House budget resolutions. The reconciliation process may be brief and more a matter of form than substance or it may be an extended series of negotiations reaching agreement through compromise

When the Congressional budget is approved, it is sent to the President for final approval. Although the President does not have specific authority to change items within the submitted budget, he does have the authority to veto the submitted budget entirely. In practice, this authority, although seldom acted upon, gives the President a way of bending Congress toward the his preferences because he can let it be known that this item or that item is so onerous that unless they're changed the President may veto the entire budget.

Although different parties and groups within each party are often blamed for unpopular budget inclusions and exclusions, the reality is that the process described above is sufficiently complex to make assigning such blame as much a political ploy as a serious charge. Effectively, no one party is entirely to blame and everyone – the President and both branches of Congress, including its committees – bears partial responsibility.

The Difference Between What the Government Spends and the Deficit

In practice, the amount the Federal Government spends each year is always more than the allotted deficit. If the government only spent what was allocated in each year's Federal Deficit, the National Debt would be less than it is.

Like the Federal Deficit itself, which is often politicized to a degree that doesn't represent the complex reality of the budget process, this increased amount of debt beyond what is allocated in the Federal Deficit is often viewed as the result of some kind of dark conspiracy.

The reality is less exciting. The Federal Deficit documents the government's intentions with respect to current spending. By design, it does not include other necessary (and anticipated) expenses, such as the payment of interest on accumulated federal debt, Social Security obligations and Veteran costs. While conspiracy theorists sometimes propose that this discrepancy between the Federal Deficit and what the government spends each year is a dishonest attempt to bamboozle the public, it's known by economists in and out of government that the Federal Deficit is based only on current budget items and is not intended to forecast what the government actually spends

Is Spending More Than Incoming Revenues Good or Bad?

Traditionally, the battle between those who want the government to spend more than its revenues under certain circumstances, and those who want the government to spend only what it takes in no matter what the specific circumstances may be is viewed as a battle between economic liberals (who think deficit spending is OK) and economic conservatives (who think it's wrong).

But the 2018 budget proposed by a Republican Congress without a single approving Democratic congressional vote, includes the largest budget deficit in the history of Congress. Over ten years it will add more than $1 trillion to the National Debt. Yet, Republicans have long advertised themselves as "budget hawks" who oppose deficit spending.

This alone suggests that the way the Federal Deficit has been politicized doesn't reflect the complexity of the budget process. It insufficiently accounts for the battle over federal deficits as political theater and overestimates the way it's viewed as a fundamental battle between economic liberals and conservatives.

It's also widely (not universally) agreed by economists that whether running a budget deficit is a good thing or a bad thing can't be argued intelligently without considering the current state of the economy, that in some circumstances it can be helpful, but in other circumstances can lead to inflation with little stimulative effect on the economy.

If the economy is in a recession, where economic activity has decreased and unemployment has increased, then according to some, running a deficit may be the responsible thing to do because it puts money back into the economy (through government spending), thereby increasing economic activity and stimulating the economy when stimulation is needed.

But if the economy is already heated up, then running a deficit to promote more current economic activity may not be helpful and could lead to inflation – an increase in prices and a decrease in what a dollar will buy.

Taxes, Deficits and Economic Stimulation

Answering the question "Is (Government) spending more than revenues good or bad" is further complicated by another dispute over the effect of reduced (or increased) taxation.

According to a theory developed by economist Arthur Laffer and incorporated in what's generally described as the Laffer Curve, decreasing taxes stimulates increased economic activity. Therefore, according to Laffer and his followers, increased government debt when it accumulates as a result of decreased taxation, can stimulate the economy.

But Laffer's theory is held almost exclusively by Republicans, and Republicans far more than Democrats generally profess opposition to deficit spending! Similarly, Democrats who more often than Republicans see the value of running federal deficits to stimulate the economy, have loudly opposed the Republican tax bill of late 2017 that increases deficits by lowering tax rates.

What these contradictions suggest is that the battle between those who profess opposition to deficit spending and those who profess that it stimulates the economy can be as much political theater as principled opposition.

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About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.

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