Why Should I Care About the Federal Deficit?

by Patrick Gleeson, Ph. D., Registered Investment Adv ; Updated December 30, 2017
Why Should I Care About the Federal Deficit?

Republicans and Democrats regularly oppose each other over the federal deficit. But this opposition may sometimes be more political theater than a difference in fundamental beliefs. While there are reasons why you should care about the federal deficit, its effect on the economy is more complex than these political battles suggest.

Republicans on Deficit Spending

The Federal Deficit is the difference in a given year between the amount of money the government takes in (revenue) and the amount it spends (outflow). Republicans have long held that Federal Deficits are categorically bad. For one thing, Republicans point out that a growing federal deficit creates an unsupportable national debt that will make life harder for later generations who (according to the Republican view) must eventually pay it off.

Also, Republicans generally believe in "small government," and oppose government policies that in their view often over-reach and interfere in private lives. They oppose Democrats who advocate allowing federal deficits as a way to stimulate the economy because the use of federal deficits for that purpose is the very essence of expanding the role of government in economic activities. This Republican view is efficiently encapsulated in the often quoted excerpt from Ronald Reagan's first inaugural address: "Government isn't the solution ... government is the problem."

Democrats on Deficit Spending

From the Democrat perspective, the classic instance of deficit spending as a remedy for a failing economy is Franklin Delano Roosevelt's New Deal – the various economic initiatives in the 1930s to end the Great Depression. The WPA (Works Progress Administration) and his initiation of Social Security, for example, are pointed to as expansive New Deal programs that produced economic benefits far exceeding their costs.

Although the effects of the Great Depression lingered to some extent until military spending at the beginning of WWII finally ended it entirely, Roosevelt's stimulation of the economy through deficit spending is generally conceded to have contributed to ending the Great Depression.

Despite Roosevelt's successful use of deficit spending, Republicans have traditionally opposed deficit spending on the grounds that the expansion of the economic role of government has unintended consequences that eventually harm the Americans significantly in ways only indirectly related to the economy. The social welfare programs that deficit spending pays for, Republicans maintain, reduce the individual motivation to overcome economic problems through innovation and hard work. Instead they create a "welfare state" where citizens cease contributing and expect a handout.

Political Theater?

Two related events in late 2017 call into question the conventional wisdom that Democrats generally favor federal budgets that include deficits and that Republicans generally oppose them. The tax bill passed in December 2017 generates an increase in federal debt of at least $1 trillion over 10 years. Despite this, the bill was passed entirely by Republicans, without a single affirmative vote by Democrats in either the House or the Senate.

The opposition to this same deficit increase was strongly opposed by Democrats. These late 2017 events suggest that views by both Democrats and Republicans about federal deficits are sometimes political and are always circumstantial: Democrats tend to approve federal deficits that result from programs like Medicaid that benefit their constituents; Republicans oppose federal deficits that support these same programs, but do not oppose federal deficits resulting from decreased taxes. While the late 2017 tax bill provides some tax benefits for all Americans, it especially benefits Republicans' wealthiest supporters, who are the primary beneficiaries. Democrats point out that while the bill's tax cuts that primarily effect the middle and working classes expire over time, the cuts in the corporate tax rate and the lowering and eventual elimination of the inheritance tax, which benefits only the wealthiest Americans, are both permanent.

Republicans respond to these criticisms by pointing out that while some tax benefits in the new bill immediately benefit the wealthy, because lower tax rates stimulate the economy by releasing into it what would have been money paid to the government, lower taxes eventually benefit everyone. This, like most everything else related to deficit spending, is opposed by one party or the other. Democrats deride the notion of benefits for the rich eventually benefiting everyone as "trickle-down economics" that, historically, never produced a discernible benefit

Are There Reasons You Should Care About Federal Deficits?

There are still good reasons why, whether you're a Democrat or a Republican, you should care about federal deficits. One important reason is that deficits, even if initiated to support goals many Americans support, are financed by sales of Treasury bonds and other government securities, thereby competing for the same dollars that would otherwise have been available for commercial activities. Eventually, this constrains the economy by reducing the capital available. This doesn't suggest that federal deficits are categorically bad, but that like a lot of things in life, they're better used in moderation and with an awareness of the consequences.

Another consequence of federal deficits is that they can contribute to inflation. This isn't an inevitable consequence, but it's a consideration, especially if the government chooses to fund the debt by increasing the money supply – what fiscal conservatives characterize as the government's "printing money to pay its bills." This doesn't mean that running federal deficits by increasing the money supply always results in inflation. On the contrary, during the Great Recession when the federal deficit increased as a matter of policy , the inflation rate remained low, possibly because the economic depression was so severe.

Another reason you should care about federal deficits is that when federal deficits increase they can increase the interests rates you pay on your credit cards and, especially, on the interest rates you'll pay on a home mortgage. If you already have a home mortgage with a fixed rate, this won't effect you. It will, however, if you're planning to apply for a mortgage as interest rates increase or if you have an existing mortgage with a variable rate. If, for example, the government pays for the deficit by issuing government bonds, as is often the case, they do so by offering bonds at higher interest rates to induce increased purchases of the bonds. Since commercial lenders look to this rate as a benchmark; when it increases commercial institutions respond by raising their prime rates. This increase in the prime rate inevitably raises the rates you pay on your credit cards and home mortgages.

The Bottom Line on Federal Deficits

When politicians, whether Democrats, Republicans, fiscal conservatives or Keynesian fiscal liberals give you their opinions on federal deficits – either that they're just what the economy needs or that they're always ruinous, be aware that the reality is more complex and nuanced. Also, keep an eye on federal deficit policy when making your own financial decisions. Since growing federal deficits can raise interest rates, when federal deficit spending increases, you may want to get out of a variable rate mortgage and into a fixed rate mortgage while you still can – that is, before interest rate increases make a new fixed rate mortgage unaffordable.

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.