How Big Is the Deficit, Anyway?

By James Kwak

According to its CBO score, the Budget Control Act of 2011 (a.k.a. the debt ceiling agreement) initially reduced aggregate budget deficits over the next ten years (2012–2021) by $917 billion, with a provision that ensures that deficits will be reduced by another $1.2 trillion (either through an agreement in the joint committee that is ratified by Congress, or through automatic spending cuts). The chatter in Washington is that even with the $1.2 trillion, this is still too small, and there is still this massive deficit hanging over our heads. This is true to an extent, but not the way you are being led to believe.

The first question is this: How big is the deficit anyway? The answer is pretty complicated—complicated enough for S&P to mess up (although in my opinion they made a rookie mistake, as I’ll explain later). Warning: lots of numbers ahead, though the only math is addition and subtraction.

What’s complicated is that the CBO score doesn’t say what the projected deficit is: it just says what the impact of the Budget Control Act was on some baseline. And the baseline was—wait for it—the March 2011 baseline (included in the annual Analysis of the President’s Budgetary Proposals), modified to include the extrapolation of the final FY 2011 appropriations (remember the first spending cut showdown?), and excluding overseas contingency operations such as Iraq and Afghanistan (which are in the January Budget and Economic Outlook, Table 1-7). So let’s go through this step by step.

In March, this is what the CBO baseline looked like:

For example, the federal government was projected to run a primary surplus of $78 billion and pay $807 billion in interest in 2021, leaving a deficit of $729 billion, or 3.1 percent of GDP.

This is the effect on outlays of extrapolating the changes in 2011 appropriations:

(The CBO didn’t estimate the effect on debt service, but it’s sure to be trivial.) The CBO has to do this because, by law, its baseline forecast must assume that all discretionary spending grows at the rate of inflation. So projections for discretionary spending in future years (which, by definition, has to be appropriated by Congress each year) are just the actuals for the most recent year plus future inflation.* In this case, those are positive numbers, so they reduce future deficits.

Then we have phase one of the Budget Control Act:

The numbers in the top row add up to $917 billion (actually, $918 billion since my spreadsheet doesn’t do the rounding correctly). Those are the new caps on discretionary spending, which are, in aggregate, $917 billion lower than the numbers in the old CBO baseline.

Various extreme right-wingers, including GOP presidential frontrunner Michele Bachmann, have been claiming that those spending cuts are fake because they only affect future spending. This is silly. First of all, there’s no other way to reduce future discretionary spending, because you can’t actually reduce it until appropriations season rolls around. Second, these caps are below the CBO baseline, which grows at the inflation rate. The CBO baseline has generally been considered too optimistic (from a deficit-minimizing point of view), because historically discretionary spending growth has been closer to the rate of economic growth than to the inflation rate. So setting caps below the inflation rate is a major reduction from the general path of policy.

Add those numbers together, and this is what you get:

Now, in 2021, the federal government has a primary surplus of $210 billion, interest payments of $767 billion, and a deficit of $557 billion, or 2.3 percent of GDP. That is roughly where the official baseline should stand after the Budget Control Act. (The CBO score also includes $1.2 trillion of unspecified future deficit reductions because of part two of the BCA.)

But, you may be saying, the CBO baseline is unrealistic to begin with. This is true. So I then adjusted the numbers above by applying three alternative assumptions from the January Budget and Economic Outlook: the planned drawdown of forces from Iraq and Afghanistan (since we know that spending on the wars is not going to grow at the inflation rate);** extension of the Medicare doc fix; and additional patches to the AMT that have the effect of indexing the AMT to inflation. These are the three policies from the CBO’s list that are the most likely to actually happen. Here they are:***

(Note that in this case the CBO estimates changes to outlays and then effect on debt service separately; the first number does not include the second, so you have to add them together to get total deficit impact.) You can see at a glance that the drawdown of forces slightly outweighs the two other adjustments, so the overall effect is to reduce future deficits. So when you add these to the previous numbers, you get:

That is, from 2018 through 2021 the government runs primary surpluses around $200 billion (0.9–1.1 percent of GDP), pays about $700 billion in interest (3.0–3.2 percent of GDP), and runs a deficit around $500 billion (1.9–2.3 percent of GDP). In total, we’ve sliced about $1.3 trillion off the 2021 national debt, bringing it down from 76 percent of GDP (in the March baseline) to 70 percent.

If you’ve made it to this point, there should be three things you should be thinking. (Actually, four, including “Doesn’t James have anything better to do?”)

First, since when is a stable deficit of 2 percent of GDP a national emergency? I agree the situation is not ideal. We won’t have a lot of fiscal space to deal with future shocks (e.g., financial crises), and we’ll be in a race pitting economic growth against the real interest rate on the debt. But at that point we’ll basically be paying interest on stupid policy decisions from the past (take your pick).

The real problem is that over the following two decades, things will slowly and then rapidly get worse as more Baby Boomers retire and health care costs continue to increase. But that takes place outside the ten-year window—and it’s mainly a health care problem. So why do we have a joint committee of Congress mandated to slash $1.2 trillion from the budget within that window? I know the political reason, but that doesn’t mean it makes any economic sense.

Second, the not-so-bad scenario painted above has one major assumption: that we let all expiring tax cuts, well, expire. If, instead, we make them all permanent, we’ll never have primary surpluses, we’ll have deficits over 5 percent of GDP in 2019–2021, and the national debt will be around 90 percent of GDP in 2021—with the demographic wave only beginning. But it seems to me this could be a political opportunity. President Obama can say: “I have a bulletproof, real plan to bring the deficit down to a sustainable level within this decade. I will veto any tax cut extension unless it is fully offset. The entire existence of a deficit crisis over the next decade is predicated on extending the tax cuts.” (I know, the fact that I used the word “predicated” rules me out as a political speechwriter.) Then he can negotiate from a position of strength. But, of course, we’ve been through this before.

Third, and less importantly: What was S&P thinking? According to their downgrade explanation, the problem is that total government debt (including all levels) is growing from 74 percent of GDP in 2011 to 85 percent in 2021—and they’re counting the $1.2 trillion in deficit reduction from the second phase of the BCA. I don’t know the state/local figures, but by my spreadsheet, if you count that $1.2 trillion (which I didn’t count above), federal debt falls from 69 percent at the end of 2011 to 65 percent at the end of 2021. The only way they get numbers that high is by working off of an alternative scenario in which all the tax cuts are extended and then assuming poor economic growth. (Poor economic growth seems like a good assumption, but it also argues for less deficit reduction rather than more in the short term.) In other words, S&P downgraded the U.S. because they assumed that the Bush tax cuts will be extended again. Again, President Obama could call them out on this if he were willing to let the Bush tax cuts expire—but we’ve been there before.

So if there’s one thing you should take away, it’s this: The ten-year deficit problem is a tax cut problem. No tax cuts, no problem. This won’t solve the all the long-term problems, but it’s a good start.

* S&P’s mistake was thinking that the “baseline” included discretionary spending growing at the rate of GDP. This is a big mistake because, by law, there is only one CBO baseline, and it has discretionary spending growing at the inflation rate. The CBO does publish projections under “alternative policy assumptions,” but they don’t call them baselines. Furthermore, the CBO’s score for the Budget Control Act—published in August 1, four days before the downgrade—was painfully explicit about what baseline it was using, and even repeated, “In CBO’s baseline projections, appropriations for discretionary programs are assumed to grow each year with inflation from the amounts provided for the most recent year.”

** This adjustment should be applied. The Budget Control Act excluded overseas contingency operations. So think of all discretionary spending in the March baseline as (a) overseas contingency operations and (b) everything else. We captured the reductions to (b) above. Since (a) was not affected by the BCA, the alternative policy assumption from January is still applicable.

*** These are from January and were not updated in March, so they could be off by now by a few billion dollars. In this context, that is not real money.

32 thoughts on “How Big Is the Deficit, Anyway?

  1. Mr. Kwak: Is this what you really meant? “So if there’s one thing you should take away, it’s this: The ten-year deficit problem is a tax cut problem. No tax cuts, no problem. This won’t solve the all the long-term problems, but it’s a good start.” ???????

    It is confusing enough that everyone–EVERYONE–acts as if money is a real thing, instead of simply a function of law, politics, and the powerful wielding the law as a sword over everybody else.

    But when from behind the wizard’s curtain the elite spear-carriers make statements like “No tax cuts, no problem,” it becomes completely incomprehensible.

  2. “…GOP presidential frontrunner Michele Bachmann…” Um, no. Romney is the front-runner in every major poll and in individual match-ups. Bachmann is a declared candidate who won a straw poll but who loses to Romney in individual match-ups and in overall preference polling.

  3. do you think the treasury can negotiate some of this debt to china as a result of us overlooking a trade defeceit and china’s devaluaing their currency?

  4. what grifters do – from Wiki:

    “Confidence tricks exploit typical human qualities such as greed, dishonesty, vanity, honesty, compassion, credulity, irresponsibility, desperation, and naïveté. The common factor is that the victim (mark) relies on the good faith of the con artist.
    Just as there is no typical profile for swindlers, neither is there one for their victims. Virtually anyone can fall prey to fraudulent crimes. … Certainly victims of high-yield investment frauds may possess a level of greed which exceeds their caution as well as a willingness to believe what they want to believe. However, not all fraud victims are greedy, risk-taking, self-deceptive individuals looking to make a quick dollar. Nor are all fraud victims naïve, uneducated, or elderly.
    A greedy or dishonest mark may attempt to out-cheat the con artist, only to discover that he or she has been manipulated into losing from the very beginning.
    Shills, also known as accomplices, help manipulate the mark into accepting the con man’s plan. In a traditional confidence trick, the mark is led to believe that he will be able to win money or some other prize by doing some task. The accomplices may pretend to be strangers who have benefited from performing the task in the past.”

    Health care in USA…

  5. @Bill Munny

    Bush was the dummy put in the driver’s seat (AKA Eliza Doolittle) – the car is still speeding along, no? When’s the next *rapture*…?

    A President writes him/herself into the pages of history – so the answer is “forever”….or would a Russell Crowe moment of “….into eternity…” answer your question?

    Isn’t that part of the story – the lure of the *POWER* of the Dark Side – shoot, Cheney is half machine now just like Darth Vadar…

  6. Munny– not only Bush, but all the Republicons: The CBO projected that the surpluses Clinton left for Bush were enough to pay off the entire US debt by the time that the Social Security/Medicare trust funds would have to be amortized for beneficiary payments, all without having to raise taxes to pay for the amortization of those trust funds. These “surpluses” were made up entirely of excess payroll taxes building up the trust funds. Bush took those excess payroll tax receipts and gave them “back” as income tax reductions, heavily weighted to the wealthy–who didn’t create those surpluses in the first place. By doing this, Bush guaranteed that taxes would have to be raised in order to amortize the trust funds. The failure to do so simply permits the Republicons to steal the money contributed by workers for their retirement. Everything about not raising taxes or limiting expenses, is about stealing our money.

  7. “The only way they get numbers that high is by working off of an alternative scenario in which all the tax cuts are extended and then assuming poor economic growth.”
    Uh, if I were making predictions about a country with a completely disfunctional government (which S&P stated was a factor) my BASE CASE would that whatever is happening right now continues to happen. I see no policy or trend that would indicate the US economy improves in any reasonable time frame, other than a doctrinaire faith that everything goes up eventually. Similarly, nobody who has been alive the last 2 years could honestly argue that the Bush tax cuts will be allowed to expire. Yes, I know that “doing nothing” means that they expire, but in fact Washington has not been “doing nothing” (well, except maybe the Fed) they have been very much doing the WRONG things. I have faith they will continue.

  8. Confused on one point. Post says this:

    “The CBO score also includes $1.2 trillion of unspecified future deficit reductions because of part two of the BCA.”

    But later this:

    “if you count that $1.2 trillion (which I didn’t count above), federal debt falls from 69 percent at the end of 2011 to 65 percent at the
    end of 2021.”

    So are the second round of BCA cuts (i.e. the supercommittee’s recommendations and/or automatic sequesters) included in your version of the baseline or not? If they’re not, how would that effect your conclusion that we’re looking, at least over the 10-year horizon, at a “non-emergency” 2% of GDP deficit?

  9. “First, since when is a stable deficit of 2 percent of GDP a national emergency?”

    The answer: Since conservatives saw an opening to advance their “starve the beast” strategy.

  10. Will President Obama campaign on the repeal of all of the Tax Cuts? Very doubtful. After the election, whether he wins or loses, will be the oppurtunity to play into the hands of the Republicans not wanting to extend any tax cuts unless he extends the ones for the wealthiest. Refusing to make the deal for the top earners would probably kibosh all of the cuts. Does he have the cajones to do so? Unfortunately the best predictor of future behavior is past behavior.

  11. @James Kwak, you write: “The CBO baseline has generally been considered too optimistic (from a deficit-minimizing point of view), because historically discretionary spending growth has been closer to the rate of economic growth than to the inflation rate.” So why do you think, it is a “big mistake” that S&P has assumed this more realistic path of spending growth initially? Because the Treasury department calls it a “math error”?

    I think it was indeed political pressure from the Treasury department that has led the rating guys change their baseline – to the CBO baseline. But even with this “corrected” baseline they came to the conclusion that the debt will rise until 2021 – as you can see even in the Treasury’s blog post. The S&P decision was not a alone driven by political reasons – what actually is another Treasury’s myth. As S&P explains: “Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria…”

    And later: “When comparing the U.S. to sovereigns with ‘AAA’ long-term ratings that we view as relevant peers–Canada, France, Germany, and the U.K.–we also observe, based on our base case scenarios for each, that the trajectory of the U.S.’s net public debt is diverging from the others. (…) However, in contrast with the U.S., we project that the net public debt burdens of these other sovereigns will begin to decline, either before or by 2015.”

  12. Clearly the time has arrived to finally do something purely logical and reasonable:

    Scene: White House

    Characters: President Obama and Me

    Act 1: Enter Soft-toes Moses. He uses his incredibly soft toes to shuffle across the White House lawn unseen into the back door of the Oval Office. The atmosphere is dead quiet as Obama sends a text message to Michelle, telling her not to eat ice cream on camera, as it makes her look hypocritical to America’s schoolchildren. Moses dons his Jester’s cap equipped with bells after stealthily evading the Secret Service.

    Moses Herzog: Noble Obama!!! Patriot of our lost dreams!!! Do not keep continence with the barbarous Republicans!!!

    Obama: Huh???*

    Moses Herzog: Rome is bleeding!!! For she has no leader against the Republicans!!! You make all Democrats feel they doth wear the Vulcan’s badge!!! I will now b*tch slap you into sanity!!! You will withhold your pen!!! No more will you doth cheat your political base with extended tax cuts for the rich when I am done with you!!!

    Obama: Eh??? There is no sanitarium near the White House….

    [Moses grabs a wet sock filled with berries and proceeds to whip Obama’s face mercilessly for 5+ minutes. Obama finally concedes he will not extend the tax cuts for the rich, and Moses forces him to recite “I have been a wussy with my veto pen” 20 times before Moses stops the merciless B*tch slap with the berry-filled sock]

    After President Obama discovers what a major wuss he has been, the Kingdom eventually takes care of other important steps for debt control and lives happily ever after.

    The End

    *Huh—Old English—WTF???

  13. People have said that Buffett is a few weeks late with his editorial on tax cuts for the rich. I would agree that he is late on this. But better late than never:

  14. Poor old Warren is a tool being used to further a gvts end. And an evil one at that.

  15. I want to thank you for ‘not having anything better to do’. This was very helpful to me, a non-economist who is trying to follow the arguments on this topic. I really appreciate the time and care you took with this post. The news media so rarely — well, actually never — include explanatory details such as how the CBO generates a baseline. I hope you continue to have time to waste in this way!

  16. The #’s do get overwhelming deb, its a sideshow to mask all gvt debt possibilities, wall street needs to cover all its tracks so it can trap others in a lie. I’m glad you had the time to waste, as a non-economist, to follow and comment about others wasting thier time in a way you disapprove of. It beats teaching your kid how to steal and feel good about it.

  17. Is reducing the deficit a good enough reason to not make the Bush tax cuts permanent for the middle class? I say no. I say we should be more concerned about economic inequality than the deficit. A low unemployment rate should be the goal, not a balanced budget. After all, low unemployment produces a balanced budget, so it’s a total win-win.

  18. @André Kühnlenz: Because S&P was attempting to forecast discretionary spending, given the discretionary spending caps in the Budget Control Act. If the BCA did not exist, then it would be reasonable for them to forecast discretionary spending to grow at the rate of nominal GDP. But the BCA did exist, and S&P knew it existed, and the BCA explicitly caps discretionary spending at a certain level. That number is the CBO baseline (discretionary spending grows with inflation) minus $917 billion. That’s what the BCA says, and that’s what the CBO score for the BCA says. With the caps in place, there is no need to guess at whether discretionary spending will grow with inflation or with nominal GDP: it will grow with the caps (meaning it will fall in real terms). That’s a pure factual mistake, not an issue of judgment.

  19. @Tyler: I’m not going to try to prove it to you here, but my belief is that the middle class will be better off without their tax cut because the lost revenue from the tax cut will result in cuts to Social Security and Medicare—and the middle class is better off with Medicare than with their small tax cuts. It’s an issue of whether the middle class is a net beneficiary of government spending or not, and the numbers I’ve seen indicate that it is.

    In any case, it’s not arguable that the poor are definitely better off with no tax cut, because they didn’t get one in the first place: 46 percent of households pay no income tax at all, and therefore saw no Bush tax cuts. And from a moral perspective, I think it’s more important to do what’s best for the poor than what’s best for the middle class (and certainly not the rich).

  20. @Peter Principle: I didn’t include the $1.2 trillion in my adjusted baseline (which ends with a $557 billion deficit in 2021) because I wanted to make the point that the $1.2 trillion is silly and unnecessary. If we’re going to have a joint committee address deficit reduction, they should be looking at 2030—not the next ten years. Focusing on the next ten years would just lead them to cut the wrong things.

    If you include the $1.2 trillion, then we’re looking at even less of an emergency than in my adjusted baseline. So if you take the $1.2 trillion as given (which it is, according to current law), that just makes the argument even stronger that we already solved the 10-year problem—one way or another—and it’s time to move on to other things (unemployment, climate change, nuclear proliferation, whatever). But it’s impossible to tell if that $1.2 trillion will help the long-term (2030) picture, because we don’t know what’s in it. (And the automatic sequesters will certainly not help the 2030 picture.)

  21. James,

    Thanks for responding. I totally agree with your final sentence. I came at my position on the Bush tax cuts based on the following, written by James Galbraith last year:

    “Social Security and Medicare are government programs; they cannot go bankrupt, and they cannot fail to meet their obligations unless Congress decides–say on the recommendation of the Simpson-Bowles Commission–to cut the benefits they provide. The exercise of linking future benefits and projected payroll tax revenues is an accounting farce, done for political reasons. That farce was started by FDR as a way of protecting Social Security from cuts. But it has become a way of creating needless anxiety about these programs and of precluding sensible reforms, like expanding Medicare to those 55 and older, or even to the whole population.”

  22. James, nicely structured article. It demonstrates two things with crystal clarity. First, that calculating deficits beyond a couple of years is virtually a fool’s errand. Second, that in our present depressed economic environment (we can argue depression or recession, but it is NOT recovery by almost any measure), there are many far more important econmic discussions to have. Remember that, although WWII is credited with getting us out of the Great Depression, in 1946 we had a debt of more than 130% of GDP. In other words, the cost of the “war stimulus” was greater than it’s positive effect, and all it really did was grease the economy into real positive movement so that the recovery could get stronger and continue. On this same basis, and since our present problem is the same kind of (bubble) depression/recession, the best reaction to it (forget talking Keynes or Friedman), is the same as what got us out of the last problem, that is massive government stimulus (just figure what percentage of GDP the government had to invest during the major years of WWII, and that would dictate what should be spent now). It that isn’t done, soon, there will be a massive failure of our government (either party) to move the country forward, and a collapse will ultimately happen. Without massive growth policies, we will never get out of the chasm called a “ditch,” by misnomer.

  23. Bayard, you can not get out of any ditches by moving forward, efficiency is the new name of the game and competition is the motivator. Its move it or lose it from here on out. Life must be lived forward, but can only be understood, backwards.

  24. There are three problems with this important analysis. First, the revenue loss from tax cuts will partially be offset by their stimulation of additional economic growth. Second, any projected progress on the deficit is likely to result in additional spending. Third, there is likely to be backlash after cuts or tax expirations are announced or felt, leading to additional spending and lower tax collections than projected.

    Irv Leveson

  25. @James Kwak

    Thank you for your answer. That makes sense. I think consultations with the debt issuers are absolutly usual for the agencies to avoid these mistakes. But that is not the point in your posting. So thank you for the enlightening reading.

  26. When you start getting towards 50% of a countries revenue is allocated to interest on it’s debt, it’s time to turn that around. The US has been bailing out the world for forever, who is going to bail us out? No one, it’s time to tighten our wallets a little bit and listen to Warren Buffet.

  27. @ Mary – “The US has been bailing out the world for forever, who is going to bail us out?”

    Well, according to Friedman, we have to bail ourselves out – without *cash*, though – go figure…

    Here’s the math – 3 billion a year to a country that is now at 8 million people – how many years was that aid flowing? Sure, easy to brag about *start ups* that are being paraded out as *see how smart we are with $$$?*….

    USA – after TRILLIONS in *losses* suffered by USA SAVERS – we got a one time assist of 237 billion to water 300 million people who just had TRILLIONS stolen from them…AKA as the *war* being put on the books…

    hard to do *start ups* with those numbers…and anyone saying that is the answer is DELUSIONAL…

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