The U.S. federal budget deficit reached $2.8 trillion for the fiscal year 2021. It was the second-highest deficit since 1945; the 2020 deficit of $3.1 trillion as a result of the COVID-19 pandemic takes the top spot.
Learn more about the factors impacting the federal budget deficit, how it's calculated, and whether you should be concerned.
The Deficit as a Percentage of GDP
While debt is sometimes measured as a dollar amount, it's often measured as a percentage of the country's gross domestic product (GDP).
The Congressional Budget Office (CBO) projected in February 2021 that the year's deficit would be 10.3% of U.S. GDP. After the American Rescue plan, that percentage was increased to 15.6%. Before the pandemic, the deficit for 2021 was projected to be $966 billion, at 8.6% of GDP. By the end of the fiscal year 2021, the deficit was 12.4% of GDP.
Factors Impacting the Federal Budget Deficit
Many people blame the federal budget deficit on mandatory spending, but that's just part of the story. The biggest contributors to the current federal budget deficit have been COVID-19, tax cuts, mandatory programs (including entitlement programs), and military spending.
In March and April 2020, Congress passed several laws to offset the damage done by the coronavirus pandemic:
- The Coronavirus Preparedness and Response Supplemental Appropriations Act provided $8.3 billion to federal agencies to respond to the pandemic.
- The Families First Coronavirus Response Act provided $3.5 billion for paid sick leave, insurance coverage of coronavirus testing, and unemployment benefits.
- The largest, at over $2 trillion, was the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). It sent $1,200 stimulus checks to eligible taxpayers, expanded unemployment insurance, assisted small businesses, and funded state and local governments. (The 2021 American Rescue Plan also provided $1,400 stimulus checks to individuals and families, provided funding for COVID-19 testing, vaccinations, and prevention, and more.)
- The Paycheck Protection Program (PPP) and Health Care Enhancement Act allocated $483.4 billion for small businesses, hospitals, and testing.
This spending largely increased the federal budget deficit, but it was necessary to keep the U.S. economy afloat during stay-at-home orders throughout the country.
Tax cuts immediately reduce revenue and add to the national debt. For example, the Bush tax cuts added $5.6 trillion to the national debt between 2001 and 2018. The national debt and the federal deficit are related because the national debt is the accumulation of each year's deficit. So every year, tax cuts add to the deficit by reducing revenue.
The Trump tax cut reduced revenue by lowering taxes on personal income, small businesses, and corporations. The Joint Committee on Taxation projected that these cuts would add nearly $1.5 trillion to the debt between 2018 and 2027.
Some economists say that tax cuts boost the economy so much that additional revenues in the long term will offset short-term losses. The National Bureau of Economic Research found that in the long run, only 17% of revenue from income tax cuts may be regained, while half of the revenue from corporate tax cuts may be regained.
Unfunded Mandatory Spending
Congress has mandated spending on some programs without raising taxes to pay for them. Some of these are also known as "entitlement programs," like Medicare, where people have paid taxes into the program while they were working. They are entitled to those benefits once they retire.
The most expensive mandatory program is Medicaid, which provides health care to those who can't afford it. In fiscal year 2021, $521 billion was spent on Medicaid.
Next is Medicare, which was projected to cost $709 billion in 2021. In actuality, $698 billion was spent on Medicare in fiscal year 2021. However, only 40% of its cost goes toward the deficit. The remaining 60% of it is paid for by payroll taxes and premiums.
The mandatory budget also includes billions for a variety of programs. These include welfare programs like TANF, EITC, and Housing Assistance. Other programs are entitlements, such as unemployment benefits and federal retirement programs.
Some people mistakenly point to the $1 trillion that Social Security spends on an annual basis as a contributor to the deficit. However, that's funded through payroll taxes and the Social Security Trust Fund until 2034, so it's not a factor.
U.S. Military Spending
The War on Terror and related defense spending have added trillions to the national debt since 2001. That includes increases to the budgets of the Department of Defense, the Department of Veterans Affairs, and Overseas Contingency Operations. Unfortunately, it's difficult to reduce the budget deficit without cutting U.S. military spending.
U.S. military spending is greater than the next 10 largest government expenditures combined. It's almost three times greater than China's military budget, and 10 times bigger than Russia's defense spending. It plays a large factor in the federal budget deficit because of its size.
Government Spending, GDP, and the Budget Deficit
A budget deficit occurs when government spending exceeds revenue. The federal government's revenue is the income it collects from taxes, fees, and investments. When spending is less than revenue, it creates a budget surplus.
The president and Congress overspend on purpose. They realize that the more the government spends, the more it stimulates the economy. Government spending is itself a component of GDP. It is the country's total economic output for a year.
Should You Be Concerned About the Budget Deficit?
A budget deficit is not an immediate crisis. In moderation, it can actually increase economic growth. It can help put money in the pockets of businesses and families so that they spend money, which then helps create a stronger economy.
If the debt-to-GDP ratio exceeds a tipping point of 77% for an extended period of time, it slows the economy. Every percentage point of debt above this level costs the country 1.7% in economic growth. It's even worse for emerging markets, in which each additional percentage point of debt above 64% could slow growth by 2% each year.
There is also some cause for concern when the economy is doing well. The government should be reducing the deficit in an effort to lower the national debt. Deficit spending in a healthy economy could make it overheat, and that could create a boom-and-bust cycle, which could lead to a recession.