Deficit spending occurs when purchases exceed income. It happens to individuals and businesses, but it usually refers to governments. Governments have strong incentives to spend more than they take in and few reasons to balance the budget.
When government spending exceeds government revenue, it creates a budget deficit. Each year's deficit is added to the sovereign debt. There is a small but important difference between the deficit and the debt. In addition to the deficit, the government lends money to itself from the Social Security Trust Fund. That adds to the debt without increasing the deficit.
- Deficit spending is an expansionary fiscal policy used to end recessions.
- Congress approves deficit spending to spur growth.
- Deficit spending should be reduced when the economy is on its expansion phase to avoid adding to the debt.
Causes of the Deficit
Deficit spending is not an accident. The president and Congress intentionally create it in each fiscal year's budget. They do it to increase economic growth. For example, the government buys defense equipment, medical supplies, and buildings. The businesses it contracts with hire people. The government hires people directly. Both federal and local government spending is a crucial component of gross domestic product.
Deficit spending is also part of expansionary fiscal policy. Job creation gives more people money to spend, which further boosts growth. Tax cuts are the other tool used to expand the economy.
The opposite is contractionary fiscal policy. That is when the government spends less than it receives in revenue to achieve a balanced budget. Contractionary policy also includes tax increases.
There is a more powerful cause of deficit spending. Politicians often get elected for creating jobs and growing the economy, but that may not happen when unemployment is high and taxes are raised.
The United States can afford deficit spending because the interest on the debt is so low. One reason is that China, Japan, and other investors demand U.S. Treasurys. That's especially true in the face of economic uncertainty. China and Japan are still the largest foreign owners of the U.S. debt, but their appetite has slackened.
U.S. Deficit Spending
Most people blame deficit spending on entitlements. To some extent, that's true. Social Security, Medicare, and Medicaid cost more than $2 trillion a year. Those payments consume nearly two-thirds of the revenue received each year.
This mandatory spending must be paid to legally fulfill the acts of Congress that created these programs. To cut spending, Congress must pass another act to amend or reduce them. This is rarely done since millions of current beneficiaries, who are also voters, will have their incomes reduced.
For example, Congress passed the $831 billion economic stimulus package in March 2009 to end the 2008 financial crisis. It paid for extended unemployment benefits and public works projects.
Wars and the Deficit
Most people don't realize that wars create more deficit spending than recessions. For example, President Franklin D. Roosevelt only increased the deficit by $3 billion a year to fight the Great Depression. He spent around $50 billion a year to fight World War II. If FDR had spent as much on the New Deal, he may have ended the Depression sooner.
The attacks on 9/11 increased deficit spending more than the Great Recession. The War on Terror drove military spending to new heights. The War in Afghanistan cost taxpayers $36 billion in 2018 alone. The War in Iraq cost $731 billion between FY 2003 and FY 2013.
Deficit spending under President Barack Obama escalated. He received a Nobel prize for his peace efforts. Ironically, he didn't reduce military spending. In FY 2011, he increased the defense budget to its highest level since World War II.
Deficit Spending and the Debt
Deficit spending should only be used to boost the economy out of a recession. When the GDP growth is in the healthy 2% to 3% range, Congress should restore a balanced budget. Otherwise, it creates a frightening debt level. When the debt-to-GDP ratio approaches 100%, owners of the debt will become concerned. They worry that the country won't generate enough income to pay the debt.
Attempts to lower deficit spending typically create conflict within Congress, as legislators argue over which programs should be cut. In 2013, tea party Republicans shut down the government over this issue. They also hinted Congress would allow the United States to default on its debt in 2013 and in 2011.
The Bottom Line
Deficit spending is intentional. Congress and the president know that it's almost a sure-fire way to get re-elected. Those who benefit from tax cuts and increased spending become loyal constituents. It won't change until voters punish leaders who overspend.
The result is debt that's greater than the economy's ability to pay it off. Interest payments on the debt consume almost 10% of the budget. As a result, Congress is caught between a rock and a hard place. This dilemma will only worsen as interest rates rise. If this concerns you, contact your U.S. representatives and senators and let them know.
Frequently Asked Questions (FAQs)
What part does interest play in deficit spending issues?
The interest rate environment determines how much it costs the government to borrow money for deficit spending. The U.S. raises debt funding through Treasury securities. If a 10-year Treasury bond comes with a rate of 2%, then the government will pay 2% on its debt for 10 years. As rates rise or fall, the cost of debt does, too.