At the end of the Clinton administration the U.S. had a budget surplus and was over $5 trillion in debt.
How was this possible? The answer is a simple tweak of terminology.
What Is The Budget Deficit?
Although easy to confuse, the budget deficit and the national debt are not the same thing.
Budget deficits are the gap between allocated spending and total revenue in any given year. When the government spends more than it takes in, it leaves a budget deficit that has to be filled by assuming additional debt.
So, for example, take a fiscal year where Congress spends $400 billion more than it collects in revenue. This $400 billion shortfall is the budget deficit for that given year. The Treasury would then issue bonds, notes and other financial instruments to raise the money to pay for this spending through debt.
While budget deficit can refer to any imbalance between spending and revenue, in casual use it typically refers to the U.S. government's annual budget.
The Annual Budget Deficit
The budget deficit is an annual measurement. It calculates the degree to which spending exceeds revenue. The national debt is a total measurement. It calculates the entire amount owed by the United States (typically focused only on interest bearing debt).
Absent any other factors, each year's budget deficit adds to the national debt. Interest and budget deficits are the two primary ways that the national debt grows.
Although Americans have grown used to an annual budget deficit it is not always the case. When the government collects more revenue than it spends in a given year, it runs a budget surplus. Since 1970, the U.S. has run a surplus four times, in 1998 through 2001. This is largely attributed to a combination of tax increases and social spending cuts.
This is also referred to as a "balanced budget."
Budget Deficit Triggers
Typically, one or more of three factors will trigger a deficit in any given year:
• Planned spending growth that pushes government expenses past its revenue streams, such as the Medicare expansion of 2003.
• Planned tax cuts that push government revenue below its expenses, such as the 2017 tax bill.
• Unanticipated events that cause a sudden spike in government spending, such as the stimulus packages issued in the wake of the Great Recession of a decade ago, or the significant growth in unemployment, Medicaid and other social insurance claims during that time period.
All three of these have become common features of the American political landscape, but in recent years, tax cuts have also driven budget deficits to a predominant degree. Of the three dramatic expansions of the annual deficit in the 21st Century, two followed major tax cut legislation (in 2001 and 2017) and one followed a fiscal crisis (in 2008).
In 2019 the government anticipates a budget deficit of approximately $981 billion, of which $228 billion will be due to the 2017 tax cut alone.
The Significance of Budget Deficits
Some believe there is little inherent danger to budget deficits except to the degree that they contribute to ongoing debt.
Much coverage of this issue discusses rising interest, the risk that too much borrowing will cause lenders to charge higher interest rates out of a fear that U.S. debt will grow less sustainable, and "crowding out," the risk that ultra-secure government bonds will attract too much investor money and leave private companies unable to find buyers for their debt. In addition to these concerns, there are also issues more connected with the total volume of government borrowing rather than the isolated budget shortfall of any given year.
The other often-discussed concern regarding budget deficits is inflation, yet this is a concern linked not with revenue shortages but rather with government spending overall.
Of the many factors that can drive inflation, theoretically one can include government overspending relative to the size of the economy. If the government spends too much it runs the risk of pumping too much cash into the economy and creating more demand for goods and services than the market can handle. In this situation prices will start to rise.
For example, consider the market for laptops. Let's assume that the U.S. economy can at its peak supply a total of 1 million new laptops per year to all consumers. Let's further assume that right now consumers purchase 900,000 new devices annually. (These numbers are off by orders of magnitude, but they are more useful for demonstrative purposes than the real figures.)
If, in this market, the government suddenly begins a massive purchase program that buys 200,000 new laptops per year, suppliers will expand until they hit peak production. Then, with more customers than they can produce new computers for, suppliers will raise prices until 100,000 buyers drop out and the market stabilizes. This is an inflationary cycle.
However, in the context of budget deficits readers should take these warnings with a grain of salt. This is typically a criticism of government spending overall, not a targeted concern with deficits. Budget deficits are a means by which large scale government spending can occur, but inflation has more to do with total spending figures than the relationship between revenues and expenses.
Budget Deficits, Keynes and Interest Rates
In recent years many economists have begun calling for the United States to run larger deficits, or to at least worry less about the current rate of deficit spending. This is an historical anomaly as only in recent years has America significantly increased annual deficits outside of wartime. (Again note: America has increased its debt steadily, however increasing the deficit refers to overspending the budget by more than the previous year.)
It is an alternative to the traditional Keynesian model which governed American economic thinking for much of the 20th Century. Under this thinking (named after the economist John Maynard Keynes), a government's peacetime budget should run counter-cyclically to the market. It should run significant deficits during economic downturns to replace the economic activity of impoverished consumers and provide the so-called "spender of last resort." During periods of prosperity the government should cut back, letting private spending take over and focusing on paying off debt.
A relatively recent argument has suggested focusing instead on interest rates. This argument, partially championed by New York Times columnist Paul Krugman, suggests that a government should borrow during periods of low interest to invest in projects with long-term dividends such as infrastructure and education. It should then focus on paying off that debt when interest rates are high.
Supporters of this idea say that projects such as those to improve highways, sanitation systems and schools tend to have strong social and fiscal benefits. To build them with borrowed money, then, makes sense say proponents, as long as that money is borrowed at a lower rate of return than the project will likely yield.
But the merits of this theory remain hotly debated.