(Bloomberg Businessweek) -- The US is on track to run its largest federal deficit outside of crisis times such as the Covid-19 pandemic, the global financial meltdown and World War II. The extra-large shortfall is more fuel for the election year blame game in Washington, with Republicans decrying out-of-control Democratic spending and Democrats retorting that the culprit is Republican tax cuts that have shriveled revenue.
The deficit for the fiscal year ending on Sept. 30 will amount to almost $1.9 trillion, equal to 6.6% of gross domestic product, according to projections released Friday from the US Office of Management and Budget, which is an arm of the White House. Estimates from the nonpartisan Congressional Budget Office put the gap at an even wider 6.7%.
Government revenue will hit 17.6% of GDP this year, according to the OMB’s figures, which is slightly above the 17.2% average the US logged from 1984 to 2023. Yet overall spending is set to outdistance the average over that period by even more—24.2% to 21.1%. Those data points appear to support Republicans’ argument that higher spending is the source of the problem.
But a closer look shows a more complicated picture. The trouble isn’t coming from outlays the White House and Congress must agree on each year for everything including defense, education, national parks and nutritional assistance. At 6.4% of GDP, discretionary spending in the current budget is projected to be below the 40-year average of 7.5%.
Instead, the increased deficit stems from “factors that are external to the budgeting process,” says Shai Akabas, executive director of the Bipartisan Policy Center’s Economic Policy Program. “It’s largely being driven by demographics and health-care costs.”
Broadly speaking, there are two culprits: the mandatory programmatic spending, or so-called entitlements, to which Akabas alludes, and the interest costs on the national debt.
Mandatory outlays have grown steadily over the years and are set to reach 14.6% of GDP this fiscal year, a full 3 percentage points above the 40-year average. That growth is driven largely by Social Security and health-care programs that have expanded with the rapid climb in the number of Americans age 65 and over. The Social Security Administration estimates there will be more than 67 million people receiving benefits in 2024, an increase of more than 8 million since 2015.
The increase in older Americans, along with rising healthcare costs, are the driving forces behind increased spending on federal government health programs, including Medicare and Medicaid. Outlays for major healthcare programs are expected to reach 5.8% of GDP in 2024, according to projections from the nonpartisan Congressional Budget Office. That compares with a 3.4% average between 1974 and 2023.
At the same time, payments on the $27.8 trillion debt held by the public have surged because of higher interest rates. Since the Federal Reserve began raising rates to combat inflation in March 2022, the average rate the government pays on Treasuries has more than doubled, to 3.3%.
The OMB projects net interest payments will equal 3.2% of GDP in 2024, the most since 1991. “Because that debt is so significant, the dollars add up pretty quickly, and we don’t have a cushion,” says Alex Brill, senior fellow at the American Enterprise Institute.
In fiscal year 2024, revenue from individual income taxes, corporate taxes and payroll taxes is expected to exceed its average over the past 24 years, as a percentage of GDP, for all three categories. That doesn’t mean the tax cuts Donald Trump enacted during his presidency paid for themselves, as Republicans frequently claim. Most economists who have studied the impact of the Tax Cuts and Jobs Act of 2017, or TCJA, have found that the reductions cost the government far more than was generated from the growth and employment attributable to the changes.
Rather it’s factors such as government stimulus and historically low unemployment that boosted economic activity and thus generated more tax revenue. And corporate profit margins soared during the pandemic as companies were freer to raise prices which also drove tax revenue.
Republicans want to make permanent the individual tax cuts in the TCJA that are set to expire next year. But some Democrats only want to preserve the cuts for households making less than $400,000 while ramping up rates for corporations and high earners.
Michael Feroli, chief US economist at JPMorgan Chase & Co., says not allowing the TCJA to sunset will continue to dampen revenues and makes the 10-year projections for US deficits worse. Any solution for shrinking the gap will require a combination of higher revenues through raising taxes and lower mandatory outlays, not just one or the other, he says.
“There are a lot of ways you can ‘fix Social Security,’” Feroli says. “Medicare and healthcare spending is a little harder but there are certainly options there as well.”
There are no formal plans in the works to revamp Social Security, which is projected to run short of enough money to pay full benefits in 2033, or Medicare, which could hit the wall in 2036. Several Republicans favor cutting some benefits or raising eligibility ages. Some Democrats have proposed raising taxes on the wealthy to generate more revenue for the programs.
Treasury Secretary Janet Yellen told Bloomberg News in June that asking households making more than $400,000 to pay more in Social Security taxes “certainly seems like a reasonable approach” to addressing the issue.
The trajectory of America’s public finances—projections the CBO released last month show a cumulative deficit of $22.1 trillion for the decade from 2025 through 2034—is becoming a source of concern beyond the country’s shores. The International Monetary Fund in a June statement criticized the US for running a deficit that is “too large,” noting the attendant increase in the country’s debt burden poses risks for the global economy.
Economists in the US are also sounding the alarm. “At the end of the day, we’re going to need some combination of spending cuts and increases in tax revenues,” says Karen Dynan, a Harvard Kennedy School professor and former assistant for economic policy at the US Department of the Treasury in the Obama administration. “We need to reduce the deficit, and if not, we’re going to see harm to our economy. But there are different levers you can use to achieve that.”
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