In the long run, federal budget deficits are driven by rising interest costs and by demography and rising health care costs pushing spending above scheduled revenues. Short-term deficits have moved sharply because of shocks like the Great Recession and the COVID-19 pandemic. In addition, persistent deficits have also been driven by conscious policy choices. When events conspire to drive revenues above the trend, for example, tax cuts usually bring them down with alacrity.
The budget deficit has been on a roller coaster in the past two decades because of the Great Recession and the COVID-19 pandemic. In 2007, before the financial crisis, the deficit had fallen to 1.1 percent of gross domestic product (GDP) despite the wars in Afghanistan and Iraq and significant tax cuts earlier in the decade. Then the recession hit and the deficit soared to 9.8 percent of GDP in 2009, as tax revenues fell, automatic safety net programs kicked in, and hundreds of additional billions were spent to stimulate the economy. But the economic recovery and subsequent economic expansion quickly lowered the deficit again. By 2015 it was 2.4 percent of GDP.
The deficit then grew faster than the economy, reaching 4.6 percent of GDP in 2019. That increase was driven by a combination of tax cuts (e.g., the tax cuts enacted at the end of 2017) and spending increases (e.g., the lifting of discretionary spending caps in early 2018). Then came Covid-19.
In 2020, the deficit reached 14.9 percent of GDP; the following year it was 12.3 percent. These enormous deficits reflected the deep economic contraction during the pandemic, which lowered GDP, and the dramatic increase in spending to support families, businesses, and the broader economy. As the policy response wound down and the economy recovered, the deficit fell to 5.5 percent of GDP in 2022.
As of early 2023, the Congressional Budget Office projected that deficits would range from 5.4 to 6.0 percent of GDP through 2030 and then rise further, reaching 7.3 percent of GDP in 2033. In the near term, those increases are primarily driven by increasing interest payments. Increased interest spending reflects both the increasing amount of debt from prior year deficits and a substantial rise in interest rates in recent years. Those deficits would increase the debt-to-GDP ratio from 97 percent of GDP in 2022 to 118 percent by 2033. These levels exceed the highest debt-to-GDP ratio after World War II.
Over the longer run, federal deficits are projected to increase because of three factors: rising interest burdens, an aging population, and rising health care costs. Social Security, Medicare, and Medicaid will account for over 50 percent of total spending over the next decade and are expected to continue to grow faster than the economy and tax revenues for the foreseeable future. Medicare and Medicaid face the added challenge that even if the population were not aging, costs per recipient would be rising faster than incomes per capita after one adjusts for the effects of aging. This so-called additional cost growth slowed surprisingly after 2009. However, the Congressional Budget Office expects the growth of Medicare and Medicaid costs to reaccelerate, although not to the high levels experienced in past decades.
The ratio of revenues to GDP was remarkably consistent until the financial crisis, almost always varying between 17 and 19 percent of GDP. Whenever the ratio rose above 19 percent, a significant tax cut followed. A surtax imposed during the Vietnam War pushed the ratio to 19 percent in 1969, but it was quickly removed. Rapid inflation again pushed the tax burden above 19 percent in 1981, provoking the large Reagan tax cuts. The Bush tax cuts of the early 2000s followed an enormous surge in revenues during the dot-com boom of the late 1990s that also pushed the tax burden above 19 percent.
The Great Recession was devastating to revenues and briefly brought them below 15 percent of GDP. Revenues recovered with the economy but in an unusual move, the government passed a major tax cut in 2017 when revenues were already near their historical lower bound of 17 percent. Revenues averaged around 16.3 percent of GDP in 2018 to 2020, then rebounded sharply to 19.6 percent of GDP in 2022. That spike is expected to be temporary, with CBO seeing revenues under current law in the 17.4 to 18.3 percent of GDP range over the next decade. Under current law, revenues would then rise faster in subsequent years, but not enough to keep up with rising spending.
The growth in Social Security and health spending combined with rising interest costs and moderate increases in tax burdens leads to the conclusion that the United States is on an unsustainable fiscal path. If these well-entrenched fiscal policies continue, the deficit will persist on an upward trend and the debt will continually grow relative to GDP. Eventually, there may be no choice but to undertake painful spending and tax policy changes.