The Treasury Department reported this week that the federal budget deficit for fiscal year 2018 increased by $113 billion, or 17 percent from 2017, resulting in a deficit of 3.9 percent of Gross Domestic Product. This is appalling, not least because it happened at time when the economy is strong, the nation is close to full employment, and we are pretty much at peace. Where will it leave us when the economy slumps, as it inevitably will, or when we must ramp up military spending in response to a foreign threat?
The FY ’18 deficit of $779 billion is nearly twice the $440 billion that the Trump Administration predicted when it initially proposed last year’s fiscal plan—a miss of remarkable proportions given the stability of the economy. That budget, you may recall, predicted fiscal balance by 2028. The most recent projection by the Congressional Budget Office is a bit more pessimistic: It forecasts a 2028 deficit of roughly $1.5 trillion.
How did we get here? The Committee for a Responsible Federal Budget does a nice job of summarizing the answer. Though the economy grew smartly and corporate profits boomed, overall tax revenues grew by only 0.4 percent in the fiscal year that ended on Sept. 30. Individual income taxes rose by about 6 percent but corporate income taxes fell by 31 percent, thanks largely to the big corporate rate cuts in the Tax Cuts and Jobs Act (TCJA). And keep in mind that those tax cuts, which passed at the end of calendar 2017, were in effect for only the last three quarters of the fiscal year. The effects of the tax cut will be even more dramatic in fiscal 2019 when we see the full-year effects of the law.
Rising interest costs
Overall the TCJA accounted for a 2018 revenue decline of about $164 billion. The congressional budget deal boosted spending by $68 billion. Those tax cuts and spending increase were somewhat offset by slightly higher payroll and excise tax revenue and a small reduction in some domestic programs. But the net effect was very bad.
The other dismal news came from federal interest payments, which rose from $263 billion in 2017 to $325 billion in 2018, an increase of nearly 24 percent. The total amount of public debt rose with the deficit, of course, and so did interest rates (don’t say we didn’t warn you). Those rising rates eventually will increase borrowing costs for business and wipe out the benefits of the TCJA’s investment incentives.
Except for Social Security, Medicare, defense, and Medicaid, the federal government spends more money on interest on the debt than on any other programs. And last year it spent nearly as much on interest as on Medicaid.
This short-sighted profligacy will constrain opportunities for fiscal stimulus when the next recession hits. And with interest rates still relatively low, the Federal Reserve will have little room to maneuver. Congress and President Trump went on a wild spending and tax cut spree at a time when the economy least needed it. They may have juiced the short-term economy and, perhaps, their popularity. But I fear we will all pay the economic price in the long run.
It has become popular on both the political left and the political right to argue that deficits don’t matter. We may soon find out.
