Government Spending and the Budget Deficit

February 23, 2009
In his FY2009 budget, President Bush and the Office of Management and Budget (OMB) estimated that Gross Domestic Product (GDP) would be $15 trillion, federal spending would be $3.1 trillion, federal revenues would be $2.7 trillion, and the budget deficit would be $407 billion.  Since the onset of the recession, passage of the $700 billion Troubled Asset Relief Program (TARP), and other actions taken to shore up various sectors of the economy, significant changes have occurred in those forecasts.  The result of all the actions already taken mean that, as a percentage of GDP, government spending and the budget deficit will both be at their highest levels since World War II.

In early January, the Congressional Budget Office (CBO) projected that in FY2009 GDP would be $14.24 trillion and that, on a cash basis, federal spending would be $3.54 trillion (24.76% of GDP), revenues would be $2.36 trillion, and the deficit would be $1.19 trillion (8.32% of GDP).  Most of the differences in spending are related to the TARP program, the takeover of Fannie Mae and Freddie Mac, and additional payments for unemployment and nutrition assistance.  The drop in revenues is a result of lowered individual and corporate tax payments because of the recession.  The CBO does not include any of the over $500 billion borrowed by the Treasury to "help it finance initiatives to enhance liquidity in the credit markets" in its budget projections and they use a net present value basis for TARP spending, so only about $180 billion of the $700 billion that will be spent is reflected in the deficit.

Since their projection was made, a $787 billion stimulus package was passed, which the CBO estimates will add $185 billion to the deficit this year and $400 billion to the deficit next year.  In addition, another $200 billion for more Fannie Mae and Freddie Mac subsidies and guarantees has been approved, at least $75 billion for a mortgage bailout bill is expected, another $130 billion to bailout the automobile industry is likely, and even more stimulus has not been ruled out.  CBO also anticipates that another $82 billion will be required for the wars in Iraq and Afghanistan this year.  On top of that, another $2 trillion in loans and guarantees for financial institutions is being discussed and just today a proposal for another $410 billion in spending was unveiled by House Democrats.

Right now, it is unclear exactly how much of all the additional stimulus, spending, loans, and guarantees that have been approved or are planned will be treated as part of the FY2009 budget.  Based on the programs and numbers identified so far, it is probably safe to assume at least $750 billion will be added to the budget, which would indicate that government spending for the year will likely exceed $4.25 trillion (29.8% of GDP) and the budget deficit will probably be more than $1.95 trillion (13.7% of GDP).  Those percentage of GDP numbers are astronomically higher than at anytime since World War II.  The deficit will be more than twice the 6% of GDP it reached after the most severe recession of the last 60 years that we experienced in 1981-1982 when unemployment, inflation, and interest rates were all in double digits.

President Obama has vowed to cut the deficit in half by the end of his first term.  That shouldn't be too difficult given a baseline starting point of nearly $2 trillion.  However, it means that the budget deficit will still be well over 6% of GDP in 2013, which is unacceptably high and unsustainable.  While the massive deficit spending we are embarking on ought to lead to faster growth in the economy in 2010 and 2011, it comes at a very high price over the longer term.  The huge deficits virtually guarantee that we will experience another round of the devastatingly high inflation and exorbitant interest rates that most who lived through the economic morass of 1970's and early 1980's expected to never see again after they thought President Reagan tamed those beasts once and for all.