Do federal budget deficits matter? This question has divided economists. Some argue that deficits are of little concern, given the US's ability to print money. However, others warn that persistent large deficits could significantly undermine the country's creditworthiness. If the latter warning is on the mark, 2025 could be a crucial turning point. This is when unprecedentedly large budget deficits and projections that they will become even larger coincide with the decision to extend or end the 2017 tax cut, a decision that could have far-reaching implications for the country's economic and financial stability.
The last time the US ran a budget surplus was in 2000. The dramatic turnaround in the US fiscal position in the late 1990s led to wild claims and predictions.
How many recall former Fed Chairman Alan Greenspan's statement in January 2001 before the Senate Budget Committee? He stated. "The most recent projections from the OMB indicate that, if current policies remain in place, the total unified surplus will reach $800 billion in fiscal year 2011, including an on-budget surplus of $500 billion. The CBO reportedly will be showing even larger surpluses. Moreover, the admittedly quite uncertain long-term budget exercises released by the CBO last October maintain an implicit on-budget surplus under baseline assumptions well past 2030."
As we all know, long-term projections are notorious for being off the mark. Yet, no one could have foreseen the extent of the US fiscal position's deterioration over the past twenty-five years. Recessions, financial crises, spending increases, and tax cuts have led to significant and ballooning annual budget deficits, pushing the US debt level to around $35 trillion, a $30 trillion increase from 2000.
It's counterfactual to think how the economy and the financial markets would have performed had the federal government not run large deficits. Yet, it is intriguing that the $30 trillion increase in federal debt coincides with a $40 trillion increase in the market value of equities over the past twenty-five years. Is there a direct connection or merely a spurious correlation?
The Congressional Budget Office's latest long-term budget projections, issued in June 2024, predicted that the US would run budget deficits totaling $22 trillion over the next ten years. If the 2017 tax cuts were to be extended, the bill for the next decade would increase by another $4.6 trillion.
It is difficult to envision the US adding another $20+ trillion in debt over the next decade without triggering negative economic and financial consequences. Yet, many, including myself, would have expected the runup to $35 trillion in debt to have had negative consequences. However, the Fed has blunted some of the adverse effects by introducing a new policy tool (QE), which enabled them to purchase trillions of government debt in the last fifteen years.
In 2025, the budget deficit debate could reach a crucial juncture with significant implications for the economy and financial markets. This pivotal moment will determine our financial limits and constraints. Given the annual budget deficit nearing $2 trillion, Congress faces the decision of whether the US can sustain the 2017 tax cuts and address the array of federal tax incentives proposed by the two presidential candidates.
The economy and financial markets have been positively impacted by federal budget deficits, as they have allowed for lower taxes on individuals and businesses while also enabling increased federal spending on programs. Investors are currently not concerned about the potential removal of these tax benefits and, in certain instances, are even anticipating more benefits in the upcoming Congress. However, the main concern is the possibility of Congress not extending the tax cuts from 2017 and beginning to contemplate higher taxes to address the growing deficits in the future.
Renowned economist Herb Stein once noted that economists excel in predicting when something cannot continue indefinitely, but struggle to pinpoint exactly when it will cease. Considering the stakes at the close of 2025, it is not a substantial gamble to suggest that the economic and financial benefits stemming from federal budget deficits will come to an end.
Joe, this is indeed a thought provoking article. Fact is democractic politics and short termism implicit with the elctoral cycles means left to themselves they will not do the needful. Regardless of the reserve currency position and ability to ride ever increasing deficits and a balooning debt moubtain, one cannot but feel that the US is building a castle of sand. The premise of sustaining a large deficit is that economy would grow and yield tax revenues that will bring the deficit down but that is not happening. Either the expected wealth creation is not happening or that there is a transfer of wealth from the state (tax payers) to the private sector and the burgeoning population of billonaires. This…