Money Management: Despite strong economy, federal deficit soars

Kevin B. Murray//November 12, 2018

Money Management: Despite strong economy, federal deficit soars

Kevin B. Murray//November 12, 2018

One item that seems to have been forgotten, or at least received very little press coverage, is that despite having a very strong economy, the federal deficit is going up at a time it would be expected to be dropping. Recently it was announced that in fiscal year 2018, the federal deficit rose to its highest level in six years. The Treasury Department reported a 17 percent increase in debt compared to the previous fiscal period.

The Congressional Budget office has projected that even at full employment we will be running enormous deficits well into the next decade. When the inevitable recession comes, we will be in much deeper trouble. During a period of full employment, both workers and businesses would be earning more and ordinarily this would translate into them paying more taxes. On the expenditure side, full employment reduces the need for some government expenditures (unemployment/welfare), further lowering any deficit or increasing a government surplus.

Last year’s huge corporate tax cut, together with increased government expenditure, has led to an increasing federal deficit at a time it should be shrinking. The Congressional Budget Office projects that spending will grow rapidly, from 21 percent of Gross Domestic Product in 2018 to over 29 percent in 2048. Revenue however, is projected to grow much slower, from 17 percent in 2018 to 20 percent in 2048. This will result in annual deficits rising from the current 3.9 percent of GDP to 9.5 percent by 2048. The latter percent is close to the post WWII record percentage of GDP deficit that occurred in the first year (2009) of the recent great recession. (Congressional Budget Office—2018 Long-Term Budget Outlook)

There are many adverse and potentially dangerous consequences of a high and rising federal debt. The debt increase will lead to slower economic growth, lower average incomes, higher interest rates and ballooning interest payments on the debt. The payments will balloon both because the size of the debt is so much larger and because the interest rate we will have to pay to convince investors to purchase our debt will be much larger than the current interest rate.

As the debt eats up more and more of government spending, it will reduce what is left for other purposes. As our population ages, the percentage in the workforce will decline and the cost of Social Security and health plans will continue to go up. Conflict between the older retirees and those working will likely occur. Funds to maintain our international leadership position will be difficult to find as well.

Currently foreigners own approximately 47 percent of our national debt. The largest holders are China and Japan. Currently we are having trade problems with China; if they choose to stop buying or become a net seller of our debt it could affect the interest rate we must pay to fund the debt. The fact that China owns a considerable amount of our debt certainly gives them some leverage in all discussions with the United States.

Currently the United States has the fourth highest debt as a percentage of gross domestic product of all the G20 nations (only Japan, Italy and Singapore have debt to GDP higher than the United States) and ninth in the entire world. (TradingEconomics.com). Fixing the debt problem will get harder the longer policymakers wait. Delaying necessary deficit reduction will mean more draconian spending cuts and tax increases when the deficits are finally dealt with.

Comparing the size or percentage of GDP that the current full employment deficit is to what it was during periods of war or massive unemployment will only delay needed action. The projected deficits would only get much larger if the economy were to see higher unemployment or higher spending due to larger foreign military action. During periods of full employment, the deficits should be reduced substantially — and currently they are being increased dramatically. That is neither prudent nor sustainable. Between 1965 and 2017, the full employment deficit as a percentage of GDP averaged 2.3 percent. Currently the percentage is 3.9 percent and projected to go up to 9.5 percent by 2048. (CBO 2018 Long-Term Budget Outlook)

Politically it is always easier to make friends by reducing the taxes they pay and increasing government expenditures that they receive. It is, I believe, fiscally unsustainable. The sooner the public and the leaders choose realize this, the better our nation’s economy will be in the future.

Kevin B. Murray, is a vice president at Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees.  Offices are located at 183 Sully’s Trail, Pittsford, NY 14534, (585) 586-4680.