Wall Street Journal: Why Trillion-Dollar Deficits Could Be the New Normal

August 07, 2018

Article by Nick Timiraos in Wall Street Journal

Trillion-dollar deficits are coming back to Washington, and this time they could be here to stay.

In 2009, deficits swelled after the economy contracted sharply. Unemployment soared, revenues plunged and the government boosted spending to cushion the shock. Deficits reached nearly $1.5 trillion, or 10% of gross domestic product. They didn’t fall below $1 trillion until 2013, when growth improved and policy makers approved tax increases and spending curbs.

What’s different about the current situation: The economy is humming. Output expanded at a 3.1% annual rate during the first half of the year.

Federal spending is outpacing revenues, however, because Congress and President Trump approved measures to cut taxes last year and boost outlays earlier this year.

Deficits are helping to boost growth by pumping money into the economy, but they could come with long-run costs. Buyers of government debt could demand higher yields to soak up the supply of bonds issued, constraining growth in the future. Moreover, big deficits during good times could leave future policy makers less willing to support the economy during the next downturn.

The Treasury Department estimates it will issue $769 billion in debt this quarter and next, a 63% increase over the same six-month period last year. The White House projects deficits will run above $1 trillion, for the year that begins in October, up from $666 billion, for the year ended Sept. 30, 2017.

“Gigantic deficits are not good, and we’re going to run, as a share of GDP, 4%, 5%,” said Lawrence Kudlow, director of the White House National Economic Council, at a conference hosted by CNBC last month.

In the postwar period, the U.S. has run deficits of at least 5% of GDP only after the two recessions in which unemployment reached 10%, in 1983 and 2009.

The Trump administration’s budget submitted to Congress earlier this year would bring deficits under $1 trillion by 2022. It relies on two assumptions.

The first is that the economy expands at a 3% rate not just for one year or two, but for the next decade. 

Most professional forecasters, including at the Federal Reserve and the Congressional Budget Office, believe the economy will return to a growth rate a little below 2% after the initial boost from the tax cuts and spending increases fade after next year. That’s in part because the population is growing slowly and productivity growth is soft.

Fiscal stimulus “is going to hit the economy in a big way this year and next year, and then in 2020, Wile E. Coyote is going to go off the cliff,” former Fed Chairman Ben Bernanke said at a conference in June.

The White House projections also don’t account for hard-to-predict but inevitable recessions, which would send deficits higher.

The Trump administration’s projection of declining deficits also count on large cuts in spending, mostly after President Trump’s current term in office ends. The White House has proposed to reduce federal funding of non-defense programs, which include research, education and housing, to their lowest levels as a share of the economy since World War II.

Lawmakers in both parties have shown little appetite for such curbs.

“In the last three years, Congress has passed bills that raised the discretionary spending caps, completely undermined the spending caps, reversed Medicare cost controls and reduced revenues without cutting spending,” said Paul Winfree, who served last year as a budget adviser to President Trump and is now at the Heritage Foundation, a conservative think tank.

If either the optimistic growth assumptions or the ambitious spending cuts don’t materialize, trillion-dollar deficits could be here to stay. The Trump administration’s fiscal projections account for extending certain tax cuts set to expire next decade for individuals, but not others for businesses. Extending those would further reduce federal revenues.

Other challenges loom, including retiring baby boomers. In June, trustees for the Social Security program said its costs will exceed its income this year for the first time since 1982, forcing the program to dip into its nearly $3 trillion trust fund to cover benefits.

Meantime, Democrats are looking at how GOP lawmakers turned from deficit foes under President Barack Obama to supporters after President Trump’s election to conclude they, too, should worry less about tapping the public purse to pay for new health care, education and infrastructure initiatives.

 “The idea that somehow there are no costs to that, that we’re going to learn that the laws of math have been repealed…is very unlikely,” former Treasury Secretary Timothy Geithner told reporters last month.

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