Economy Watch: Federal Deficit Outlook Better—and Worse

It's almost like the beginning of a well-worn joke: there's good news and bad news about the federal deficit.

It’s almost like the beginning of a well-worn joke: there’s good news and bad news about the federal deficit. First the good news: the sky hasn’t fallen yet. In fact, it hasn’t fallen for decades, despite what Democratic critics of Republican administrations and Republican critics of Democratic administrations have said. As a percentage of GDP, the deficit is currently 2.7 percent, according to the Congressional Budget Office, and with the recent growth of the economy—the first quarter notwithstanding—revnues are up for the government, so the deficit will probably end the year lower than that, perhaps 2.4 percent of GDP.

Without many exceptions since the end of World War II (the exceptions being in the 1990s), federal deficits have often been more than that as a percentage of GDP, in fact averaging 2.7 percent from 1965 to 2014. In fact, assuming nothing fundamental changes in current tax policy, monetary policy, or demographics (a risky assumption, but that’s the way the CBO rolls), the budget deficit will decline in 2016 to 2.4 percent of GDP, and then to hold roughly steady relative to the size of the economy through 2018. That’s certainly good compared with recent years. As the recession slowed revenues, the deficit peaked at 9.8 percent of GDP in 2009, and as recently as 2011 it was to 8.5 percent. Those numbers were unsustainable, and sure enough they haven’t been sustained.

Then there’s the less-than-good news: The long-term outlook for the federal budget has changed little since last year, according to CBO’s projections. Federal debt held by the public would will decline slightly relative to the economy’s annual output over the next few years, but after that, however, growing budget deficits—caused mainly by an aging of the population and rising health care costs—will push debt back to, and then above, the current level. Extrapolating into the fairly far future (25 years), the federal deficit would grow from less than 3 percent of GDP this year to more than 6 percent in 2040. At that point, federal debt held by the public would exceed 100 percent of GDP. (Federal debt is now equivalent to about 74 percent of GDP, a higher percentage than at any point in U.S. history except a seven-year period around World War II.)

Moreover, the CBO predicts, in 2040, debt would still be on an upward path relative to the size of the economy. The rising debt can’t be sustained indefinitely; the government’s creditors would eventually begin to doubt its ability to pay its debt obligations, forcing the government to pay much higher interest rates to borrow money. Should that situation come to pass, it would certainly affect other borrowers, such as the real estate industry, and while 25 years seems like an eon in the real estate world, plenty of active real estate pros in 1990 are still in the market.