Our deficits may finally be coming home to roost

With a new Congress set to take office, the most recent projections have the U.S. budget deficit reaching nearly $1 trillion in 2019, or more than double the level of 2015.

The deficit is a perennial topic of discussion for politicians, reporters, pundits and economists, yet many people have difficulty understanding why it’s a problem.

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Spending more than we take in sounds irresponsible, but how does the deficit actually impact the life of average Americans? The downside is especially hard to see when deficit spending generates immediate benefits, while the costs occur well into the future.

The recent debt default in Greece, along with the lingering deficit crisis in Italy, has highlighted the danger of excessive public borrowing. Those countries lack their own currency, however, which makes their situation very different from that of the United States.

The fact that our government is able to print money means that outright default is extremely unlikely; rather, the cost of excessive borrowing shows up in more subtle ways.

These costs can, for example, show up in the form of some combination of inflation, tax increases and spending cuts. Given the political difficulty of cutting popular entitlement programs, future tax increases are more likely than spending cuts. This option imposes a burden on the private sector of the economy.

Excessive budget deficits might also lead to higher future inflation — itself a sort of tax. However, the Fed is committed to a 2-percent inflation target, thus future tax increases again seem the most likely outcome of deficit spending.

Another danger is that of deficits leading to higher interest rates, which slow the rate of capital formation, a concept called the “crowding out” of investment.

Pundits have been complaining about deficits for decades, so why haven’t we already paid the price in one form or another?

It turns out that the U.S. government has been a bit less irresponsible in the past than advertised. While we run deficits during most fiscal years, they have not been large enough to push the national debt to the sorts of levels seen in Greece, Italy and Japan, which have even larger public debts as a share of national income.

As with the boy who cried wolf, the public is becoming numb to the constant warnings about a debt crisis.

Today, however, there really is reason to be concerned about the budget deficit.

For the first time in history, America is seeing its budget deficit rise dramatically higher during a period of peace and prosperity. While there have been even bigger deficits on occasion — measured as a share of GDP — they were always associated with a temporary situation such as war or high unemployment.

The deficit would then shrink sharply when the economy returned to normal. The current situation is unusual because the deficit has been soaring dramatically higher even as unemployment has fallen to the lowest level since the 1960s (3.7 percent).

Unsustainable budget deficits can be seen as a sign of political dysfunction. The United States last ran budget surpluses during 1998-2001. These surpluses created fiscal space for the politically popular tax cuts and spending increases of the George W. Bush administration.

Because the costs are occurring long after most of that era’s politicians left office, there is little incentive for today’s leaders to make the less-popular decision to re-instill discipline.

Governments have little incentive to run budget surpluses and today seem to be ignoring even the more modest goal of keeping the deficit at sustainable levels.

The economics profession shoulders some of the blame for this situation. Many economists relied on dubious macroeconomic theories to advocate deficit spending during the past recession. This provided a cloak of respectability to large budget deficits.

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When that sort of “fiscal stimulus” later became inappropriate — even according to the sort of Keynesian models that call for deficit spending when unemployment is high — it was difficult to get average people to understand why they should all of a sudden worry about budget deficits.

After all, just a few years earlier, budget deficits were touted as a cure for high unemployment and a spur to growth.

This created a golden opportunity for the current administration to pursue politically popular tax cuts and spending increases once again, while passing the costs on to future generations.

There are no “free lunches” in fiscal policy. All government spending must be paid for by taxpayers, either today or in the future. The burden of deficit spending may show up as an inflation tax, if the Fed opts to monetize the debt.

More likely, the burden will fall on future generations that inherit a smaller capital stock and are faced with paying higher tax rates.

Scott Sumner is an emeritus professor of economics at Bentley University and director of the Program on Monetary Policy at the Mercatus Center at George Mason University.