Analysis and Implications of U.S. Budget Deficit at $1 Trillion

By the Curmudgeon



Executive Summary:

The U.S. government's budget deficit ballooned to nearly $1 trillion in fiscal year 2019, a $205 billion increase from a year earlier and its highest level in seven years. The deficit grew $205 billion, or 26 percent, in the past year and is up nearly 50 percent since Trump took office. 

The actual deficit number was $984 billion but would’ve been OVER $1 trillion had it not been for the additional revenue from President Trump’s tariffs on trading partners like China, which brought in more than $70 billion into the government coffers.  For comparison, the U.S. budget deficit was $665 billion in fiscal 2017.

As a share of economic output, the budget deficit was 4.6% in fiscal 2019, up from 3.8% in 2018, the U.S. Treasury said. Revenues as a share of gross domestic product fell last year, to 16.3% from 16.4% in the previous fiscal year, while federal outlays surged, to 20.9% of GDP from 20.2% the previous year.

Years of sustained budget deficits have led the U.S. Treasury to steeply increase borrowing in recent years. The government has said it expects to borrow more than $1 trillion for the second year in a row in 2019.  See below for the impact of U.S. interest payments on the exponentially increasing national debt.

The annual federal budget shortfall is the largest since 2012, when the unemployment rate was twice as high - topping 7 percent - and the economy was emerging from the worst financial crisis since the Great Depression.  America's fiscal imbalance has increased for four consecutive years despite a sustained period of economic growth during that time. 


So how did the U.S. budget deficit increase so much with no recession?  Blame it on federal government spending and, to a much lesser extent, the 2017 GOP tax bill!

President Trump has endorsed big spending increases and steered most Republicans to abandon the deficit obsession they held during the Obama administration.  For example, military spending has risen dramatically under Trump, from about $550 billion annually to more than $700 billion in 2019, and Democrats successfully pushed for increases to other parts of the budget in exchange for their support to boost money for defense.

Victor and I touched upon this astonishing dynamic of the budget deficit increasing during an economic expansion.  In a post titled, “Bond Vigilantes and Deficit Hawks are Extinct; Stocks love DEBT!”  we wrote:  “Deficit hawks would not have tolerated the budget busting GOP tax bill in late 2017 that has produced a budget deficit this fiscal year that will approach or slightly exceed $1 trillion!”

Budget deficits typically decrease a lot during economic expansions as tax revenue increased since households earn more money and corporations make higher profits.  Also, fewer people use safety net programs like unemployment benefits and food stamps so government welfare payments decrease. The United States entered its longest expansion on record in July and the jobless rate is at a 50-year low, yet the budget deficit has continued to widen.

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Republicans, who in years past have shut down the federal government in their quest to cut spending, have enabled the increases that are exacerbating the deficit.  In August, the Republican controlled Senate gave final approval to a two-year budget deal that raised federal spending by hundreds of billions of dollars and allowed the government to keep borrowing money. Democrats reluctantly agreed to President Trump’s demands on military spending in order to satisfy their desire to bolster spending on social programs. Twenty-eight Republicans joined with Democrats to send the bill to Trump’s desk where he signed it into law.

Former fiscal policy/deficit hawks such as Mick Mulvaney, Mr. Trump’s acting chief of staff, quietly lamented that agreement as a fact of life in a divided government. What a contrast! During the Obama administration Mulvaney held “Spending, Debt and Deficit” town hall meetings and repeatedly criticized lawmakers of both parties for increasing the deficit, including through funding relief for Hurricane Sandy (the strongest, deadliest and most destructive hurricane of the 2012 Atlantic hurricane season. Inflicting nearly $70 billion of damages).

Since becoming President, Trump has endorsed big spending increases and steered most Republicans to abandon the deficit obsession they held during the Obama administration.  That is why we wrote (in the above referenced Curmudgeon post) that “deficit hawks are extinct

Trump administration officials did not defend the steep increase in the budget deficit.  Instead, they cast blame on Congress for not doing more to reduce expenditures. Treasury Secretary Steven Mnuchin called on lawmakers “to cut wasteful and irresponsible spending.” But neither Trump nor Congress has done much to cut spending in recent years, with Trump repeatedly backing away from his own budget proposals. Trump has also demanded new spending on the military and for a border wall. He has recently told aides that he will focus on cutting spending if he is elected to a second term next year.

Budget experts also say the 2017 GOP tax bill (a tax cut for business, but a huge tax increase for people living in high tax states like CA or NY) has led revenue to come in lower than they normally would during an economic expansion.  Tax revenue remained roughly flat the first year the law was in effect, despite economic growth of nearly 3 percent. Tax revenue was modestly higher in fiscal 2019, aided in part by a 70 percent increase in tariff revenue as noted above.

Most alarming is that non-controllable government outlays are increasing at a relatively fast pace. Mandatory allocations, which include Medicare and social security payments, are growing amid an aging population and with one of the world’s least efficient health-care systems. Interest payments are also adding up, now comprising about 8.4% of total outlays.

America’s expanding federal deficit is an anomaly among developed nations around the world. Nearly all other advanced-economy countries are on track to see their debt shrink as a share of their economy over the next five years, according to the International Monetary Fund.

Other Voices:

The mounting red ink has raised a new round of alarm bells from deficit watchdog groups and politicians, whose warnings have long gone unheeded in Washington.  Here are a few quotes:

“This administration came into office talking about reducing deficits, and the results have been the exact opposite. The current levels of debt are unprecedented in peacetime during a growing economy, and the consequences of this irresponsible spending are unknown,” said G. William Hoagland, senior vice president at the Bipartisan Policy Center.

“This is the first time in our history that we are seeing a boom in the economy at the same time deficits are rapidly rising. It’s alarming,” said Marc Goldwein, senior policy director of the Committee for a Responsible Federal Budget, which supports reducing the deficit.

“Our nation’s leaders are in debt denial, running up red ink all while ignoring trillions of dollars in shortfalls for Social Security, Medicare, and other programs that many millions of Americans rely upon," said Mitch Daniels, co-chairman of the Center for a Responsible Federal Budget. “We are at a turning point — without action now to phase in reforms over the coming years, Americans will face a much different future than the one that was promised.”

Leon Panetta, a former budget director under President Bill Clinton and CIA Director under President Obama, said in a statement issued by the Committee for a Responsible Federal Budget (where he is co-chair): “Instead of getting our fiscal house in order and preparing for the next downturn, our leaders continue to binge on debt-fueled tax cuts and spending hikes rather than showing the leadership necessary to set our fiscal path.”

“There is very little discussion among Republicans about the deficit and virtually no serious outreach to Democrats for any sort of bipartisan deal,” said Brian Riedl, a budget expert at the Manhattan Institute, a libertarian-leaning think tank, and former chief economist for Sen. Rob Portman (R-Ohio). “The parties are not talking on this issue.”

Wyoming Senator Mike Enzi (a Republican) who leads the budget committee, called the country’s fiscal path unsustainable and said spending must come down. He said in a statement: “While the federal government’s revenue continues to grow, spending is growing twice as fast. We simply cannot afford to continue ignoring the fiscal challenges our nation faces.”

“In order to truly put America on a sustainable financial path, we must enact proposals—like the president’s 2020 budget plan—to cut wasteful and irresponsible spending,” Mr. Mnuchin said in a statement.  Does anyone believe that will really happen?

What’s Next?

The 2017 tax legislation is projected to increase the annual deficit by about $200 billion, or close to $2 trillion over 10 years when factoring in interest payments, according to the nonpartisan Congressional Budget Office.  The GOP tax-cut package is estimated to cost $1.5 trillion over a decade, with few economists outside the administration expect it will continue to fuel growth. The budget deficit -- which has little precedent at these super high levels outside recessions or wartime -- is set to widen further as spending increases for mandatory programs and interest payments.

Overall spending is projected to rise by about 16 percent between 2017 and 2020, largely because of bipartisan deals struck by Congress, including a 2018 law that lifted spending limits and disaster relief funding, according to the Committee for a Responsible Federal Budget.

By 2029, the national debt is projected to reach its highest level as a share of the economy since the immediate aftermath of World War II. 

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Fears of trillion-dollar deficits could renew the desire of Republicans in Congress to propose cuts to social programs, like food stamps, Social Security and other safety net benefits. Republicans have long pointed to swelling deficits as a reason to pursue their long-held vision of smaller government, including undoing many of the programs ushered in during the New Deal and Great Society to help the most disadvantaged Americans.

Budget experts have warned that a lack of focus on reducing the budget deficit could make it much harder for the U.S. government to respond to the next economic crisis. That’s because policymakers will have less flexibility to enact new spending programs if they are devoting hundreds of billions of dollars to interest payments on the national debt.  The federal government spent approximately $380 billion in interest payments on its debt last year, almost as much as the entire federal government contribution to Medicaid.  Interest payments on the debt will be much larger this year with the higher deficit and will truly explode higher if interest rates rise to just the average level of the past 50 years.

Federal Reserve Chairman Jerome Powell is concerned about the ballooning amount of U.S. debt.  At a January 2019 speech at The Economic Club of Washington, D.C. he said, “I’m very worried about it.  It’s a long-run issue that we definitely need to face, and ultimately, will have no choice but to face.”  

Powell told the Senate Banking Committee in testimony this February, "The U.S. federal government is on an unsustainable fiscal path.” He then noted that “debt as a percentage of GDP is growing, and now growing sharply... And that is unsustainable by definition. We need to stabilize debt to GDP (ratio). The timing the doing that, the ways of doing it —through revenue, through spending — all of those things are not for the Fed to decide.”


At some point this author believes unchecked budget deficits will become a big problem, because the national debt will reach a tipping point where it can’t be easily financed. That will cause much higher interest rates, which will crowd out borrowing by consumers and businesses and that could lead to a severe recession.  At the same time, foreigners will be wary of U.S. government debt and go on a buyer’s strike.  They could even sell their massive holdings of U.S. debt which would cause a crash in the U.S. dollar and potentially end its role as the world’s reserve currency.

It’s hard to believe I still cling to this view which was mainstream in 1981-1982 when budget deficits started to increase rapidly under President Reagan.  The day of reckoning has not yet come yet, but it will sometime in the future.

Closing Quote:

In the previously referenced Curmudgeon post, Victor concluded as follows:

“All the empirical experience points to the long run (5-10 years) as the debt timeframe to worry about. In the short run, debt and deficits apparently do not matter but it certainly looks like a ticking time bomb!”


 Good luck and till next time……

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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