The alarm bells about the U.S. government’s abysmal finances keep going off. Recently, hedge fund tycoon Ray Dalio warned that Congress is now borrowing more money just to pay for its current debt.
Back in November, the credit rating institute Moody’s lowered their U.S. fiscal outlook to “negative.” This follows Fitch’s downgrade of the U.S. government’s credit status in August.
A look at the latest numbers from the Bureau of Economic Analysis, a statistics agency under the U.S. Department of Commerce, lend a lot of credence to the alarm bells. Their third-quarter numbers for taxes and government spending show that the budget deficit—which was already at $1 trillion per year—is again skyrocketing.
The imbalance between spending and revenue is staggering. In the third quarter, the federal government spent $1,594.6 billion; since January they have spent $4,771.6 billion. This is a 6.1% increase over the same period last year. The current trend suggests that federal government spending in the 2023 calendar year will exceed $6.4 trillion. This compares to $6 trillion in 2022.
On the revenue side, the first three quarters of this year have delivered $3,536.2 billion. Here, though, there is no increase, but a decline of 5.5% from last year’s 3,741.7 billion. With spending and revenue going in different directions, the outcome can only be one:
- Over the whole of 2022, the federal government spent $1,062 billion more than it got in revenue;
- If the trajectories of revenue and spending thus far in 2023 continue through the fourth quarter, spending will exceed revenue by $1,706.2 billion at the end of 2023.
For 2022, U.S. Congress borrowed $17.60 of every $100 they spent; in 2023, loans will pay for $26.60 per $100 spent.
With bigger deficits, more credit downgrades and negative outlooks are inevitable. However, the most pressing problem is not the deficit itself, but the debt that the deficits accumulate over time. At the end of the third quarter, the total debt of the federal government amounted to $33.5 trillion, or 124% of annual GDP. Two months later, at the end of November, that debt has increased to $33.9 trillion.
Since November 30th last year, Congress has borrowed a total of $2,465 billion. This is $7.25 billion per day; as the increase in the deficit in the third quarter tells us, things are only getting worse.
Figure 1 puts the trend in the deficit in a broader context. The deficit, measured as share of spending, has gone through three phases over the past 70 years:
Figure 1
The first phase predates the modern American welfare state, which was created with the so-called War on Poverty and President Lyndon Johnson’s ‘Great Society’ project. At that time, limited deficits were interspersed with the occasional budget surplus.
The second phase begins with the implementation of the ‘Great Society’ ambitions to eradicate poverty. As the new spending programs were rolled out, the federal budget went into a permanent deficit. For three decades straight, the 1970s, 1980s, and 1990s, deficits continuously paid for 10-20% of federal spending.
There was a brief pause from budget deficits in the late 1990s, courtesy of President Clinton, a Democrat, and the Republican majority in Congress. This pause ended with the brief millennium recession, after which President Bush Jr. presided over a return to chronic budget deficits. However, unlike the second phase, the deficit has kept growing since then. After every recession (including the artificial shutdown during the pandemic) the deficit improves again. Those improvements get weaker and weaker—and the deficits get bigger and bigger.
This is symptomatic of a deeply entrenched structural fiscal problem that can only be addressed with deep, structural fiscal reforms.
One of the few remedies regarding U.S. public finances is that not all of the government spending falls under the jurisdiction of Congress. The states and local governments are responsible for a sizable portion as well. In 2022, the 50 states, their counties, cities, and other local government entities took in $3,662.5 billion in revenue and spent $3,602.1 billion. If current trends prevail, their total tally for 2023 will be $3,627 billion in revenue and $3,783.2 billion in spending,
In total, the states and the local government are considerably more fiscally responsible than the federal government. This does not really help Congress, from which the states are jurisdictionally independent, but it does illustrate that fiscal responsibility is possible, if the political will is there.
As mentioned, if Congress wants to end its budget deficits, it needs to implement significant structural reforms to its spending. The deficit problem cannot be solved with superficial measures, including different versions of the so-called ‘penny plan’ where spending is allowed to grow more slowly under a penny-on-the-dollar plan.
Tax increases are also ruled out, at least as a measure to reduce or eliminate the budget deficit. However, there is no doubt that the federal government needs a new tax system: the current model is volatile and relies on an unsustainably narrow tax base. A total of 84% of the federal government’s revenue comes from taxes on personal income:
- The ‘normal’ income tax accounts for 45.3% of total federal tax revenue;
- Taxes for Social Security and related programs bring in 38.6% of total federal tax revenue.
The corporate income tax is responsible for 9.2% of revenue, with other taxes—such as import duties and the gasoline tax—accounting for the rest.
In addition to the dependency on personal income for tax revenue, the federal government also concentrates much of its taxation to the highest-earning 20% of taxpayers. They pay, on average, two thirds of all of the federal government’s tax revenue.
A comprehensive, structural spending reform, followed by an equally comprehensive tax reform, would end the U.S. government’s seemingly inevitable slide into a fiscal crisis.
