November 6, 2020
Read time : 21 min

The US federal deficit has been a hot topic in the news lately. There have been headlines about the deficit hitting $3.2 trillion in 2020 in the wake of the COVID-19 pandemic and political pundits talking about the deficit equalling the economy for the first time since World War II. And while all of that sounds impressive and slightly scary, wouldn't it be great to know what that actually means? 

What is the federal budget deficit?

It seems like the US deficit is constantly in the news, but it can be hard to cut through the noise and understand what exactly the deficit is and why the average American should even care. On this page, discover what the deficit is, how it happens, why it matters, how it affects the US debt, and, most importantly, how it affects the US consumer. Also, explore what you can do to learn more about the US deficit and take an active role in fiscal policy in the United States.

The federal budget deficit is an estimate of how much money the federal government expects to make (revenue) and how much it expects to spend (expenditures or outlay) each fiscal year. In the United States, like in many countries, revenue comes from taxes that are placed on individuals and corporations, as well as customs duties and tariffs. Public expenditures include things like defense, transportation, unemployment, and social welfare payments, and healthcare.

The US government’s fiscal year begins on October 1 and ends on September 30. When government expenditures exceed government revenues within a fiscal year, it results in a US deficit. A deficit can be the result of an increase in spending beyond the amount of money available in the budget, also known as deficit spending. However, a federal deficit can also be the result of tax cuts, which cause a decrease in revenue for the government.

So how does a government spend more than it makes? In the consumer world, we often pay for things that we need or want right now but can’t quite afford by borrowing from a bank or another lender and then paying the money back with interest over time. The government does the same thing. The government finances the operation of its various agencies by issuing savings bonds, Treasury bonds, and securities. Tax revenues are then used to pay for those bonds when they mature. Investors, such as banks, foreign governments, and individuals, can also cash in on the bonds when they mature.

When the government can’t meet its obligations, it issues more debt. The debt ceiling is the maximum amount of money that the Treasury is authorized to issue by Congress. For the last several years, Congress has been raising the debt ceiling every year to finance deficit spending, and it is beginning to take its toll on the US economy.

Budget surplus vs. budget deficit

While the US deficit is often in the news, there have been years when government spending is lower than government revenue. This is called a budget surplus, and it can be the result of reduced government spending or from tax increases. A budget surplus removes money from the current economy to pay off sovereign debt.

When Congress is determining fiscal policies that affect ordinary citizens, they have to take into account the amount of the federal deficit or the federal surplus. Both have consequences for people who live in the country, pay taxes, and use government services and programs.

In the short-term, a budget deficit can boost the economy because people have more money to spend and invest. But if the deficit is too high, it can threaten economic growth and lead to increased inflation.

To reverse the effects of a high US deficit, spending needs to decrease or revenue needs to increase. When spending is decreased, this results in reduced services, putting off needed infrastructure projects, and reducing government staff. To increase revenue, the government has to increase current tax rates, impose additional taxes, or add additional tariffs and customs duties.

If the surplus is too high, it can result in an economy that grows too fast, creating deflation and unsustained growth. To reverse the unwanted effects of a high surplus, Congress has to increase spending or decrease taxes. A surplus often results in increased spending on needed services and projects. A surplus can also result in decreased taxes, which drive down the amount of revenue available to the government.

Current US deficit

The Congressional Budget Office (CBO) is reporting a federal deficit projection of $3.3 trillion for the 2020 fiscal year. More specifically, the projected revenues for the year are $3.3 trillion, but projected spending is estimated to be $6.6 trillion.

The current US deficit is not sustainable, and many experts agree that it can have terrible effects on the US economy. Increased borrowing and high deficit spending over the past several years has increased the federal debt to levels beyond the capabilities of our economy as stands today — the interest alone on the current debt is projected to reach $7 trillion in the next decade. 

Current federal interest rate

When someone applies for a credit card with a lot of pre-existing debt, it becomes harder to borrow money because of the high debt-to-income ratio. The government is no different. As the government gets deeper and deeper into debt, it becomes more difficult to borrow more money. And when federal debt increases, it affects the federal interest rate, or funds rate.

The federal funds rate is the target interest rate that the Federal Open Market Committee (FOMC) sets for commercial banks to borrow and lend their excess reserves overnight. The FOMC meets eight times a year to consider the current debt and balance it against the needs of the US economy to determine what the federal funds rate should be. The FOMC bases its decisions on key economic indicators that affect economic growth, such as inflation and recession.

The rate that the FOMC sets can influence the amount of interest the public is charged for consumer loans and credit cards and higher interest rates create a snowball effect on the economy. Debt grows at a faster pace. Consumers spend more on mortgages and other loans, leaving them less money to inject into the economy. Additionally, many government projects that employ the private sector, such as road construction and other infrastructure activities, are slowed or halted.

The current federal funds rate is .09%. The rates were lowered to close to 0% in March of 2020 to help boost the economy that was floundering under the COVID-19 pandemic, and the FOMC has maintained that rate in the hopes that the rate will continue to boost the economy.

Difference between the US deficit and debt

It is easy to be confused about the difference between the federal deficit and the federal debt. In simple terms, the deficit is the difference between what the government spends and what it brings in through tax revenues. The debt is the cumulative debt caused by these deficits over many years. At the end of each fiscal year, any deficit is added to the amount of money the government has borrowed in Treasure bonds, bills, and notes. This money that the government owes is the national debt.

While the national debt is technically a dollar amount, it is more often measured as a ratio of debt to the gross domestic product, or the total value of all of the finished goods and services produced in the country.

In its most recent monthly review, the Congressional Budget Office reported that at the end of the 2020 fiscal year, the national debt will total $20.3 trillion. The projected US deficit is an estimated 15.2% of GDP - the largest deficit since 1945. This is also the fifth consecutive year that the US has had a deficit increase as a percentage of its GDP. The CBO also reported that their estimated revenues were 1% lower, and spending (called “outlays” in the budget report) was 47% higher in 2020 than it was the year before.

The US deficit and COVID-19

While spending was already high at the beginning of 2020, the COVID-19 pandemic caused the US government to spend even more. This resulted in an economic recession that is likely to have long-lasting effects on the US deficit and that has influenced the entire economy, including individuals, corporations, and government agencies at the local, state, and federal levels.

In fact, a recent study from the Center on Budget and Policy Priorities shows that the pandemic has resulted in high rates of hardship for US families, with tens of millions of people suffering from unemployment and struggling to find the means to pay for food and shelter. The impacts on children have been especially difficult.

US businesses have also been hard-hit by the pandemic, and small businesses have paid a particularly high price. Many businesses have had to close their doors. According to a study by the McKinsey Global Institute and Oxford Economics, it could take more than five years for US small businesses to recover from the effects of the pandemic, with many never reopening. Businesses in the arts and entertainment; accommodations and food services; education services; transportation and warehousing; manufacturing; and mining, quarrying, and oil and gas extraction industries are those that are likely to have the longest recovery.

Furthermore, a recent study by the Brookings Institute shows that state and local revenues were heavily hit by the pandemic. State and local governments employ 13% of the nation’s workers, while state and local tax revenues represent 9% of the US GDP. The study shows that the pandemic is projected to create a substantial decrease in local and state income and sales tax revenues. Because local and state economies do not have the luxury of borrowing to finance large deficits, they have to take measures to balance their budgets if they are running at a deficit, which most often results in spending cuts. This poses a particularly difficult dilemma to communities that are being pressed to provide additional public health services and accommodations for social distancing.

To help stimulate the economy and boost the individuals and corporations that were suffering, the federal government enacted several pieces of legislation that approved the spending of trillions of dollars. To pay for this legislation, the Treasury Department had to dramatically increase borrowing, which made both the national debt and the US deficit even higher than it had been. This legislation included the following:

  • Over $8 billion in emergency funding for public health agencies to learn more about the coronavirus and develop a vaccine, which included $7.8 billion for health agencies at the federal, state, and local levels as well as $500 million for Medicare.

  • The Families First Coronavirus Response Act, which loosened restrictions on unemployment benefits, increased Medicaid and food-security spending, and allowed government health programs to provide coronavirus testing free of charge.

  • The Coronavirus Aid, Relief, and Economic Security Act, a $2 trillion relief bill that was passed at the end of March to target the financial industry, big and small businesses, households, and state and local governments.

In a recent interview, Federal Reserve Board Chairman Jay Powell said that another round of spending will be needed to mitigate the chances of a double-dip recession and even more job loss in the United States. While talk has stalled over political disagreements, when Congress finally does come to a decision, the spending will likely lead to even more debt and a larger US deficit. And while this legislation is desperately needed to help mitigate the economic recession caused by the pandemic, it also will contribute greatly to the national debt and the US deficit.

What's the impact and consequences of our federal debt?

The federal debt has a huge impact on the average American. When the national debt increases, everyone has to pay more when they borrow money, which makes things like mortgages and private business loans more expensive. And when people are paying more in interest on debts that they have incurred, that leaves them less money to spend on goods and services and less money to invest in education and retirement.

The national debt directly affects American consumers in four ways:

Increase in the risk of government default

As the government borrows more and increases the amount of money it owes, it also increases the likelihood that it might default on its obligations. When this happens, the Treasury Department has to raise the yield on securities so it can attract new investors, which decreases the amount of money available to spend on other government services. This leads to a decreased standard of living for US taxpayers because the ability to borrow for economic enhancement projects becomes more difficult.

Increase of corporate debt offerings

As US Treasury securities raise their rates, US corporations are viewed as riskier in the global economy, and the yield on new bonds is increased. This means that corporations have to raise their prices to meet the cost of their higher debt, which leads to higher inflation.

Increased cost of borrowing

As the cost of Treasury securities increases, so does the cost of mortgages and other loans that are tied to short-term interest rates and Treasury security yields. Eventually, this leads to lower home prices and a downturn in the net worth of American homes.

Loss of investment

 As the yield on US securities increases, investments in US interests begin to lose their appeal. And as the country starts to look more and more like it might default on its loans, it starts to lose its power socially, economically, and politically.

There are only five mechanisms for the government to reduce the national debt, all of which have a direct effect on US consumers and most of which are politically unpopular. The government can increase taxes, which is politically unpopular and difficult to implement because of all of the special interest groups that will demand tax exemptions for their sector of the economy. Reducing spending is equally unpopular because it cuts programs that people depend on for their comfort and livelihoods, and it also can have a negative multiplier effect, making it more difficult for people to pay their own personal debts. Debt restructuring through interest rate manipulation can help in the short term but doesn’t have long-lasting effects. Monetizing debt can also be a good short-term solution, but when a government prints too much currency, it can quickly lead to inflation or hyperinflation, which come with their own sets of problems. A final option for reducing debt is to default, which can include going bankrupt or restructuring payments to creditors.

What can you do?

The best thing you can do is get educated about fiscal policy and make changes at your college or university with Up to Us. Sign the pledge and let your representatives know that you are concerned about the US deficit and the nation’s fiscal future, or get involved and make a difference in your own community.