Promises, Promises
Subject Budget deficits and surpluses
Topic Fiscal Policy
Key Words Fiscal Policy, Budget Deficits, Federal Debt, Tax Revenues
News Story

Differences in government expenditures and tax collections determine budget deficits and surpluses. Future changes in the budget deficit or surplus depend importantly on commitments the federal government has made as far as benefit levels of federal programs, as well as on tax collections. Peter Fisher, the U.S. Department of the Treasury's undersecretary for domestic finance, estimates the current value of these commitments to be $20 trillion in excess of projected revenues.

Since 1985, the Social Security Trust Fund has collected more payroll taxes than it has paid out in retirement benefits. However, the accumulated surpluses in the Social Security Trust Fund are largely the result of the number of participating baby boomers resulting from the increase in births that occurred after World War II. These baby boomers are now between 45 and 60 years old, their peak earning years, but will, within a short period of time, be retiring. As they do, the Social Security Trust Fund will shift from producing surpluses to deficits and the deficits will increase considerably. Social Security benefits are currently about 4 percent of Gross Domestic Product (GDP) and they are forecast to increase to over 5 percent by 2080. The problem with Social Security is that there will be fewer workers for each Social Security recipient and tax receipts will fall.

Medicare/Medicaid costs, currently about 8 percent of GDP, are projected to almost triple in the next 80 years. The aging of the population, the rise in health care costs and the advances in medical technology and lifetime expectancy are important factors explaining this increase.

With budget deficits projected to rise precipitously, the logical solution would be to either raise taxes, cut benefits or lower costs. President Bush, however, wants to hold federal taxes to 19 percent of GDP and has spoken repeatedly of the need to reduce marginal tax rates to improve long-run economic growth. Analysts estimate that taxes, fixed at this level, will be insufficient to cover expenditures at current benefit levels. Reducing benefits is an option that is generally not discussed, nor has there been serious discussion of cutting health-care costs. The Administration believes that economic growth will help solve these problems.

(Updated January 2, 2003)


Suppose that these forecasts are accurate and budget deficits grow. What happens to the federal debt? How does the federal government finance these deficits?

2. Define the term "crowding out."
3. If the federal government needs to increase its borrowing substantially, what is likely to happen to interest rates? What is the impact of higher interest rates on economic growth?
Source David Wessel, "U.S. Promises Are $20 Trillion in the Hole," The Wall Street Journal, November 21, 2002.

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