President Biden is proud of the declining budget deficit under his watch. But lucky timing will turn against him if he runs for a second term in 2024.
The Congressional Budget Office updated its 10-year budget outlook on May 25, and the short-term news is encouraging. The federal budget deficit will drop from $2.8 trillion in 2021 to around $1 trillion this year, and to a bit less in 2023. That’s a better forecast than CBO’s 2021 outlook. The improvement reflects a sharp increase in government tax revenue resulting from a strong recovery from the COVID recession of 2020. Government spending is also down sharply this year as the final batch of COVID stimulus, passed last year, runs out.
The longer-term outlook is pretty horrible, however. All the structural problems with the U.S. fiscal situation remain. Spending on Medicare, Social Security and other “entitlement” programs will continue to rise as a percentage of federal outlays, as the population ages and health care costs continue to rise. That will leave a shrinking portion of money for “discretionary” spending on infrastructure, transportation, aid programs and many other things, including defense, even with the infrastructure law Congress passed last year.
The most ominous change is ballooning federal outlays on interest payments, given that inflation is much higher than it was last year and interest rates are rising as a result. Net interest payments in 2021 were $352 billion, or a manageable 5.2% of all outlays. By 2032, CBO expects net interest payments to triple to $1.2 trillion, which would be 13.4% of all outlays. That’s money the Treasury will be paying to bondholders just for the right to borrow. It won’t finance anything for taxpayers and will leave even less money for other programs.
Debt analysts have warned for years that the U.S. budget imbalance is unsustainable, but many predictions of disaster haven’t happened (yet). In theory, a debt crisis could occur if investors buying Treasury securities, which finance the government’s debt, start to think the United States is in over its head, and demand higher interest rates for what they perceive as a growing risk of buying Treasuries. That could trigger a debt spiral in which borrowing costs rise further, leaving Washington short of money for critical functions.
There are solutions. If the government had to, it could either slash spending or raise taxes to narrow a debt gap that got too large. But that would probably cause a recession, and perhaps a bad one. Congress typically provides trillions of dollars in deficit-financed aid during recessions, but if it’s a recession triggered by a debt crisis, Congress might not be able to do that.
But don’t worry! Nothing like this has happened yet because the global demand for Treasuries seems to be bottomless, and investors don’t seem to have any worries at all about Washington repaying its debts. The United States has one huge thing going for it, which is that the dollar is the world’s favorite currency, which makes dollar-denominated U.S. debt supreme to most other forms.
A time bomb
But if the CBO forecasts are in the ballpark, the magnitude of those interest payments is going to become a big political problem, at a minimum. The mushrooming national debt, now $30.4 trillion, is the ultimate boiling frog, an incrementally worsening time bomb that nobody wants to deal with today but everybody will have to deal with if or when it blows. Nobody knows when the pressure to do something will become irresistible, but it’s hard to imagine deficits and the overall debt can grow indefinitely, as a portion of the economy, without requiring fiscal or political intervention.
In CBO’s forecast, net interest payments will equal the amount spent on defense in 2029, and they will be 20% more than the defense budget by 2032. Net interest payments would be 51% more than Medicaid spending in 2032, and roughly equal to all non-defense discretionary spending. This seems, I don’t know … crazy? Could we really spend more on interest payments than we do on the Pentagon every year?
Biden has personally taken credit for the big drop in spending this year, and the stark improvement in the annual deficit, calling it “the biggest decline in a single year in American history.” His budget director, Shalanda Young, hailed the May 25 CBO report as evidence of a “strong economic recovery, powered by President Biden’s economic and vaccination policies.” Meh. Budget experts say the improving deficit is almost entirely due to the end of fiscal stimulus passed in 2020 and 2021, some under Trump and the rest under Biden.
The deficit matters, even now, because Democratic Sen. Joe Manchin of West Virginia is insisting on some form of deficit reduction if there’s ever going to be a revival of Biden’s “build back better” legislation, which died late last year when Manchin said he couldn’t vote for it. Democrats have promised a streamlined version, but that was supposedly due by Memorial Day, and BBB lite is nowhere to be seen. Yet Manchin still says a climate, energy and deficit-reduction bill could pass this year, with every Democratic vote in the Senate. Biden, dogged by inflation and a gloomy national mood, could certainly use the win, even if it’s a shadow of the bill Biden wanted originally.
Biden might get another year or so to crow about falling deficits. But the mid 2020s are shaping up as crunch time for the spending-revenue mismatch. Medicare is likely to start running short of money in the next few years, requiring more funding, benefit cuts or a combination of both. And the higher interest rates go, the sooner federal interest payments will gobble up taxpayer funding. No president wants to have to deal with the budget mismatch, but the next president may be the one who has no other choice.