    [A Citizen's Guide to the Federal Budget]
    [4. Deficits and the Debt]
    [From the U.S. Government Printing Office, www.gpo.gov]

    You've probably heard a lot about the Federal budget deficit and debt
    in recent years, primarily because both exploded in size in the 1980s.

    Put simply, a deficit occurs when spending exceeds revenues in
    any year--just as a surplus occurs when revenues exceed spending.
    Generally, to finance our deficits, the Treasury borrows money. The
    debt is the sum total of our deficits, minus our surpluses, over the
    years.

    The deficit is not a new phenomenon; the Government incurred its first
    in 1792, and it generated 68 annual deficits between 1900 and 1995.

    Chart 4-1 provides the history of budget surpluses and deficits since 1940.

    Chart 4-1. Past and Future Budget Deficits or Surpluses

    [[Page 24]]

    For most of the Nation's history, deficits were the result of either
    wars or recessions. Wars necessitated major increases in military
    spending, while recessions reduced Federal tax revenues from
    businesses and individuals.

    The Government generated deficits during the War of 1812, the
    recession of 1837, the Civil War, the depression of the 1890s, and
    World War I. Once the war ended or the economy began to grow, the
    Government followed its deficits with budget surpluses, with which it
    paid down the debt.

    Deficits returned in 1931 and remained for the rest of the decade_due
    to the Great Depression and the spending associated with President
    Roosevelt�s New Deal. Then, World War II forced the Nation to spend
    unprecedented amounts on defense and to incur unprecedented deficits.
    Since then--with Democratic and Republican Presidents, Democratic and
    Republican Congresses--the Government has balanced its books only eight
    times, most recently in 1969.

    Why have deficits become such a perennial problem for budget
    decisionmakers? Because spending has been growing faster than
    revenues.

    Chart 4-2. Outlays as a Percent of GDP

    [[Page 25]]

    Revenues have stayed relatively constant, at around 19 percent of GDP,
    since the 1960s. In that time, however, outlays have grown from below
    18 percent of GDP in 1965 to up to 24 percent in 1983 before falling
    to 21 percent today. Much of the spending growth has come in Social
    Security, Medicare, Medicaid, and interest payments (see Chart 4�2).

    Nevertheless, the deficits before 1981 paled in comparison to what
    followed. That year, the Government cut income tax rates and greatly
    increased defense spending, but it did not cut non-defense programs
    enough to make up the difference. Also, the recession of the early
    1980s reduced Federal revenues, increased Federal outlays for
    unemployment insurance and similar programs that are closely tied to
    economic conditions, and forced the Government to pay interest on more
    national debt at a time when interest rates were high. As a result,
    the deficit soared.

    Why the Deficit is a Problem

    The United States is not alone in struggling with budget deficits. As
    Chart 4�3 illustrates, this Nation has an average record when compared
    to the recent history of six other major developed economies. (To make
    accurate comparisons with the governments of other nations, the U.S.
    data include the activities of State and local governments).

    If budget deficits occur so frequently, here and abroad, should we
    worry about them?

    The short answer is, yes. The deficit forces the Government to borrow
    money in the private capital markets. That borrowing competes with (1)
    borrowing by businesses that want to build factories and machines that
    make workers more productive and raise incomes, and (2) borrowing by
    families who hope to buy new homes, cars, and other goods. The
    competition for funds tends to produce higher interest rates.

    Deficits increase the Federal debt and, with it, the Government's
    obligation to pay interest. The more it must pay in interest, the less
    it has available to spend on education, law enforcement, and other
    important services, or the more it must collect in taxes--forever
    after. Today, the Government spends 15 percent of its budget to pay
    interest.

    As shown in Chart 4-4, the Federal interest burden grew substantially
    in the 1980s. By 1997, net interest spending will be nearly as much as
    the Government will spend on national defense.

    In the end, the deficit is a decision about our future. We can provide
    a solid foundation for future generations, just as parents try to do
    within a family by

    [[Page 26]]

    limiting the amount of debt that they pass on; or we can generate
    large deficits and debt for those who come after us.

    Deficits and Debt

    If the Government incurs a deficit, it must borrow from the public.

    Table 4-1 summarizes the relationship between the budget deficit and
    Federal borrowing.

    Federal borrowing involves the sale, to the public, of notes and bonds
    of varying sizes and time periods. The cumulative amount of borrowing
    from the public--i.e., the debt held by the public--is the most
    important measure of Federal debt because it is what the Government
    has borrowed in the private markets over the years, and it determines
    how much the Government pays in interest to the public.

    Chart 4-3. Total Government Surplus or Deficit as a Percent of GDP

    [[Page 27]]

                Table 4-1. Federal Government Financing and Debt

                            (In billions of dollars)
    ------------------------------------------------------------------------------
                                   1995                     Estimate
            Function              Actual  1996  1997  1998  1999  2000  2001  2002
    ------------------------------------------------------------------------------
    Federal Government financing:
      Budget deficit (-) or
        surplus                    -164   -146  -140   -98   -64   -28     8    44
      Other means of financing       -7    -20   -24   -27   -29   -29   -28   -27
                                 -------------------------------------------------
      Borrowing from the public     171    165   164   124    93    57    20   -17

    Federal Government debt:
      Debt held by the public     3,603  3,769 3,933 4,057 4,151 4,207 4,227 4,210
      Debt held by government
        accounts                  1,318  1,439 1,566 1,693 1,828 1,978 2,133 2,297
                                 -------------------------------------------------
    Gross Federal debt            4,921  5,207 5,499 5,750 5,979 6,185 6,360 6,506

    Debt subject to legal limit   4,885  5,163 5,456 5,711 5,939 6,145 6,321 6,468

    Note: Numbers may not add to the totals due to rounding.

    Debt held by the public was $3.6 trillion at the end of 1995--roughly
    the net effect of deficits and surpluses over the last 200 years. Debt
    held by the

    [[Page 28]]

    public does not include debt the Government owes itself--the total of
    all trust fund surpluses and deficits over the years, like the Social
    Security surpluses, that the law says must be invested in Federal securities.

    The sum of debt held by the public and debt the Government owes itself
    is called Gross Federal Debt. At the end of 1995, it totaled $4.9 trillion.

    Another measure of Federal debt is debt subject to legal limit, which
    is similar to Gross Federal Debt. When the Government reaches the
    limit, it loses its authority to borrow more to finance its spending;
    then, the President and Congress must enact a law to increase the
    limit.

    The Government's ability to finance its debt is tied to the size and
    strength of the economy, or GDP. Debt held by the public exceeded 50
    percent of GDP at the end of 1996. As a share of GDP, debt held by the
    public was highest at the end of World War II, at 114 percent, then
    fell to 24 percent in 1974 before gradually rising to current levels.

    That decline, from 114 to 24 percent, occurred because the economy
    grew faster than the debt accumulated; debt held by the public rose
    from $242 billion to $344 billion in those years, but the economy grew
    faster.

    Individuals and institutions in the United States hold over 75 percent
    of debt held by the public. The rest is held in foreign countries.

    Deficit Reduction Efforts

    Ever since the deficit soared in the early 1980s, successive
    Presidents and Congresses have tried to cut it. Until recently, they
    met with only limited success.

    In the early 1980s, President Reagan and Congress agreed on a large
    tax cut, but could not agree about cutting spending; the President
    wanted to cut domestic spending more than Congress, while Congress
    sought fewer defense funds than the President wanted. They wound up
    spending more on domestic programs than the President wanted, and more
    on defense than Congress wanted. At the same time, a recession led to
    more spending to aid those affected by the recession, and reductions
    in tax revenues due to lower incomes and corporate profits.

    By 1985, both sides were ready for drastic measures. That year, they
    enacted the Balanced Budget and Emergency Deficit Control Act, better
    known as Gramm-Rudman-Hollings (GRH). It set annual deficit targets
    for five years, declining to a balanced budget in 1991. If necessary,
    GRH required across-the-board cuts in programs to comply with the
    deficit targets.

    [[Page 29]]

    Faced with the prospect of huge spending cuts in 1987, however, the
    President and Congress amended the law, postponing a balanced budget
    until 1993. The President and Congress never achieved those revised
    targets, in part because of the extraordinary costs of returning the
    Nation's savings and loan industry to a sound financial footing.

    By 1990, President Bush and Congress enacted spending cuts and tax
    increases that were designed to cut the accumulated deficits by about
    $500 billion over five years. They also enacted the Budget Enforcement
    Act (BEA)�rather than set annual deficit targets, the BEA was designed
    to limit discretionary spending while ensuring that any new
    entitlement programs or tax cuts did not make the deficit worse.

    First, the BEA set annual limits on total discretionary spending for
    defense, international affairs, and domestic programs. Second, it
    created ``pay-as- you-go'' rules for entitlements and taxes: those who
    proposed new spending on entitlements or lower taxes were forced to
    offset the costs by cutting other entitlements or raising other taxes.

    For what it was designed to do, the law worked. It did, in fact, limit
    discretionary spending and force proponents of new entitlements and
    tax cuts to find ways to finance them. But the deficit, which
    Government and private experts said would fall, actually rose.

    Why? Because the recession of the early 1990s reduced individual and
    corporate tax revenues and increased spending that is tied to economic
    fluctuations. Federal health care spending also continued to grow
    rapidly.

    In 1993, President Clinton and the Congress made another effort to cut
    the deficit. They enacted a five-year deficit reduction package of
    spending cuts and higher revenues. The law was designed to cut the
    accumulated deficits from 1994 to 1998 by about $500 billion. The new
    law extended the limits on discretionary spending and the ``pay-as-you-go'' rules.

    Clearly, the President's deficit reduction efforts have paid off. The
    deficit fell from $290 billion in 1992 to $164 billion in 1995, and by
    over half as a share of GDP, to 2.3 percent. Now, as you will see in
    the next chapter, the President wants to finish the job by balancing
    the budget over the next seven years.