    [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 69 annual deficits between 1900 and 1996.

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

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

    [[Page 22]]

    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 23]]

    Revenues have stayed relatively constant, at around 17 to 19 percent of
    GDP, since the 1960s. In that time, however, outlays have grown from
    about 17 percent of GDP in 1965 to up to nearly 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 a good 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.

    The Federal interest burden grew substantially in the 1980s, both in actual
    dollars and as a percentage of Federal income tax revenues (see Chart 4-4).
    By 1998, net interest spending will be nearly as much as the Government
    will spend on national defense.

    [[Page 24]]

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

    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 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

    [[Page 25]]

          Chart 4-4. Interest Costs as a Percent of Income Tax Revenues

    private markets over the years, and it determines how much the
    Government pays in interest to the public.

                Table 4-1. Federal Government Financing and Debt

                            (In billions of dollars)
    -----------------------------------------------------------------------------
                                    1996                     Estimate
                                   Actual  1997  1998  1999  2000  2001  2002
    -----------------------------------------------------------------------------
    Federal Government financing:
      Budget deficit (-) or
        surplus                      -107  -126  -121  -117  -87    -36    17
      Other means of financing        -22   -17   -25   -21  -22    -23   -22
                                 -----------------------------------------------
      Borrowing from the public       130   143   146   138  110     59     5
    Federal Government debt:
      Debt held by the public       3,733 3,876 4,021 4,159 4,269 4,328 4,333
      Debt held by government
        accounts                    1,449 1,578 1,715 1,853 2,003 2,157 2,319
                                 -----------------------------------------------
       Gross Federal debt           5,182 5,454 5,736 6,013 6,272 6,485 6,653
      Debt subject to legal limit   5,137 5,411 5,697 5,973 6,233 6,447 6,615
    ----------------------------------------------------------------------------
    Note: Numbers may not add to the totals due to rounding.

    [[Page 26]]

    Debt held by the public was $3.7 trillion at the end of ~1996--roughly the net
    effect of deficits and surpluses over the last 200 years. Debt held by the
    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 1996, it totaled $5.2 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 was 50 percent of GDP at the
    end of 1996. As a percentage of GDP, debt held by the public was highest at
    the end of World War II, at 111 percent, then fell to 24 percent in 1974
    before gradually rising to current levels.

    That decline, from 111 to 24 percent, occurred because the economy grew
    faster than the debt accumulated; debt held by the public rose by amounts
    ranging from $242 billion to $344 billion in those years, but the economy
    grew faster.

    Individuals and institutions in the United States hold over 70 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

    [[Page 27]]

    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.

    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 $107 billion in 1996, and by two-thirds as
    a share of GDP, to 1.4 percent. Now, as you will see in the next chapter, the
    President wants to finish the job by balancing the budget over the next five
    years.