Don't Fear the Deficit Bogeyman

You would have thought the federal budget deficit had morphed into Dr. Strangelove’s doomsday machine from the howling that followed the publication of the Congressional Budget Office (CBO) projections in August. The Wall Street Journal editors were happy to join in despite assuring readers that they are not deficit-phobic.

But the truth is, government spending and the budget deficit it engendered are what stood between us and an economic doomsday that would have rivaled the Great Depression of the 1930s. In that context, the Obama budget deficits are neither all that big nor all that bad, although they sure could have been better had the spending priorities been more progressive. And even larger deficits could have done -- and still could do -- more to alleviate the economic suffering that continues unabated even as the economy begins to stabilize.

How Big Is It?

Even after correcting for inflation, $1.58 trillion is a record federal budget deficit. But this eye-popping number needs to be seen in context.

A trillion and a half dollar deficit will equal 11.2% of Gross Domestic Product (GDP) for 2009, according to CBO estimates. That too is a record for "peacetime" deficits. The Reagan deficits in their worst year reached 6% of GDP. During World War II, however, military spending pushed the federal deficit to qualitatively different levels, reaching 31.3% of GDP and never dropping below 14.5% during the war years 1942 to 1945.

Whatever its size, before pinning the 2009 deficit on runaway government spending, it’s important to assess how much the collapsing economy contributed to the deficit. Big government bashers like the Journal editors would have you believe that the entire budget deficit was brought on by reckless government spending.

That is hardly the case. The collapsing economy added more to the deficit from 2007 to 2009 than any other factor. As economic activity dried up, personal and corporate income tax revenues plummeted: this year government revenues will drop to 14.9% of GDP, their lowest level since 1950. Plus, the crashing economy automatically pushed government spending on unemployment insurance and food stamps up, further widening the deficit. Even the financial-sector bailout and the Obama stimulus package taken together did less to swell the deficit than the economic collapse did.

To control for the effect of the business cycle on the budget deficit, economists look at the so-called standardized, or cyclically adjusted, deficit—the deficit that would occur if the economy was always operating at the peak of the business cycle, in other words, at its "potential GDP." Standardized deficit figures indicate that the 2009 budget is highly stimulative but hardly disproportionate to the economic emergency it confronted. In 2009 the cyclically adjusted deficit will reach 8.6% of potential GDP, and then shrink to 3.4% by 2011, according to CBO estimates. The previous high was 4.7% in 1986 (with data back to 1962), in the midst of the “borrow and squander” Reagan years when the only emergencies facing the nation were the desire of the rich for a tax cut and the drive to expand cold-war military spending. Under George W. Bush, tax-cutter to the rich extraordinaire, the cyclically adjusted deficit reached 3.1% in 2004, the near equal of the projected 2011 figure.

The CBO projected deficits will add $9 trillion in the next decade to the national debt, the cumulative amount of money the government will have borrowed to finance its annual deficits.

That is another frightening number, but it too needs to be seen in context. For instance, publicly held federal-government debt will reach 67.8% of GDP in 2019, according to CBO projections. That number would be the largest ratio of debt to national output since 1952, but still not in the same ballpark as the 120% figure at the end of World War II.