The President charged his bipartisan fiscal commission with making recommendations late this year to put the federal budget on a more sustainable path, including what is known as “primary budget balance” by 2015. This means the budget would be balanced except for interest payments on the federal debt. At that point, the nation’s economic growth would only need to keep up with interest rates in order to stabilize the debt. Most economists consider total deficits of around 3 percent of the Gross Domestic Product to be economically sustainable. The administration last week estimated the primary deficit for the current fiscal year at nearly $1.29 trillion, compared to a $1.47 trillion deficit figure when interest payments are included.
Not all deficits are created equal. They can be grouped into two major categories: cyclical and structural. A recession drives down government revenue because many workers and businesses are no longer earning income that the government can tax, or at least their income has dropped. At the same time, government spending rises because more people need assistance through programs such as Medicaid, unemployment benefits and health insurance subsidies. The result is a temporary, or cyclical, deficit. Once the economy recovers, tax revenue and government spending on assistance programs return to normal levels.
In contrast, a structural deficit reflects a chronic problem. If government spending exceeds tax revenue even when the economy is strong, then the deficit is structural. Structural deficits must be addressed through major changes in tax and spending policies, notably for entitlement programs that claim a large percentage of the federal budget. With structural deficits, one-time spending cuts or temporary tax increases will not solve the problem.
The United States currently faces both a cyclical and a structural deficit. The cyclical deficit is caused by the financial crisis and severe recession from which the country is still recovering. The structural deficit reflects the chronic mismatch between government revenue and spending that under current policies will dramatically worsen as health care costs rise and the population ages.