by Satya B. Dutta, Ph.D.
Satya B. Dutta, Ph.D., is a professor of economics at the College for Financial Planning in Denver, Colorado. Dutta received his master's and Ph.D. degrees in economics from Clark University in Worcester, Massachusetts. He can be reached at (303) 220-4843 or at satya.dutta@cffp.edu.
According to the Congressional Budget Office (CBO), for fiscal year 2010-2011, there will be as much as a $1.6 trillion deficit. How did we get here?
Deficits are nothing new for the U.S. federal budget. Since 1970, the budget was in deficit all but four years. The dramatic turnaround in the deficit picture that occurred between 1996 and 2001 resulted from a nearly a 50 percent increase in taxable income-about a third of which came from a booming stock market. From 1991-2000 taxable capital gains income increased from just over $100 billion to more than $630 billion, effectively turning a $300 billion deficit in 1992 into a $236 billion surplus in 2000.
However, in 2000 things began to shift. After reaching its peak in March 2000 (12,000 on the Dow Jones, 5,000 on the NASDAQ), the stock market began a two-and-a-half year decline, cutting taxable capital gains by more than half. When President George W. Bush took office, the economy was in a recession. He delivered on a promised tax cut in the spring of 2001 that further diminished revenues. The attacks of September 11 resulted in a vast increase in government spending for reconstruction, military, and homeland security. More tax cuts, uncontrolled federal spending unrelated to defense, and wars in Iraq and Afghanistan further increased the deficit, which by 2005 deficit was more than $239 billion.
The 2008 tax cuts and the weakening of economy in early 2008 further swelled the deficit, resulting in predicted deficits of $500 billion to $600 billion. Then the bottom dropped out of the financial sector in 2008, creating four strains on the deficit. First, because of the prolonged recession and rising unemployment, tax revenue fell. Second, the recession and unemployment caused increased government spending for unemployment compensation, Medicaid, and other welfare spending. Third, to rescue the U.S. financial institutions and to prevent a global financial crisis, a $750 billion Troubled Asset Relief Program (TARP) was appropriated. Faced with these strains, a month after being sworn in, President Obama signed a $787 billion stimulus package. These additional spending initiatives added to the deficit, which is now projected to be $1.6 trillion for fiscal year 2010-2011.
Economists debated the merits of the stimulus plan. Advocates of the Obama plan argued that increased government spending was better than reduced taxes. This is because, according to standard Keynesian theory, the government expenditure multiplier exceeds that of the tax multiplier. They argued that increased spending on schools, roads, highways, and other infrastructure needs was the better way to create jobs and increase aggregate demand.
Other economists were more skeptical. One concern was that spending on infrastructure would take time, whereas tax cuts could occur immediately. The CBO estimated that only about 10 percent of the outlay would take place in the first nine months of 2009, and a large fraction of spending would be years away. By the time much of the stimulus went into effect, they argued, the recession might well be over.
The Great Recession of 2007-2009-the longest since the Great Depression-is now over. According to the National Bureau of Economic Research, the recession ended in the third quarter of 2009 when the GDP started growing again. In the third and fourth quarters of 2009, GDP grew at the annual rate of 2.2 percent and 5.6 percent, respectively, and in the first quarter of 2010, the GDP grew at an annual rate of 3.2 percent.
Some economists credit the stimulus program for this turnaround. The program, originally estimated at $787 billion but later re-estimated at $862 billion, will continue to pump federal money into the economy well into 2011. While some say that the stimulus program is a huge waste of money, others, including the CBO, credit the program with creating close to 3 million new jobs. And while the unemployment rate remains high, it is falling rather than rising, dropping to 9.7 percent in May from 9.9 percent in April.
