Is the United States looking at a balanced federal budget in ten years or, alternatively, a budget deficit equivalent to 2.6 percent of GDP? There is a big discrepancy in the projections that the Trump administration has made regarding the country’s fiscal balance at the end of the decade and those that the Congressional Budget Office released in its July analysis of the president’s 2018 budget.
One key element that explains the divergence is that the analyses are based on very different expectations of U.S. economic growth over the next decade. The Trump administration has based its projections on the expectation that U.S. GDP will grow at a rate of 3 percent per year. In contrast, the CBO expects economic growth to remain modest, averaging only slightly above 2 percent through 2018 and falling below that for the rest of the period.
This matters because the size of the federal budget deficit is tightly linked to how well the U.S. economy is performing. When the economy grows at a faster rate, this raises tax revenues and tends to lower spending on social safety net programs, both of which help to reduce the budget deficit, even with no change in spending or tax policy. During a recession, the budget deficit increases both because this process works in the opposite direction and because the government may undertake tax cuts and spending policies to bolster growth. This is illustrated by an analysis that looked at the deficit projections of the CBO’s January report by economist Michael Klein in a recent EconoFact memo. (See chart. The green line represents the GDP Gap, an indicator of the performance of the economy.)
Large government budget deficits may be warranted at times when the economy is in a downturn in order to stimulate spending and mitigate economic weakness. But large deficits that occur when the economy is at or near its full-capacity raise concerns of increasing costs of borrowing, reduced private capital formation, and potential financial and economic destabilization.