How Washington Blew the Budget Surplus to Smithereens

A projected budget surplus turned into record deficits thanks to lawmakers' lack of foresight.


Chad Stone is chief economist at the Center on Budget and Policy Priorities.

In last week's post, I discussed how claims of a bright line between safe and unsafe levels of government debt were recently debunked, illustrating the complex relationship between U.S. debt and economic growth from the end of World War II through the 1990s (with the chart below). This post picks up the story in 2001.

The federal budget was in good shape in January 2001. In fact, the public debt was $3.4 trillion and the Congressional Budget Office (CBO) projected that the policies then in place would generate budget surpluses over the next decade that would total $5.6 trillion – more than enough to pay off the debt.

[See a collection of political cartoons on the budget and deficit.]

To CBO's credit, its 2001 report with these "baseline" projections also discussed its considerable uncertainty about the underlying economic and technical assumptions. It also noted that the major debates in the 2000 Presidential and Congressional campaigns over how best to use the projected surpluses "may presage major changes in federal spending or tax policies in the coming years that are not reflected in CBO's budget outlook."  Indeed.

CBO also repeated the warning it had issued since 1997 that the aging of the population and rising health care costs would pose budget challenges beyond the 10-year budget horizon and that, if federal policies did not respond to those challenges, "high deficits would return and eventually drive federal debt to unsustainable levels."

In 2001, the test for policymakers was whether they would make budget decisions with an eye toward both addressing those future challenges and sensitivity to the uncertainty about projections of large surpluses. They failed on both counts.

[Read the U.S. News Debate: Should Balancing the Federal Budget Be a Top Policy Priority?]

In retrospect, we know that the long 1990s expansion began to falter in late 2000 and a recession that was already on its way when CBO published its projections was about to undermine them. But, fiscally speaking, the more important story is that President George W. Bush and Congress made policy decisions in the wake of the 2000 election that dwarfed the impact of the 2001 recession, turning large projected surpluses into large projected deficits.

The President and Congress 1) allowed the budget control mechanisms that had contributed to deficit reduction in the 1990s (realistic discretionary spending caps and pay-as-you-go rules for taxes and entitlement spending) to lapse; 2) enacted major tax cuts but disingenuously scheduled them to expire at the end of 2010 in order to evade budget rules designed to control long-run deficits; 3) launched expensive wars in Afghanistan and Iraq without offsetting the costs elsewhere; and 4) far from taking any steps to address the country's long run budget challenges, enacted a new entitlement, Medicare Part D prescription drug coverage, without providing a means of financing the new benefits.

In the short term, economic growth in the recovery from the 2001 recession partially masked the fiscal damage these decisions caused. The long-term fiscal outlook, in contrast, was bleak unless policymakers tackled the coming demographic and health care cost challenges and let the Bush-era tax cuts expire or found other sources of revenue to support realistic future spending levels.

[See a collection of political cartoons on the economy.]

Then, the Great Recession of 2007 to 2009 changed everything. Revenues fell from 18.5 percent of gross domestic product in 2007 to 15.1 percent in 2009. Spending jumped from 19.7 percent of GDP to 25.2 percent over the same period – partly because unemployment insurance and other safety net spending rises automatically in a recession, partly because policymakers enacted temporary measures to fight the recession, and partly because GDP (the denominator of the spending-to-GDP ratio) contracted sharply.

The Great Recession and the policies enacted to combat it certainly contributed to the sharp increase in debt after 2007. But, as the chart below from a Center on Budget and Policy Priorities analysis of CBO data shows, the embedded effects of tax cuts and war spending are more significant contributors.

[Read the U.S. News Debate: Is Obama Turning the Economy Around?]

Policymakers' willingness to accept larger budget deficits in the short run kept the recession from growing even worse. CBO estimates that GDP was as much as 4 percent higher in 2010 than it otherwise would have been due to the 2009 Recovery Act policies (see Part III of this chart book), and economists Mark Zandi and Alan Blinder argue that the full package of financial and fiscal measures in 2008-2009 "probably averted what could have been called Great Depression 2.0."

The past few years provide a clear example of how poor economic performance leads to higher debt, not the other way around. Sound policymaking going forward requires that we drop slogans like "the looming debt crisis" and "we have a spending problem" and find ways to stabilize the debt without jeopardizing the economic recovery.

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