Remember the deficit? The mismatch between annual revenues and spending, which ballooned to a record $1.412 trillion in fiscal and was threatening to destroy America? The subject of a dozen-odd panels, commissions, marathon negotiating sessions? The horrific force that was going to turn America into the next Greece? The gigantic iceberg the United States was steaming toward?
Well like many icebergs today, it’s melting—as a political issue and as a real-world phenomenon.
Fiscal year 2014 ended last week, on September 30. And while we won’t get the final numbers until later this week, the numbers are essentially in. Through the first 11 months, the deficit was $589 billion, compared with $755 billion in the first 11 months of fiscal 2013, a decline of 22 percent. But that understates the progress. In months when corporations and individuals have to file quarterly income tax payments—January, April, June, and the current month, September—the government typically turns a profit. In September 2013, the government reported a surplus of $75.1 billion. The surplus for this September should be even higher. Why? According to the Daily Treasury Statement of September 30, government collections of combined individual and corporate income taxes were up about 16 percent in September 2014 from September 2013. A monthly surplus of $100 billion for September would bring the final deficit for the year to $491 billion—a decline of nearly 28 percent from fiscal 2013, and a two-third decline from the peak year of 2009. (Historical deficit figures can be seen here.)
Now, $491 billion—for simplicity’s sake, let’s just call it $500 billion—is still a very large number. But context is everything. The U.S. economy, which recovered from its first-quarter contraction to grow at an annual rate of 4.2 percent in the second quarter, is about $17.3 trillion. That puts the annual deficit at less than 3 percent of GDP. What’s more, the amount of government debt held by the investing public, $12.77 trillion on October 2, has essentially stabilized. Between March 31 and June 31, the amount of debt held by the public actually shrank by $47 billion.
Many of those who specialize in complaining about the size of the annual deficit have failed to grasp that deficits (and surpluses) are highly procyclical. That is to say, the factors that help drive the budget into deficit in the first place make them much worse. When markets crash and millions of people go out of work and companies rack up huge losses, tax collected on income, payrolls, and capital declines fall sharply. At the same time, spending on unemployment benefits and food stamps automatically rises. When things are really bad, the government spends a lot more on auto and bank bailouts and stimulus spending, and cuts taxes—further exacerbating the problem. That’s how we got trillion-dollar deficits.
But the same dynamic works in the opposite direction. The underlying economic factors that cause deficits to shrink often create circumstances that push them to shrink even faster. And that’s what is happening now. As the economy and labor market continually improved through 2012, 2013, and this year, taxes collected on earnings and income taxes rose steadily. In September 2014, there were 2.588 million more people with payroll jobs—and hence paying income and payroll taxes—than there were in September 2013. The doubling of the stock markets has created a gusher of capital gains taxes. The temporary reduction of Social Security payroll taxes was allowed to expire in early 2013. Oh, and as a result of the fiscal cliff negotiations in late 2012, tax rates on some people actually rose.
At the same time, spending on certain procyclical items decreased—in part due to politics, and in part due to the improving economy. The emergency-era extended unemployment benefits ended on January 1, 2014. Thanks to that, and to the fact that fewer people are filing for new benefits, spending on unemployment benefits was off $23 billion, or 37 percent, through the first 11 months of fiscal 2014. That’s a significant chunk of deficit reduction. Through the first 11 months of this fiscal year, spending on food and nutritional services was off, from $100.5 billion to $94.5 billion, a decline of $6 billion, or about 6 percent—because the number of recipients has fallen by about 1.264 million between June 2013 and June 2014.
Another big factor in the evaporating deficit has been similarly cyclical. The bailouts—the TARP funds sent to banks, cash sent to automakers, $180 billion to prop up AIG, and another $188 billion for mortgage giants Fannie Mae and Freddie Mac—massively exaggerated the deficits in 2008, 2009, and 2010. They were all treated as federal spending when the money went out the door, even though they were designed to be paid back. Contrary to most expectations, the money has come back—and then some. Here’s a good illustration First came the large banks in 2009, then smaller banks and AIG in 2010 and 2011. In the last two years, the housing agencies—whose profits the government effectively owns—have kicked back significant funds to the government—a combined $219 billion so far.
The return of the bailouts was made possible by the Federal Reserve’s extreme efforts to reflate the nation’s housing, stock, and credit markets. But deficit hawks should thank the Fed for another contribution. Under Ben Bernanke and his successor, Janet Yellen, the central bank has created huge volumes of money to purchase government bonds and mortgage-backed securities. These so-called quantitative easing measures were intended to keep interest rates low. And they resulted in the Fed sitting on a portfolio of bonds and other assets worth more than $4 trillion.
But here’s the thing. Every week, every month, the Fed collects interest on all those bonds—from the taxpayers, in government bonds, but, indirectly, from all the homeowners making payments on their mortgages. Doing so can be a very profitable endeavor, in a time of low interest rates. In the just-concluded fiscal year, Federal Reserve banks turned over more than $99 billion in profits to the Treasury, up from $69.5 billion in the first 11 months of fiscal 2013. Put another way, the Fed’s contributions alone are probably accounting for about half of this year’s deficit reduction.
This is not to say that we should never worry about deficits. We still don’t collect enough revenues to pay for all the government we want—and for the benefits we have promised to people in the future. A shock or recession could send deficits spiraling much higher. Tax evasion by our largest corporations remain a big problem. The deficit hawks still have some work to do. But for now, the battle of the deficit bulge seems to have been won. It’s time to retire the phrase “trillion-dollar deficit” from our political vocabulary.