The Federal Budget Outlook

It’s a long-standing adage in Washington that the federal debt is a problem only when the other party is in charge. Republicans label Democrats as the party of “tax and spend,” while Republicans are deemed the party of “borrow and spend.” In truth, the federal budget is about what kind of society we want and who pays for that. Periodically, over the years, the budget has sometimes been seen to be in a crisis. The real concern has always been the long run, which is getting a lot closer.

By now, the demographic story should be well-entrenched. Labor force growth has slowed in recent decades – and will continue to slow in the years ahead. In the last half of the 20th century, the baby-boom generation entered the workforce and female labor force participation rose. Those trends are far behind us now. Growth is simply labor force growth plus productivity growth. Job growth estimates simply reflect the demographics. Productivity growth, which is more uncertain, is seen largely as a function of previous business investment. A softer pace of capital spending following the Great Recession meant slower growth in output per worker over the last decade. Capital spending appears to be picking up now, and advances in artificial intelligence and robotics should lift productivity growth in the years ahead. That will help to offset some of the slowdown in labor force growth. However, it’s unlikely that the trend in real GDP growth will be much above 2%. Moreover, if productivity growth doesn’t pick up, potential GDP growth would be more likely to center around 1.5%.

The federal budget deficit ballooned to $1.4 trillion (10% of GDP) during the financial crisis, but that was temporary. The surge merely reflected the magnitude of the economic downturn. Revenues dried up. Recession-related spending (food stamps, unemployment insurance, etc.) rose sharply. The budget deficit was 2.4% of GDP in FY15, but is now rising again.