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All the fearmongering in Washington over the $1.5 trillion federal budget deficit hides a truth few politicians would admit: That hefty headline number you hear so much about is an unreliable measure of U.S. fiscal health.
Savvy economists prefer what’s known as the primary deficit, which is the overall shortfall minus what the government spends each year on interest payments. At $637 billion, this measure is smaller, less frightening, in line with recent history and, more important, shrinking, having narrowed from $1 trillion in 2023.
It’s a shame that lawmakers don’t focus their attention on the primary deficit, using that measure to help bridge the political divide and forging bipartisan solutions that will put the government on a fiscally sound and sustainable path. Instead, they bicker over less-than-meaningful numbers that threaten the U.S.’ “exorbitant privilege” in the global financial system by way of government shutdowns and reckless talk of not raising America’s borrowing capacity, a move that would risk a catastrophic default.
Why does it make economic sense to focus on the primary deficit, which ignores federal interest payments? The answer is because tax revenue and interest rates can diverge, often with unexpected results. For example, a booming economy will increase tax revenue but also push up borrowing costs; a slowing economy would have the opposite effect on rates.
Think back to the early 1980s, when the budget and primary deficits were a similar percentage of gross domestic product as today and concern about the nation’s fiscal situation was also elevated. In 1983, the primary and headline deficits were 3.3% and 5.7% of GDP, compared with 3.8% and 5.4% currently. And like now, the U.S. was also emerging from a painful recession, during which GDP contracted faster and deeper than any time since the Great Depression only to begin a strong recovery that lasted six years, increasing government revenue. As a result, that primary deficit of 3.3% in 1983 became a primary surplus of 0.3% by 1989.
Total debt as a percentage of GDP was little changed, however, going from 38.9% of GDP to 38.5% as the rapidly growing economy kept interest rates relatively high. Federal interest payments grew as a percentage of the economy from 2.5% of GDP in 1983 to 3% in 1989. As a result, the headline deficit in 1989 was 2.7% of GDP, much higher than the post-war average of 1.2% of GDP at the time. If you had judged the country’s fiscal health based on the headline deficit alone, you would have thought the U.S. went from the worst shape since World War II in 1983 to merely bad shape in 1989. In fact, America’s fiscal health had stabilized, debt was no longer growing as a percentage of GDP and the stage had been set for the massive surpluses of the 1990s.