Key factors affecting federal borrowing needs
Federal borrowing is affected both by policy decisions and by economic conditions. Decisions that lead to lower tax revenues or higher spending would increase the need to borrow, whereas decisions that lead to higher tax revenues or lower spending would reduce borrowing needs.
Economic conditions, such as economic growth and inflation, can affect federal spending and revenue without changes to policy. Built into the structure of the federal budget are provisions, known as automatic stabilizers, that decrease revenues and increase spending when the economy slows (and vice versa when the economy expands). For example, increases in unemployment automatically reduce payroll tax and income tax receipts and increase spending for some programs, such as unemployment insurance. The effect is largely on the revenue side of the budget. Stabilizers are seen as tending to reduce the depth of any downturn and dampen expansions.
The Congressional Budget Office (CBO) provides estimates of how changes in economic conditions can affect federal borrowing. In January 2012 CBO said that slower economic growth of just 0.1 percentage point each year over the next 10 years would increase its projection of federal debt in 2022 by $314 billion. Debt would be lower by a similar size if economic growth were 0.1 percentage point higher each year than CBO estimated at that time. Also, higher inflation A rise in the general price level. increases both revenues and outlays.
For further discussion and estimates, see CBO’s, The Effects of Automatic Stabilizers on the Federal Budget, CBO’s Budget and Economic Outlook, and the Analytical Perspectives of the President’s Budget.
Policy responses to external events also affect borrowing needs. For example:
Recession: Borrowing can help to maintain household income and spending levels and reduce the severity of a recession. Government action to increase spending on goods and services or to reduce taxes can also substitute for missing private spending or seek to lessen the decline in private spending.
War: Borrowing can finance increased defense spending, lessening the need for reductions in other government spending or tax increases. For example, the federal government financed World War II with huge deficits to avoid even larger tax increases and economic distortions.
Emergencies: Borrowing can finance higher government spending in response to other temporary challenges or national needs, such as large natural disasters like Hurricanes Katrina and Rita or terrorist attacks, such as those of September 11, 2001. As with a war, borrowing for such short-term circumstances can permit the government to hold tax rates and other spending relatively stable and avoid economic disruptions.
Over the long term, federal borrowing needs are expected to grow as the gap between revenue and spending widens. Long-term simulations show that the gap will be driven on the spending side by rising health care costs and an aging population, which will persist long after the return of financial-market stability and economic growth. See GAO's Long-Term Fiscal Outlook for more information.