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; decisions that lead to higher tax revenues or lower spending would reduce borrowing needs.
Economic conditions, such as economic growth and inflation, can also 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 tend to reduce the depth of downturns and dampen expansions.
The Congressional Budget Office (CBO) provides estimates of how changes in economic conditions can affect federal borrowing. For example, CBO said in January 2017 that slower economic productivity growth of just 0.1 percentage point each year over the next 10 years would increase its projection of federal debt in 2027 by $273 billion. Debt would be lower by a similar size if economic productivityAverage real output per unit of input. Labor productivity is average real output per hour of labor. The growth of labor productivity is defined as the growth of real output that is not explained by the growth of labor input alone. Total factor productivity is average real output per unit of combined labor and capital services. The growth of total factor productivity is defined as the growth of real output that is not explained by the growth of labor and capital. Labor productivity and total factor productivity differ in that increases in capital per worker raise labor productivity but not total factor productivity. growth were 0.1 percentage point higher each year than CBO estimated. Also, higher inflationA rise in the general price level. increases both revenues and spending.
For further discussion and estimates, see CBO’s Budget and Economic Data and Budget and Economic Outlook, as well as the Analytical Perspectives volume 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 Hurricane Katrina 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 our Federal Fiscal Outlook and Fiscal Health pages for more information.