[A Citizen's Guide to the Federal Budget]
[4. Deficits and the Debt]
[From the U.S. Government Printing Office, www.gpo.gov]

4. The Budget Surplus and Fiscal Discipline

In 1998 the Federal budget reported a surplus of $69 billion, the 
first surplus since 1969, and reduced Federal debt held by the public 
by over $50 billion. With continued prudent fiscal policies, the budget 
can remain in surplus for many years. The turnaround from deficit to 
surplus can be attributed to fiscal discipline and strong economic 
growth. The change from deficit to surplus is an important milestone.

   Put simply, a surplus occurs when revenues exceeds spending in any 
    year--just as a deficit occurs when spending exceed revenues. 
    Generally, to finance

Chart 4-1.  Past and Future Budget Deficits or Surplus

Deficits began increasing dramatically in the 1980s, but have 
now been reversed.

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past deficits, the Treasury has borrowed money. With certain 
exceptions, the debt is the sum total of our deficits minus our 
surplus, over the years.

The Government incurred its first deficit in 1792, and it generated 
70 annual deficits between 1900 and 1997.

Chart 4-1 provides the history of budget surplus and deficits since 1940.

For most of the Nation's history, deficits were the result of either 
wars or recessions. Wars necessitated major increases in military 
spending, while recessions reduced Federal tax revenues from businesses 
and individuals.

The Government generated deficits during the War of 1812, the recession 
of 1837, the Civil War, the depression of the 1890s, and World War I. 
Once the war ended or the economy began to grow, the Government followed 
its deficits with budget surplus, with which it paid down the debt.

Deficits returned in 1931 and remained for the rest of the decade--due 
to the Great Depression and the spending associated with President 
Roosevelt's New Deal. Then, World War II forced the Nation to spend 
unprecedented amounts on defense and to incur unprecedented deficits.

Chart 4-2.  Outlays as a Percent of GDP

Between 1965 and 1998, spending on Social Security, Medicare and 
Medicaid, and interest as a percentage of GDP grew, while spending 
on defense fell.

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Since then--with Democratic and Republican Presidents, Democratic and 
Republican Congresses--the Government has balanced its books only 
nine times, most recently last year.

Nevertheless, the deficits before 1981 paled in comparison to what 
followed. That year, the Government cut income tax rates and greatly 
increased defense spending, but it did not cut non-defense programs 
enough to make up the difference. Also, the recession of the early 
1980s reduced Federal revenues, increased Federal outlays for 
unemployment insurance and similar programs that are closely tied 
to economic conditions, and forced the Government to pay interest 
on more national debt at a time when interest rates were high. As 
a result, the deficit soared.

Why have we been able to move from deficit to surplus? Because 
spending growth has been restrained. Outlays are growing slower 
and revenues are holding steady.

Revenues have stayed relatively constant, at around 17 to 21 percent 
of GDP, since the 1960s. In that time, however, outlays have grown 
from about 17 percent of GDP in 1965 to up to nearly 24 percent in 
1983 before falling below 20 percent today.

Since 1983, spending had been reduced or held constant as percent 
of GDP across a wide variety of programs. The most significant 
reduction has occurred in discretionary spending, which has fallen 
from 10.3 percent to 6.6 percent of GDP. Combined spending on social 
security and net interest has remained roughly constant at about 
7-1/2 percent of GDP since 1983. A similar path has been followed in 
the rest of mandatory spending in total, but only because the growth 
in Medicare and Medicaid has been offset by declines in other 
mandatory spending (see Chart 4-2).

Why a Budget Surplus is Important

As Chart 4-3 illustrates, this Nation has a good record when compared 
to the recent history of six other major developed economies. (To make 
accurate comparisons with the governments of other nations, the U.S. 
data include the activities of State and local governments.)

Should we worry about the possibility of a return to budget deficits?

The 2000 Budget forecasts surplus for decades to come, if we maintain 
the policy of fiscal discipline and strategic investments in the 
American people.

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          Chart 4-3.  Total Government Surplus or Deficit as a Percent
                                    of GDP

    Of the seven nations shown above, only the United States and Canada eliminated their total Government budget deficits in 1997.

We must do all we can to keep the days of deficits in the past. 
Budget deficits force the Government to borrow money in the private 
capital markets. That borrowing competes with (1) borrowing by 
businesses that want to build factories and machines that make 
workers more productive and raise incomes, and (2) borrowing by 
families who hope to buy new homes, cars, and other goods. The 
competition for funds tends to produce higher interest rates.

Deficits increase the Federal debt and, with it, the Government's 
obligation to pay interest. The more it must pay in interest, the 
less it has available to spend on education, law enforcement, and 
other important services, or the more it must collect in taxes--
forever after. As recently as 1997, the Government spent over 15 
percent of its budget to pay interest, in contrast to a projected 12 
percent for 2000. Continuing surplus will reduce these interest 
payments further in future years.

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In the end, the surplus is a decision about our future. We can 
provide a solid foundation for future generations, just as parents 
try to do within a family. For a Nation, this means a strong economy 
and low interest rates and debt. Alternatively, we can generate 
large deficits and debt for those who come after us.

Surplus and Debt

If the Government incurs a surplus, it generally repays debt held by 
the public.

Table 4-1 summarizes the relationship between the budget surplus or 
deficit and the repayment of Federal debt.

Federal borrowing involves the sale, to the public, of notes and 
bonds of varying sizes and time periods until maturity. The cumulative 
amount of borrowing from the public--i.e., the debt held by the 
public--is the most important measure of Federal debt because it 
is what the Government has borrowed in the private markets over the 
years, and it determines how much the Government pays in interest to 
the public.

Debt held by the public was $3.7 trillion at the end of 1998-roughly 
the net effect of deficits and surplus over the last 200 years. 
Debt held by the public does not include debt the Government owes 
itself--the total of all trust fund surplus and deficits over the years, 
like the Social Security surplus, which the law says must be invested 
in Federal securities.

Because of the progress in eliminating the budget deficit, the debt 
held by the public has been reduced for the first time in 29 years.

           Table 4-1. Federal Government Financing and Debt
                       (in billions of dollars)
                              1998                  Estimate
                                    Actual  1999  2000  2001  2002  2003  2004
Federal Government financing:
 Budget surplus..............           69    79   117   134   187   182   208
 Other means of financing....          -18   -29   -19   -17   -17   -16   -15
                                     -----------------------------------------  Repayment of debt held by the public    51    50    98   117   170   166   193
Federal Government debt:
 Debt held by the public............ 3,720 3,670 3,572 3,455 3,285 3,119 2,926
 Debt held by government
   accounts......................... 1,759 1,945 2,140 2,326 2,530 2,736 2,948
  Gross Federal debt.......          5,479 5,615 5,711 5,781 5,815 5,856 5,874
 Debt subject to legal limit........ 5,439 5,577 5,674 5,745 5,780 5,821 5,842
Note: Numbers may not add to the totals because of rounding.

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The sum of debt held by the public and debt the Government owes itself 
is called Gross Federal Debt. At the end of 1998, it totaled $5.5 trillion.

Another measure of Federal debt is debt subject to legal limit, which 
is similar to Gross Federal Debt. When the Government reaches the 
limit, it loses its authority to borrow more to finance its spending; 
then, the President and Congress must enact a law to increase the limit. 
Because the budget has returned to surplus and debt is being reduced, 
there will be no need to increase the statutory limit in 2000.

The Government's ability to finance its debt is tied to the size and 
strength of the economy, or GDP. Debt held by the public was 44 
percent of GDP at the end of 1998. As a percentage of GDP, debt held 
by the public was highest at the end of World War II, at 109 percent, 
then fell to 24 percent in 1974 before gradually rising to a peak 
of 50 percent in the middle 1990s.

That decline, from 109 to 24 percent, occurred because the economy 
grew faster than the debt accumulated; debt held by the public rose 
from $242 billion to $344 billion in those years, but the economy 
grew faster.

Individuals and institutions in the United States hold two-thirds 
of debt held by the public. The rest is held in foreign countries.

Returning the Budget to Surplus

Ever since the deficit soared in the early 1980s, successive Presidents 
and Congresses have tried to cut it. Until recently, they met with 
only limited success.

In the early 1980s, President Reagan and Congress agreed on a large tax 
cut, but could not agree about cutting spending; the President wanted 
to cut domestic spending more than Congress, while Congress sought 
fewer defense funds than the President wanted. They wound up spending 
more on domestic programs than the President wanted, and more on 
defense than Congress wanted. At the same time, a recession led to 
more spending to aid those affected by the recession, and reductions 
in tax revenues due to lower incomes and corporate profits.

By 1985, both sides were ready for drastic measures. That year, they 
enacted the Balanced Budget and Emergency Deficit Control Act. It 
set annual deficit targets for five years, declining to a balanced 
budget in  1991. If necessary, GRH required across-the-board cuts in 
programs to comply with the deficit targets.

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Faced with the prospect of huge spending cuts in 1987, however, 
the President and Congress amended the law, postponing a balanced 
budget until 1993. The President and Congress never achieved those 
revised targets, in part because of the extraordinary costs of returning 
the Nation's savings and loan industry to a sound financial footing.

By 1990, President Bush and Congress enacted spending cuts and tax 
increases that were designed to cut the accumulated deficits by 
about $500 billion over five years. They also enacted the Budget 
Enforcement Act (BEA)--rather than set annual deficit targets. The 
BEA was designed to limit discretionary spending while ensuring 
that any new entitlement programs or tax cuts did not make the 
deficit worse.

First, the BEA set annual limits on total discretionary spending 
for defense, international affairs, and domestic programs. Second, 
it created ``pay-as-you-go'' rules for entitlements and taxes: those 
who proposed new spending on entitlements or lower taxes were forced 
to offset the costs by cutting other entitlements or raising other taxes.

For what it was designed to do, the law worked. It did, in fact, 
limit discretionary spending and force proponents of new entitlements 
and tax cuts to find ways to finance them. But the deficit, which 
Government and private experts said would fall, actually rose.

Why? Because the recession of the early 1990s reduced individual and 
corporate tax revenues and increased spending that is tied to 
economic fluctuations. Federal health care spending also continued 
to grow rapidly.

In 1993, President Clinton and the Congress made another effort to 
cut the deficit. They enacted a five-year deficit reduction package of 
spending cuts and higher revenues. The law was designed to cut the 
accumulated deficits from 1994 to 1998 by about $500 billion. The 
new law extended the limits on discretionary spending and the 
``pay-as-you-go'' rules.

Although the 1993 plan had exceeded all expectations in reducing the 
deficit, the task of reaching balance would require one final push. 
That would come with the historic 1997 Balanced Budget Act (BBA). 

Originally designed to balance the budget by 2002, the BBA provided 
for $247 billion in savings over five years. It also extended the 
solvency of Medicare's trust fund for at least 10 years while 
providing for the largest investment in higher education since 
the G.I. Bill in 1945, the largest investment in children's 
health care since the creation of Medicaid in 1965, and a 
$500-per-child tax credit for about 27 million working families.

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Clearly, the President's deficit reduction efforts have paid off. 
The deficit fell from $290 billion in 1992 to a surplus of $69 
billion in 1998.

The President is now proposing to reserve the surplus until Social 
Security is reformed. His plan for reform uses 62 percent of the 
projected unified budget surplus of the next 15 years to put the 
Social Security system on sound financial footing well into the next 
century. In 2000 the challenge for both the President and the Congress 
is to maintain fiscal discipline and reach comprehensive Social 
Security reform while continuing to invest in the American people. 
The next chapter describes the President's plans for achieving that goal.