A cooling U.S. economy and rising interest rates could widen the federal budget deficit, potentially undercutting the White House’s message that a shrinking budget gap under President Biden shows fiscal responsibility in a time of high inflation.
The federal budget shortfall shrank by half to roughly $1.4 trillion in fiscal year 2022, which ended Sept. 30, the Treasury Department said Friday. The budget deficit for the just begun 2023 fiscal year is forecast to hold nearly steady at that level—and above its prepandemic mark—the White House and private sector economists say.
In the just-ended fiscal year, federal outlays were $6.3 trillion, down 8% from the prior year, the Treasury said. That largely reflects reduced government spending on Covid-19 programs.
Government revenue from taxes and other sources rose to $4.9 trillion last fiscal year, the highest annual level on record and up 21% from the prior year. A strong labor market and rising wages for many workers was a driver of higher income tax collection.
President Biden has cited declining deficits as a significant economic achievement, but that trend is expected to reverse. The nonpartisan Congressional Budget Office in May projected the deficit will rise in most years during the next decade and top $2 trillion in 2031 and 2032.
Some budget analysts say higher deficits and government debt levels carry hazards for the nation’s fiscal outlook. Running annual deficits requires the government to borrow, often from overseas investors. The debts need to be repaid through more borrowing, higher taxes or reduced spending.
High deficits and borrowing could limit the federal government’s ability to respond to public needs, such as nutrition and education programs, said Christina Skinner, an assistant professor at the University of Pennsylvania’s Wharton School.
“The consequence is that there’s not enough left in the revenue pie to fund the government’s ordinary spending…so deficits become higher in a way that’s difficult to escape,” Ms. Skinner said.
The economy has shown signs of slowing in recent months, which could crimp income and related tax revenue from companies and individuals in the coming fiscal year. Meanwhile, yields on Treasury bonds have risen as the Federal Reserve lifts interest rates to fight high inflation. That means issuing debt will be more expensive for the government.
About $9.8 trillion, or 40%, of the national debt will roll over within the next two years and so could be subject to higher interest rates, according to the nonpartisan
Peter G. Peterson
Foundation, which advocates for deficit reduction.
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The government spent $718 billion on interest costs on the public debt in fiscal year 2022, up 28% from the previous year, Treasury data show. Total federal borrowing reached $24.3 trillion last fiscal year, a $2 trillion year-over-year increase, the Treasury said.
Treasury officials have said previously that further increases in borrowing costs will be realized as the average interest rate across government securities rises. The average interest rate on marketable, fixed-rate Treasury securities began rising from a historic low in January 2022, reaching 1.99% at the end of September, the highest level since the end of March 2020.
The yield on the benchmark 10-year Treasury note this month exceeded 4% for the first time in more than a decade.
“Between the traditional imbalance between spending and revenue and increasing interest rates, which are going to be more of a factor going forward, the overall deficit is going to gradually creep up,” said Alec Phillips, chief political economist at Goldman Sachs.
The 2022 deficit figure includes the cost of the administration’s student-loan forgiveness plan, which is an estimated $379 billion. While those costs must be accounted for in a single year by law, they will be realized over many years of smaller student debt payments.
Excluding student-loan-cancelation costs, the deficit would have been lower in the last fiscal year and expected to rise in the current one.
Republicans campaigning ahead of next month’s midterm elections have argued Democrats’ spending agenda fueled inflation, which is running near the highest rate in four decades. The Biden administration and Democrats have countered that their policies helped fuel a strong economic rebound as the pandemic receded and provided a financial buffer for families.
The Biden administration said recently enacted laws intended to bolster the domestic semiconductor and clean-energy industries and its student-loan relief plans will increase the economy’s potential to grow. The White House pointed to a narrower deficit in 2022 as a justification for student-debt relief.
“There are definitely dynamics in fiscal year 2022 that don’t prevail in fiscal year 2023,” said Jared Bernstein, a member of the White House Council of Economic Advisers. “But if you look at our budgets, they’re carefully crafted to achieve fiscally responsible outcomes.”
However, if the recent economic slowdown tips into a recession, deficits could widen more than forecast.
A recession could mean higher government spending on stabilizers, such as unemployment benefits, said
Nancy Vanden Houten,
lead economist at Oxford Economics. She forecasts a mild recession during the first half of next year.
“We’re not looking for sharp declines in revenues or steep increases in spending, but the risks are enhanced that revenues will be weaker and stabilizers might have to kick in, given our outlook,” Ms. Vanden Houten said.
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