The U.S. Deficit

The White House and the Congressional Budget Office will both release their financial budget estimates on Aug. 25 and there's good news and bad news. The good news is that the Obama Administration has scaled back its estimate of this year's budget deficit to an estimated $1.58 trillion (down from $1.84 trillion in May). The bad news is that this is by far the largest budget shortfall in U.S. history — nearly $900 billion more than last year's deficit — and it accounts for 11.2% of GDP, the largest percentage since 1945. It's more money than we have circulating in actual currency and if added to the national debt, it will raise the tally by 13%. (To understand debt vs. deficit, think of a credit card: debt is the outstanding balance on the card while the deficit is the amount added each fiscal year.) At this rate, the Administration estimates that the U.S. could face a cumulative $9 trillion in deficits over the next decade — $2 trillion more than previously thought. (Read "How to Understand a Trillion-Dollar Deficit.")

It may be hard for many Americans to believe, but the United States' checkbook hasn't always been in the red. Aside from periods of war or economic turmoil, the federal budget was actually in surplus for most of the nation's first 200 years. The government incurred considerable debt during the Civil War and the Spanish-American War but paid it off by the early 1900s. Between 1901 and 1916, the budget was almost always balanced. But then came the Great Depression followed closely by World War II, which resulted in a long succession of deficits that caused the federal debt to balloon from $16 billion in 1930 to $242 billion by 1946. (Adjusted for inflation, that's about $206 billion and $2.67 trillion, respectively.)

The federal government's spending oscillated over the subsequent decades, running a surplus in the good years and a deficit in the bad ones, until the early 1980s. President Ronald Reagan's economic and foreign policies — tax cuts combined with substantial increases in Cold War–era defense spending — led to a string of deficits that averaged $206 billion a year between 1983 and 1992. The balanced-budget acts of 1990 and 1997 helped reverse this unprecedented level of peacetime spending, and in 1998 the U.S. recorded its first budget surplus in nearly 20 years.

Deficits aren't always bad: excess government spending can help alleviate the pain of an economic downturn by encouraging business and curbing unemployment (this is the theory behind the New Deal and Obama's stimulus package). But that doesn't mean that deficits are good, either. The U.S. covers the shortfall by issuing more government bonds, which can drive up interest rates and lead to inflation. Deficits also make it harder for a financially strapped government to deal with unexpected disasters. In fact, the last U.S. budget surplus occurred in 2001, when Washington was able to use fiscal and monetary policies to cushion the fallout following 9/11 and keep the economy from tumbling into a recession.

This year's federal deficit is the result of declining revenue — people are making less money so they're paying less in taxes — and increased spending. So far, the government has spent $530 billion more this year than it did last year, a number that includes $169 billion for the Troubled Asset Relief Program (TARP), $125 billion for the American Recovery and Reinvestment Act and $83 billion to bail out Fannie Mae and Freddie Mac. And that doesn't even account for the spending scheduled for next year. Add to this the projected $1 trillion price tag of Obama's proposed health-care plan and things begin to look pretty expensive.

But don't hoard your money under the mattress just yet. After all, the $9 trillion figure is just an estimate, and who knows what the economy will look like in 10 years. With any luck we won't be in a recession anymore, so revenue will be up and stimulus spending will disappear. The real budget problems lie in the long-term programs, such as Medicare and Social Security: Medicare's 2003 prescription-drug program has added nearly $1 trillion to the deficit and baby boomers' looming retirement will stress Social Security's already financially precarious situation. It's one thing to spend our way out of a recession. It's entirely different if we keep doing this forever. The U.S. is currently burdened with $11.7 trillion worth of debt and it's growing every day.

See pictures of the 1929 stock-market crash.