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4. The Budget Surplus and Fiscal
Discipline

In 1998, the Federal budget reported its first surplus ($69 billion) since 1969. In 1999, the surplus nearly doubled to $125 billion, and then again in 2000 to $236 billion. As a result of these surpluses, Federal debt held by the public has been reduced from $3.8 trillion at the end of 1997 to $3.4 trillion at the end of 2000 and to an estimated $3.2 trillion in 2001. With continued prudent fiscal policies, the budget can remain in surplus for many years. Under the President's budget proposals, $2.0 trillion in Federal debt held by the public will be retired over the next 10 years—all of the debt that can responsibly be retired.

Put simply, a surplus occurs when receipts exceed spending in any year—just as a deficit occurs when spending exceeds receipts. Generally, to finance past deficits, the Treasury has borrowed money. With certain exceptions, the debt is the sum total of our deficits, minus our surpluses, 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 surpluses and deficits since 1940.

Chart 4-1. Returning the Budget to Surplus

Deficits began increasing dramatically in the late 1970s and
1980s, but have now been reversed.

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 receipts 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 surpluses, 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 corresponding unprecedented deficits.

Since then—with Democratic and Republican Presidents, Democratic and Republican Congresses—the Government has balanced its books only 11 times, most recently last year.

During the 1970s, large budget deficits emerged as the economy was disrupted by oil shocks and inflation. In the 1980s, this trend increased. By 1992, the deficit reached $290 billion. Budget deficits have gradually declined since that high point, returning to balance in 1998. In 2000, the budget surplus was $236 billion.

Why have we been able to move from deficit to balance? The main reason is because strong economic growth has increased tax receipts faster than the growth in Federal spending. Also, the end of the Cold War allowed the growth in defense spending to slow.

Until recently, receipts have stayed relatively constant, at around 17 to 20 percent of GDP, since the 1960s. However, strong economic growth since the mid-1990s has increased receipts to nearly 21 percent of GDP, the highest level since World War II. In that same time, outlays grew from about 17 percent of GDP in 1965 to nearly 24 percent in 1983 before falling to 18 percent in 2000.

Nevertheless, since 1983, spending has grown dramatically across a wide variety of programs. Total spending in 2000 is 37 percent higher than in 1983 in constant dollars. Medicare and Medicaid, combined, are 175 percent higher and Social Security is 48 percent higher. Similarly, spending for net interest is 60 percent higher in 2000 than in 1983. In total, discretionary spending is six percent higher. But non-defense discretionary spending is 30 percent higher while national defense discretionary spending is 11 percent lower than in 1983. In recent years the growth in discretionary spending has accelerated, especially since 1997. Between 1997 and 2000, total discretionary spending has increased five percent, with non-defense discretionary spending increasing more than eight percent during this three-year period. (Note: all numbers adjusted for inflation). (See Chart 4–2.)

Chart 4-2. Constant Dollar Outlays by Category

Between 1966 and 2000, spending on Social Security,
Medicare and Medicaid, and interest grew, while spending on
defense fell.

Why a Budget Surplus is Important

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

Of the five nations shown above, only the United States,
Canada, and the United Kingdom eliminated their total
government budget deficits in recent years.

As Chart 4–3 illustrates, this Nation has a good record when compared to the recent history of four 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.)

The 2002 Budget forecasts surpluses for decades to come if we maintain a policy of fiscal discipline.

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

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, defense, law enforcement, and other important services, or the more it must collect in taxes. As recently as 1997, the Government spent more than 15 percent of its budget to pay interest, in contrast to less than 10 percent projected for 2002. The President’s budget will reduce these interest payments dramatically in the next 10 years.

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 and the repayment of Federal debt.

Table 4-1. Federal Government Financing and Debt

(In billions of dollars)

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 $3.4 trillion at the end of 2000—roughly the net effect of deficits and surpluses over the last 200 years. Debt held by the public does not include debt the Government owes itself—the total of all trust fund surpluses and deficits over the years, like the Social Security surplus, which the law says must be invested in Federal securities.

Because the large budget deficit has been turned into a surplus, the debt held by the public was reduced for three years in a row, for the first time since 1947–1949.

The sum of debt held by the public and debt the Government owes itself is called Gross Federal Debt. At the end of 2000, it totaled $5.6 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 either reduce the debt by raising receipts or reducing spending, or enact a law to increase the limit. Because the budget has returned to surplus and publicly held debt is being reduced, there will be no need to increase the statutory limit in 2002.

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 35 percent of GDP at the end of 2000. 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 49 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 about two-thirds of debt held by the public. The rest is held in foreign countries.

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