The Federal Deficit is Not Caused by High Spending or Low Taxation

The $1 trillion federal deficit is not actually a sign of America's gluttony and reckless spending, but of the depressed economy, according to recent analysis by Paul Krugman. And, he says, that's OK because that means it will shrink as employment increases, regardless of any budget cuts or tax increases.

"For starters, we need to be aware that we don't need a balanced budget to have a stable fiscal situation," he writes. "All we need is for debt to grow no faster than GDP."

He then goes on to explain that, if you account for the fact that the economy isn't operating at its full potential as we recover from the 2008 financial crisis, the deficit is right where it should be. The job crisis has had two major impacts on the deficit: first, fewer employed people means fewer income tax dollars being collected; about $450 billion fewer, according to Krugman. Second, fewer employed people means more strain on benefit programs like food stamps and unemployment insurance, to the tune of about $250 billion.

So, according to those numbers, if employment were where it should be, the deficit would be reduced by about $600 billion. What's left, $400 billion, or 4% of the GDP, is about the rate of GDP growth, which means it's a perfectly healthy amount of debt to have.

The problem, then, isn't reckless spending or insufficient taxation, as each of the two sides have been claiming in the so-called 'fiscal cliff' negotiations. The only way to close the gap, Krugman says, is to get employment up.

In their astute analysis of Krugman's position, Business Insider provided this chart to show how closely tied unemployment and deficits have been in the past:

  

"If you want to have a real discussion about how large/unsustainable government spending is," Joe Weisenthal wrote on Business Insider, "you don't want to use periods of economic abnormality, such as the last few years (just as you wouldn't want to go back to the Clinton years, and say that the government was a model of sustainability because the dot-com bubble lead to a surge in tax revenue). You have to cyclically adjust the deficit to have a real starting point, and if you do that now, then everything now is basically fine."

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Lilly O'Donnell

Lilly O'Donnell is a freelance writer, currently working on her first book.

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