Before the Great Depression of the 1930s, government spending was less than 5 percent of GDP. Introduction of the “New Deal” during the depression doubled this percentage, and since then it has increased to between 20 and 25 percent of GDP, a range in which it has hovered since the mid-1970s. About 46 percent of the federal government’s revenue comes from individual income taxes, about 12 percent from corporate income taxes, about 5 percent from sales taxes, and about 37 percent from Social Security payroll taxes, accounting in 1998 for over 1.8 trillion dollars of tax receipts. About 17 percent of the government budget is spent on defense, about 22 percent on Social Security, about 10 percent on Medicare, about 6 percent on Medicaid, and about 13 percent on interest payments on the national debt. Other areas of expenditure are much smaller: welfare and foreign aid, for example, are together less than 3 percent of total government spending.

When government spending exceeds tax revenues, there is a government budget deficit, which is financed by selling bonds. The sum of all outstanding government bonds is called the national debt, which grows each year by the amount of the budget deficit. (It would shrink if there were a budget surplus.) Some bonds are sold to the central bank, an agent of the government, so this part of the national debt the government owes to itself; consequently, nobody worries about it. The remaining bonds are sold to the public, augmenting the publicly held national debt. Until the remarkable expansion of the late 1990s increased tax revenues markedly, growth in this debt was of concern.

An important legacy of Keynes is that budget deficits became respectable side effects of efforts to keep an economy operating at full employment. Keynes’s intention was that deficits required to stimulate the economy when it is in recession would be offset by budget surpluses in times of full employment–ensuring that in the long run the national debt would not continually grow.

History has not treated the Keynes legacy kindly. Once initial fears of budget deficits were overcome, politicians went overboard, producing deficits in both good times and bad. In the 1960s the federal budget deficit was less than 1 percent of GDP; in the 1970s this jumped to over 2 percent; and in the 1980s and 1990s, before dropping precipitously, it ballooned to over 4 percent, topping out at 290 billion dollars in 1992. Three main culprits were responsible for the growing deficit:

1. Tax decreases. The ratio of tax revenue to GDP is about 30 percent in the United States, the lowest of all OECD countries. Canada’s ratio is about 40 percent, and Sweden’s is about 50 percent.

2. Growing entitlement expenditures. Social Security and Medicare expenditures cannot easily be controlled because anyone eligible is entitled to coverage. As our population ages, spending in these two categories continually increases, with politicians refusing to increase taxes to pay for it.

3. Higher interest payments. Because of higher interest rates and a higher national debt, interest payments as a fraction of government spending have jumped from about 9 percent to about 13 percent. Recent decreases in interest rates have alleviated this burden considerably.

Because each year a dollar of budget deficit increases the national debt by a dollar, deficits have caused growth in the national debt that has many worried about our future. Even though the budget position moved into surplus in the late 1990s (the 1998 surplus of $69 billion was the first surplus since 1969), this issue remains a fundamental policy concern.