5.4 - Government Deficits and the National Debt
Definitions
Fiscal policy shapes the federal budget balance, tax revenue minus government spending and transfers.
- Budget surplus: tax revenue exceeds spending, a genuinely rare situation.
- Budget deficit: spending exceeds tax revenue, the much more common scenario.
- Balanced budget: revenue exactly equals spending.
- National debt: the total accumulated debt, which grows every time the government runs a deficit.
Deficits happen year by year; debt is the cumulative total. Think of a sink: the annual deficit is water flowing in, while the total debt is all the water already sitting in the sink.
Example: say a country’s national debt is $20 trillion at the start of the year. This year it collects $5 trillion in taxes and spends $6.5 trillion on government purchases and transfer payments, so it runs a $1.5 trillion deficit and the debt grows to $21.5 trillion. Even a smaller deficit next year would still add to the debt. Only a surplus shrinks it.
Fiscal Policy and the Budget
Expansionary fiscal policy (tax cuts and/or more spending) pushes toward a deficit, since it’s either bringing in less money, sending out more, or both. Deficits and rising debt are trade-offs that come with expansionary policy.
Contractionary fiscal policy (raising taxes or cutting spending) moves toward a surplus, or at least a smaller deficit.
Automatic Stabilizers
Deficits don’t only happen because of deliberate choices. During a recession, automatic stabilizers (like unemployment benefits, welfare, or food stamps) kick in automatically, pushing the budget toward a deficit without any new legislation. During expansions, these same stabilizers automatically push toward a surplus.
Consequences of the Debt
Governments have to pay interest on their debt, and that interest itself adds to the debt, representing money that can’t be spent elsewhere. In fiscal year 2025, for example, the U.S. paid roughly $1 trillion in net interest, about 14% of all federal spending and more than it spent on national defense, just for money already owed.
That’s the main burden of the debt. Every dollar spent on interest is a dollar that can’t go to schools, roads, defense, or tax cuts, and as the debt grows, so does the interest bill, so a bigger and bigger share of the budget goes to paying for past borrowing. Government borrowing can also push up interest rates and crowd out private investment (see 5.5).
There are also implicit liabilities, promised future payments like Social Security and Medicare that aren’t technically counted as debt but still loom large, with estimates ranging from $50 to $200 trillion.
Ultimately, the national debt shows up eventually as higher future taxes, higher future inflation, or major cuts to government services. Most economists agree the current trajectory isn’t sustainable.