There Goes the Budget Deficit

So much effort has been put into worrying about the government's budget deficit and rising debt that we forgot things can, in fact, get better. 

That's what happened this year. In January, the Treasury forecast the government's finances in fiscal 2013 would look like this: 

Instead, the actual amount was this: 

Source: Treasury. 

With fiscal year 2013 in the books as of this week, spending came in $220 billion below budget, taxes were $70 billion above budget, and the budget deficit was $292 billion below forecast. That is remarkable improvement. 

Whenever I point this improvement out, a commenter invariably shouts, "Oh, whoopdeedoo. We still have a $680 billion deficit. You think that's OK?"

Well, yes. Let me explain.

When measuring government debt and deficits, what matters most aren't the raw numbers, but the numbers in context of the size of the economy and economic growth. For the same reason that a $100 million mortgage would be no big deal for Bill Gates, a country as rich as the United States can handle a lot of debt without much problem. 

Since a government has an indefinite lifespan, it can run in the red forever if annual deficits match, or are below, nominal GDP growth. As long as it does, debt-to-GDP does not rise, and debt burdens do not increase. (This doesn't apply to households, which eventually retire and die. That's why comparing a government budget to a household budget is logically flawed). From 1940 to 2000, the government ran a deficit in all but eight years, with an average deficit equal to 3.2% of GDP. That was fine, because nominal GDP growth averaged more than 6% during that period. Even though we racked up about $5 trillion in debt, the nation's debt burden fell by half. 

This year's budget-deficit improvement brings us to an important milestone: A $680 billion deficit equals 4.1% of GDP. That's below the economy's 4.2% nominal growth rate achieved in the last year.

In other words, we are now at a point where debt-to-GDP is no longer rising.

Things change fast, especially when the economy slows, but for now, our short-term deficit problem is gone. Long term, it gets scary as entitlements grow; but even those forecasts are under question as health-care cost growth comes in far below expected. It is Halloween, but here's one thing scaring me less and less: the nation's finances. 

For more, check out:

• What Happens to the National Debt When Interest Rates Surge?
• The End of the Health Care Bubble.