(Originally published here.)
We finally have a federal budget! But that doesn’t tell us much about what will happen to the deficit. That’s because business cycles are the biggest drivers of tax revenue and government spending. Just look at the change in the budget balance as a share of gross domestic product against the change in the unemployment rate.
As you can see, the budget deficit falls as a share of GDP when unemployment is falling and rises when unemployment rises. If the economy keeps growing, the budget deficit should continue to shrink. We may even have a small federal budget surplus by the time the next recession hits.
Meanwhile, the long-term uptrend in federal spending as a share of GDP has been partly caused by the aging of the U.S. population.
While spending on emergency programs for the poor and unemployed ought to fall as the economy recovers, federal spending as a share of GDP almost certainly won’t shrink back to levels from the late 1990s.