Uncle Sam wants you to pay your taxes!

Each of us gives a portion of our income to Uncle Sam to help fund the federal government. Although this may sometimes seem like an unnecessary  burden, that money isn’t given in vain. In fact, these funds help pay for many important federal services including education, health care, transportation, environmental protection, national defense, and many more. Adding up all of the tax revenue helps the government formulate a federal budget so that it can manage its spending.

Oh, yeah! Uncle Sam also needs a loan

At the moment, the federal government spends nearly $4.5 trillion each year. However, the government usually collects far less than that in tax revenue. The gap between what the government spends and what it receives represents the federal budget deficit, and requires the government to borrow money from, among other sources, you! If you own US Treasury securities in your portfolio, what you’re really doing is lending money to the government. Hey, we all need a hand sometimes!

A deficit is not the same as debt

It’s important to distinguish between the United States’ deficit – which is the gap or shortfall each year – and its total debt – which is the accumulated amount of deficits over time. In other words, the deficit is the shortfall in a given year, while the debt is the grand total.

The size of the federal deficit changes over time. While many people focus on the dollar amount of the deficit – which averages about $780 billion per year at the moment – a more useful measure is to compare the deficit to the size of the economy, or our gross domestic product (GDP), which is the value of all goods and services produced over a period of time. After all, a larger economy can potentially support a larger deficit.

How does the deficit compare to GDP?

The current federal deficit is 3.4% of GDP (as of 1/31/2019). The chart below shows the federal budget deficit since 1980. During the global financial crisis, the deficit reached 10% of GDP in 2009. This was the worst deficit level in the United States since World War II. So while there may not be a simple political solution to today’s deficit level, it’s a much more manageable amount compared with just a few years ago.

This chart shows the federal budget deficit since 1980 in two ways: in billions of dollars (left axis) and as a percentage of GDP (right axis).

Source: Clearnomics, Federal Reserve

A stable deficit has minimal impact on your portfolio

If the federal deficit remains stable, then historically there has been little direct impact on the stock market, economy, and bond yields. So while many Americans would prefer there to be a smaller deficit, or even a budget surplus, stable deficits allow investors to avoid worrying on a regular basis about how government spending might affect their portfolios.