Does the Federal Government Have a Spending Problem, Revenue Problem or Both?

Sort of like the chicken or the egg conundrum, a perennial question is whether the U.S. federal government has a spending problem, a revenue problem or both. In this commentary, I will compare the U.S. federal budget data with those of the euro zone. On this comparative basis, I would say that that the US has a revenue problem. Then I will examine the CBO’s latest baseline forecast of federal outlays and revenues to try to determine where our fiscal “problem” lies. I will conclude that we have both a spending and revenue problem.

Chart 1 suggests that the federal government has a fiscal “problem” inasmuch as federal outlays have, with a few exceptions, been higher than federal revenues in the fiscal years starting in 1966 through 2024. The exceptions were in fiscal years 1998 through 2001. According to the Congressional Budget Office’s (CBO) January 17, 2025 baseline (current law) forecast, total federal outlays as a percent of total federal revenues will remain above 100% through fiscal year 2029 and will remain above the 1966-2024 median of 117.05% through fiscal year 2029. This does not tell us whether forecast federal deficits are due to a spending problem or a revenue problem. Rather it just establishes that federal budget deficits relative to their median value will persist through fiscal year 2029.

Let’s see how U.S. federal government budget deficits compare with those of the combined central government budget deficits of the euro zone countries. These data are plotted in Chart 2 (ignore the shading). From calendar years 1995 through 2023, the median value of the U.S. federal budget balance as a percent of nominal GDP was minus 3.3%. For the combined euro zone countries, the median value was minus 2.3%. So, from 1995 through 2023, relative to nominal GDP, the median value of US federal budget deficits was a full percentage point higher than that of the combined euro zone countries. Still this does not provide information regarding whether the U.S. federal government has a spending problem or a revenue problem.

So, let’s look at U.S. federal total outlays as a percent of nominal GDP and compare these data with comparable euro zone data (see Chart 3). The euro area has the U.S. beat when it comes to total government outlays compared to nominal GDP. The euro area median value is 3.6 percentage points higher than the U.S. median value.

If euro area central government outlays as a percent of nominal GDP are higher than those of the U.S. federal government, but relative euro area deficits are smaller than those of the U.S., it follows that relative euro area revenues must be higher than those of the U.S. this is shown in Chart 4. Wow! The median value of euro area central government receipts relative to nominal GDP, at 21.1%, is 4.1 percentage points higher than that of the U.S. federal government.

So, let’s get this straight. Euro area central governments spend more relative to nominal GDP than does the U.S. federal government, but the euro area collects more in revenues relative to nominal GDP than does the U.S. federal government, thus resulting in smaller relative euro area central government deficits than the U.S. federal government. The euro area might have a spending problem, but, at least, the euro area residents pay relatively more in taxes to fund their government services than do U.S. residents. Thus, growth in their central government debt, collectively, is slower than that of the U.S. federal government.

Now, let’s return to the January 17, 2025 CBO baseline budget forecast and compare some of the elements with historical data. First, let’s look past actual and forecast total federal expenditures. Plotted in Chart 5 are the year-over-year percent changes in total federal outlays – actual from 1966 through 2024 and CBO-forecast from 2025 through 2029 (the shaded area). The median year-over-year from 1966 through 2024 was 6.16%. The median forecast year-over-year change is 4.12%. Wow! Median year-to-year growth in total federal outlays is forecast to slow by 2.04 percentage points in the coming five years from its 1966-2024 median, according to the CBO’s baseline forecast.

But let’s dig a little deeper into this baseline forecast. Plotted in Chart 6 are the year-over-year percent changes in federal defense outlays – actual for 1966 through 2024 and CBO-baseline forecast for 2025 through 2029 (the shaded area). The 1966-2024 median year-over-year change in defense outlays was 4.91%. The 2025-2029 forecast median annual change is 1.96%, 2.95 percentage points lower than the 1966-2024 median annual percent change. With the U.S. having entered Cold War 2.0 with the China, North Korea, Russia and Iran axis of evil, do you really believe that the year-over-year growth in U.S. defense spending will only be around 2%? I don’t.

I believe that the 2025-2029 CBO-baseline forecast of year-over-year percent changes in net interest paid by the Treasury is too low. Plotted in Chart 7 are the year-over-year percent changes in net interest payments by the Treasury – actual for 1966-2024 and forecast for 2025-2029. The 1966-2024 median is 7.62%. The 2025-2029 median is 6.44%.

The principal reason I believe the CBO-baseline forecast for annual percent changes in Treasury net interest payments is too low is that I believe that the CBO-baseline forecast for interest rate levels is too low. Plotted in Chart 8 are the calendar-year annual averages of the 3-month Treasury bill rate and the 10-year Treasury note rate – actual for 2024 and forecast for 2025-2029. CBO forecasts that both interest rates will decline over the forecast period. Let’s compare the CBO’s interest rate forecast with that of the market’s forecast as of January 24, 2025. Plotted in Chart 9 are the market’s expectations of the interest rate levels of 3-month T-bill and the 5-year Treasury note five years ahead from the week-ended January 24, 2025. The 3-month T-bill averaged 4.97% in 2024 and is forecast by CBO to average 3.14% in 2029. The market is “forecasting” that the 3-month T-bill rate five years from now will be 4.67%, or 153 basis points higher than the CBO forecast. Similarly, the CBO is forecasting that the 10-year Treasury note interest rate will average 3.87% in FY 2029. The database I use does not have the five-year forward interest rate for the 10-year Treasury note, but it does have the five-year forward rate for the 5-year Treasury note. And of the week ended January 24, 2025, the five-year forward rate for the 5-year Treasury note was 4.92%. Because historically, the 10-year Treasury note interest rate typically trades about 20 basis points higher than that of the 5-year Treasury note, let’s assume that the market forecast of the 10-year Treasury note interest rate five years from now is 5.12%, which is 125 basis points higher than the CBO forecast for 2029. My heuristic (Asha) interest forecast is closer to the market’s than CBO’s. So, along with defense outlays, I believe that the CBO is underestimating Treasury net interest payments over the next five years. Of course, by the time DOGE gets through with its recommended cuts in federal outlays and Congress passes these cuts into law, it could turn out that the CBO has overestimated year-to year percent changes in federal outlays. I’m not holding my breath.

Moving right along to the latest CBO-baseline forecast of revenues, Chart 10 shows the year-over-year percent changes in total federal revenues – actual from 1966 through 2024 and forecast from 2025 through 2029. The median year-to-year change from 1966 through 2024 is 6.81%. The 2025-2029 forecast median is 4.98%. All else the same, I believe the CBO baseline forecast overestimates what the actual year-to-year percent changes in total federal revenues will be. Remember, the CBO baseline forecast uses current law in its estimates. The 2019 tax cut is scheduled to be terminated at the end of 2025. But, it is most likely that Congress will pass legislation to extend the 2019 tax cut. So, on that basis alone, the CBO baseline forecast of revenues is likely to be above actual revenues. The president has proposed other tax cuts. I would not even hazard a guess as to whether any of these proposed tax cuts will become law. One factor that could boost federal revenues is the tariffs that are proposed by the president. Would tariff revenues fully offset the extension of the 2019 tax cut? I doubt it.

So, in conclusion, I would argue compared with the euro area, the U.S. federal government has a revenue problem. When looking at the CBO’s baseline budget forecast over the next five years, I would argue that the U.S. federal government has both spending and revenue problems.