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Opinion The great decoupling

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Earlier this week, the Treasury Department reported that our federal budget deficit ballooned in fiscal year 2018. It got a lot of coverage for two reasons. The first is that Republicans, who control all branches of government, claim to be fiscal hawks, and yet they’re overseeing a massive widening of the deficit.

The second is that this is … not what you normally expect to happen in a recovery.

When the economy grows, people earn more money, which normally causes tax revenue to rise; simultaneously, government spending on programs such as food stamps or unemployment insurance normally falls. Both factors should cause deficits to decline or even disappear, absent other major policy changes. Which is to say: When unemployment shrinks, the deficit usually shrinks, too.

In fact, the last time unemployment was hovering around 4 percent, we had a budget surplus!

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Here’s a chart showing unemployment and budget deficits over the past six decades. I’ve inverted unemployment (shown on the right-side axis) so that it’s easier to compare the two series. Note that this is my own (updated) version of a chart that Goldman Sachs Economic Research had previously published and that I blogged about back in January.

As you can see, unemployment and deficits have moved more or less in tandem, with the notable exception of the Vietnam War (which both was expensive and left fewer workers available back home). In recent years, though, the series have decoupled. The economy has improved, but deficits have gotten worse.

What accounts for this decoupling?

It does predate President Trump, but his policies — massive tax cuts and big spending hikes — have undoubtedly made things worse. Senate Majority Leader Mitch McConnell (R-Ky.) has blamed entitlements, rather than GOP policies. To be sure, entitlements likely are on an unsustainable growth path. But long-run entitlement spending is not the reason why the federal deficit rose 17 percent last year. The tax cut and subsequent spending hikes are. Both sets of policies will add an estimated additional $2.7 trillion to deficits over the coming decade, according to the Congressional Budget Office.

Needless to say, these policies were not only bad on their own merits but also supremely ill-timed. We absolutely didn’t need a major fiscal stimulus nine years into one of the longest recoveries on record. As the saying goes, better to repair the roof when the sun is shining.

The question is: If the deficit looks this bad now, when the economy is good, what happens when (not if) the economy takes a turn? Tax revenue will plummet, deficits will rise further, and more spending will be needed. But by that point, we may not have any fiscal bullets left.