As noted in a recent column (and earlier blog posts), budget deficits and the business cycle have historically moved in tandem. When unemployment is low, deficits typically shrink, or even become surpluses. After all, when the economy is good, people tend to earn more money and pay more in taxes — and also require fewer safety-net services such as food stamps. The reverse happens when the economy is bad. Wartime is an exception to this general pattern, since wars both cost a lot of money and reduce the supply of available workers.
Again, that’s been the general pattern for many decades. More recently, budget deficits seem to have decoupled from the business cycle.
Boomers are reaching retirement age, of course, and are drawing more benefits. Plus, Congress has actively taken measures that defy these usual business-cycle trends. Usually they cut taxes and/or increase spending when the economy is ailing. Today, we’re in the middle of one of the longest expansions on record, unemployment is ultra-low, and yet lawmakers just passed a major fiscal stimulus in the form of higher spending and enormous tax cuts.
In the past, I’ve illustrated this decoupling using versions of the following chart, a template originally created by Goldman Sachs Economic Research:
To illustrate how the trends coincide, unemployment is inverted, and there are two different vertical axes. The chart gets the job done but takes some mental energy to process, as Urban Institute senior fellow Jonathan Schwabish pointed out.
Schwabish is an economist and a specialist in data visualization. I asked him whether he had any suggestions for a better way to convey these trends. He suggested a scatterplot that shows the relationship between unemployment (horizontal axis) and deficits/surpluses (vertical axis):
As you can see, for most years, there is a relatively reliable relationship between unemployment and the budget balance. When unemployment has been low, the budget balance has often been positive or only mildly negative (top left part of the graph); when unemployment has been high, the budget balance has been very negative (bottom right part of the graph). This leaves most of the dots clustered in a roughly linear pattern.
A few dots are highlighted and labeled to help better illustrate this relationship, and when it falls apart.
The several years immediately after the financial crisis (orange dots, bottom right) reflect a period when unemployment was unusually bad and deficits were especially big — both because of a steep drop in tax revenue, and a big fiscal stimulus called the American Recovery and Reinvestment Act. Some wartime years (such as the years of our largest involvement in Vietnam) are highlighted, too.
Now look at the last couple of years (green), and the projections for the decade ahead (light blue). Those projected deficits have peeled away from the main clump of dots, thanks to policy choices made by this and recent Congresses.