Does the federal budget deficit matter?

This activity can be used in Principles of Economics, Macroeconomic Principles, and Intermediate Macroeconomics courses. Simply adjust the difficulty level for your specific class and students. The exercise takes about 20 minutes and there are no class size limitations.

Overview

This exercise helps raise students' awareness of the current U.S. federal budget deficit and whether that number is too high or too low (an analogous exercise could be performed for other countries as well). Students are asked to think critically about what an increase in the budget deficit means in the context of other important economic indicators. An increase in the deficit is not bad in and of itself – context is vital and this exercise helps generate discussion about those other important factors. With a debt and federal budget deficit as large as the U.S., this is likely to be a perennially interesting topic to students.

Expected Student Learning Outcomes

Students should have a fundamental understanding of budget deficits and be able to analyze how changes in the economy impact how we view the budget deficit.

Information Given to Students

The Trump administration enacted a large tax cut in 2017, applied to the 2018 tax year, which primarily benefitted corporations (a decrease in rates from 35% to 21% - see here for source). This led to an immediate increase in the federal budget deficit, with additional increases accumulating over the next 10 years, according to the Congressional Budget Office. Rank the following factors in order from most important to least important in terms of how we view an increase in the budget deficit:
A. Current debt-to-GDP ratio
B. Prevailing rate on 10-year U.S. government bonds
C. Current rate of real GDP growth
D. Projected rate of corporate investment

Student Instructions for Do Budget Deficits Matter? (Microsoft Word 2007 (.docx) 13kB Aug24 19)

There are several lessons students can take away from this exercise. First, this should help them understand the difference between the federal budget deficit and the federal debt. Second, this can generate discussion about appropriate levels of deficits and/or taxation. Third, it demonstrates that numbers need context to be meaningful. For example, adding large amounts to the deficit may not be problematic if borrowing costs are low and expected economic growth is high. However, how these estimates are calculated also matters a great deal; if you make unrealistic assumptions or do not foresee important changes in the economy, then your policy may not have its intended effect. This exercise allows students to apply what they have learned about deficits, debt, and economic growth to a real-world situation. There are numerous pieces written on the effects of the tax cuts. Here, we focus in on the impact on the federal budget deficit. The Tax Policy Center has detailed information including short, readable pieces that are accessible to undergraduates. The Joint Committee on Taxation publicly released their (original) estimates of the contribution to the budget deficit of the tax cuts. The CBO estimated the tax cut would add $1.9 trillion to the deficit over 10 years – this information is not pertinent to the problem, but it could generate additional discussion.

In a follow-up quiz or exam, ask students to discuss the pros and cons of having a large and/or growing federal budget deficit. You could also devise a scenario in which some aspect of spending or taxes changes and ask students to determine how it will impact the deficit and the economic growth rate of the country. Finally, you could give analogous numbers for another country and ask students to discuss the potential implications (Japan and Italy could be good choices).

1. The tax cut was estimated by the CBO to add $1.9 trillion to the deficit over 10 years. It may help to show students what $1 trillion looks like. This article starts with a $100 bill and gradually increases to $1 trillion, using an adult human as a point of reference for size; there is also a video version set to dramatic music if you prefer.
2. NPR Planet Money's The Indicator is a short (10-minute) podcast and in these 2 episodes they discuss the recent changes in the federal budget deficit and whether it matters:
3. Tax Policy Center (Urban Institute and Brookings Institution collaboration); this source provides information on how the Trump tax cuts impacted the federal budget deficit.
4. Joint Committee on Taxation; this is the original source of the projected impact of the tax cuts on the budget deficit.
5. St. Louis Federal Reserve Bank; this source discusses how the budget deficit affects other areas of the economy.