A federal deficit occurs when spending exceeds revenue. Federal spending supports Social Security, Medicare, military defense, and countless other programs. Federal revenues largely come from taxes.
The federal deficit is tracked annually. The chart below shows key deficit trends. The U.S. maintained a relatively balanced budget throughout most of the twentieth century. Change began in the 1980s when sweeping tax cuts met increased spending. The deficit grew modestly before shrinking again in the 1990s thanks to rapid economic growth. This trend sharply reversed in 2001 following additional policy changes.
The United States has carried a budget deficit ever since. The 2020 deficit remains the largest ever at $3.1 trillion. Corresponding debt ceiling increases have sustained deficit growth.
The X-Date is the day the federal government can no longer pay its bills. This is a point-in-time prediction based on the Treasury’s current cash holdings and expected revenue streams. Failure to meet debt payments results in default. Such an unprecedented event would have far-reaching consequences.
The Treasury Department monitors the federal balance sheet. Treasury officials sound alarm when government funds approach insolvency. Two courses of action are available in this instance: raise taxes or adjust the debt ceiling. The latter is most commonly utilized.
By adjusting the debt ceiling, Congress enables the government to issue additional debt. The Treasury Department can then sell new bonds to investors. These funds support key programs, fulfill existing promises, and prevent default.
The debt ceiling is the maximum amount of federal debt that the government may incur. This cap ostensibly encourages fiscal responsibility and deficit management. The debt ceiling may change according to spending needs, revenue adjustments, and political tides.
The Constitution grants Congress authority to spend and tax. In turn, legislators pass a budget each year. This process reconciles spending obligations with revenues. Any shortfall adds to federal debt totals. The debt ceiling is a separate but crucial element to this procedure. This limit can only be changed via Congressional vote.
Once a routine process, debt ceiling negotiations have become contentious in recent years. These events require concessions and compromise between the two parties. The last time legislators raised the debt ceiling was 2011. Congress opted to simply suspend the debt ceiling entirely in 2013 and 2019. Each resolution funded government obligations before the dreaded X-Date.
Our blog, “Life Insurance – A Primer”, concluded that Accumulation Universal Life and Whole Life policies have characteristics that warrant their consideration as a complimentary asset class. An asset class is any category of investment that might be held in a liquid investment portfolio. For example, large and small company U.S. stocks, international stocks, bonds, etc. Life insurance is not an investment and would not be directly held in an investment portfolio but can be an important complement to the fixed income, or bond portion, of a balanced portfolio.
Let’s first look at bonds to better understand how.
A typical long-term portfolio has a 60 or 70 percent allocation to stocks with the balance in bonds. The bond allocation serves to dampen portfolio volatility. First, because bond returns are less volatile than stocks, and second, because their returns have very little (.02) correlation with large-cap U.S. equity returns. Bonds also generate taxable interest income.
A bond portfolio’s return is the combination of changes in its market value and the interest income. The market value of a bond portfolio rises and falls inversely with the direction of interest rate movements. (In 2022, the worst year ever for bonds, the most popular bond index was down 13%, due to the Fed’s dramatic increase in interest rates.) In the accumulation phase of a portfolio’s life cycle, the income is usually reinvested. In the late-stage phase, the income is often distributed. The historical return for bonds is between 4% and 6% since 1926. Let’s see how life insurance complements the valuable role played by bonds.
Let’s use whole life policies to illustrate the concept. In addition to providing an income tax free death benefit for life, the policies build cash reserves. After the first year or two, whole life policies have guaranteed cash surrender values which increase with each premium payment.
