Rising inequality’s drag on household spending has large potential fiscal consequences: Estimated unemployment gap and resulting change in cyclically adjusted federal budget deficits as a share of GDP, 1965–1979, 1980–2020, and 1980–2020 had the employment gap since 1980 been underestimated

Change in budget deficit, % of GDP Unemployment gap
1965–1979 -0.3% 0.7%
1980–2020 0.4% -0.9%
1980–2020, if NAIRU 1 ppt lower 1.0% -1.9%

Notes: The figure shows what happens to the budget deficit when the economy outperforms or underperforms potential, as captured by the employment gap. When the unemployment gap is positive, it means that the actual unemployment rate is lower than the estimated nonaccelerating rate of unemployment (NAIRU)—or the unemployment rate below which inflationary pressures begin building. When the unemployment gap is negative, the unemployment rate is higher than is needed to keep inflationary pressures in check, thus resources (workers) are going unused for no good purpose and the economy is running under its potential. The bottom set of bars estimates the impact of the negative employment gap since 1980 under the (perhaps likely) scenario that estimates of the NAIRU are too high and thus the average negative gap is even larger, reflecting greater economic underperformance.

Extended notes: The first two sets of bars estimate the average annual contribution to federal budget balance stemming from cyclical contributions, applying estimates based on Congressional Budget Office estimates of the natural rate of unemployment. The last set of bars applies CBO parameters linking the unemployment rate and budget balance to a scenario where the natural rate of unemployment is 1 percentage point lower than what CBO estimates for the post-1979 period. 

Source: Congressional Budget Office federal budget data (CBO 2020a; 2020b). 

View the underlying data on epi.org.