How Oil Prices Affect the Debt

October 3, 2013

A report from the American Enterprise Institute focuses on the intersection of two issues that have concerned policymakers and the American public for decades: heavy U.S. dependence on oil and large federal budget deficits. Surging oil prices and trillion dollar federal deficits in recent years have magnified these concerns. While both topics have been independently studied, discussed and debated, little attention has been paid to the interactions between these two factors.

One analysis estimates how historic federal deficits and debt levels would have been different if oil prices had risen at the same rate as the price of other goods and services from 2002 to 2012, instead of increasing dramatically over this period.

  • The results from this modeling exercise indicate that, by 2012, lower oil prices would have resulted in the U.S. federal deficit being $235 billion lower; the accumulated U.S. government debt being $1.2 trillion lower; and the debt-to-gross domestic product (GDP) ratio being 6.6 percentage points lower.
  • Some of the drivers of the would-be impacts of lower oil prices are direct, such as the reduction in government expenditures on fuel.
  • The more significant drivers, however, are indirect, and include reduced inflation, which reduces cost of living adjustments for Social Security payments and higher economic growth, which raises incomes and therefore income tax receipts.

Another analysis estimates how reducing petroleum dependence through improved fuel economy and the increased use of alternative fuel vehicles in the transportation sector could affect the U.S. economy and federal budget in the future.

  • The analysis finds that reducing oil dependence through the increased use of alternative fuel vehicles and improved fuel economy would make the federal budget deficit $492 billion lower in 2040.
  • It would also cause the federal government to accumulate $5 trillion less debt over the 2014-2040 period, and result in a federal debt-to-GDP ratio that is 10.3 percentage points lower in 2040.

Source: Phillip Swagel et al., "Oil and the Debt," American Enterprise Institute, September 24, 2013.

 

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