This report 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.

This report explores the impact of oil prices and oil dependence on the U.S. federal budget.  Specifically, it looks at how the quadrupling of oil prices over the last decade has affected federal budget deficits and debt. It also examines whether reducing dependence on oil in the future could improve the federal budget balance. This is done in a two‐part analysis that uses the University of Maryland’s Inforum LIFT macroeconomic model of the U.S. economy to help quantify the direct and indirect effects that oil prices and oil dependence have on the budget.

The Part 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‐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.

The Part Two 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 compares the economic and budgetary outcomes from such a scenario with those from a Baseline Scenario in which petroleum use remains roughly flat. The study 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, 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.