Tuesday, November 4, 2008

Fiscal policy recap

Seeing as it's election day, I thought it appropriate to recap the state of fiscal policy. These charts measure federal revenues, spending and deficits as a percent of GDP, which is the only meaningful way to assess what is really going on. Some observations:

Nothing is really out of whack from an historical perspective. Tax burdens (revenues) are a bit less than average. The burden of government (spending) is a bit above average. You would expect revenues to be weak and spending to be strong during an economic slowdowns, so there are no real surprises here. The deficit has gotten bigger of late, but it's been much bigger in the past without calamity setting in. It's not shown here, but our federal debt is 44% of GDP, up from a low in 2001 of 33%. It was 114% of GDP right after WWII, and it fell to the mid-20s in the inflationary 1970s.

Bush did allow government spending to grow faster than the economy, but Democratic congresses in the early 1980s and 1990s had far worse records. Bush's tax cuts were instrumental in boosting the economy out of its post-2001 slump, and from a Laffer Curve perspective they worked exactly as hoped for, since revenues grew a lot faster than the economy despite tax rates being much lower. I think Bush deserves more credit than he's gotten. Oh, and the big rise in revenues under the Clinton administration was due in large part to lower tax rates on top of the tech bubble, while the big decline in spending under Clinton was largely the result of a huge cutback in defense spending.

It's going to be very hard for the next administration to raise taxes. For one, there is no evidence that higher tax rates are going to boost revenues relative to the economy, and they could actually result in lower revenues. Two, there is no pressing need for more revenues given the size of the deficit. The Reagan deficits were much larger, and they went away despite a reduction in tax rates (and probably because tax rates were cut), because the economy surged.

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