Wednesday, December 10, 2008

Federal budget update -- why not cut taxes?

With the release today of November's budget figures, the federal deficit over the past 12 months now stands at about 4.75% of GDP. That is way up from a few years ago, but it is still less than the peak deficit of 5.8% recorded in 1983. As this chart shows, the cause of the deficit is primarily a surge in bailout-related spending, and secondarily a decline in revenues. Declining revenues are not unusual during recessions, but what strikes me about this one is how little revenues have declined compared to how much they declined in the wake of the 2001 recession.

One reason for this of course is that revenues were boosted prior to the 2001 recession by the huge rise in stock prices and associated capital gains realizations; the subsequent stock market collapse caused capgains realizations to fall dramatically. That wasn't a big factor this time. So revenue swings in the early 2000s were exaggerated by stock market swings, whereas the big story today is spending growth. Very different recessions, to be sure.

If bailout spending slows down, as I think it will given mounting public opposition, then the deficit shouldn't increase a whole lot more. I'm not a fan of deficits (the current 12-month deficit adds up to almost $700 billion), but relative to the size of the economy we are still far from being in dangerous territory. The extremely low interest rates on Treasury bills and bonds tells us that even with explosive growth in the deficit the world is clamoring for more.

It would be great to see the Obama administration back off a bit from its big-spending plans and focus instead on cutting taxes. Spending on infrastructure is not necessarily a great way to stimulate the economy, since it will take an awful lot of time to happen, and it's not clear that our current difficulties have much to do with deteriorating roads or a lack of computers in our schools or a bad mix of energy production. Cutting taxes improves incentives almost immediately, on the other hand, and coaxes more of the best out of what the private sector has to offer, which is almost certain to be more effective than what government bureaucrats can come up with. And as the chart also shows, cutting taxes doesn't necessarily make the deficit worse, particularly if lower taxes help jump-start the economy like they did in the latter half of 2003.


Tom said...

Why not cut spending? Cutting taxes with a growing fiscal deficit will not reduce the governmental burden on the economy.

With Obama administration people and advisors talking about $1 trillion + in "stimulus" do you really think that the deficit will not baloon? Consider, too, that revenues may fall much further. According to your chart, revenues didn't bottom until after the declared end to the last recession. And it sure looks like this recession could be dramatically deeper.

For that matter, wouldn't the reported deficit be much greater if the government used effective accounting policies and systems? Every unfunded increase in the present value of future liabilities should be in the deficit. The US Comptroller General's office has severely criticized the US government's accounting, that's no secret.

Tom Burger

Jon S. said...

Tom, of course we should cut spending, but no Congress in recent memory has done that no matter who's in charge. There's been a steady growth in spending for a generation now. It simply will not happen. Spending will surely rise now that we have a 'triple play' in effect: Democrats in control of the WH, the Senate, and the House.

I also wanted to comment on Scott's point about infrastructure spending. One of the many myths about this administration is that it has let infrastructure lapse dangerously; I heard this on a local NPR affiliate yesterday for the millionth time since Bush has been in office.

What almost never gets pointed out is that states, counties, and towns -- not the federal government -- are responsible for most of the nation's infrastructure spending, and there's been plenty of such spending for a very long time now. The feds spend about 15% of the annual total infrastructure amount, mostly on transportation.

I'd also like to say that WPA-style spending is not a good long-term solution; the jobs don't last long, for one thing, and the multiplier effect is typically limited. Is the change we can believe in really 1930s-era makework projects? Slash the cap gains tax rates and eliminate corporate taxes, and you'll see a huge market rally, real growth, and higher revenues in fairly short order.

Scott Grannis said...

The more I think about how stupid it is, the more I suspect that Obama's emphasis on infrastructure is not about roads and bridges but mainly about alternative energy projects. He'll call it roads and bridges and schools, but it will mostly consist of windmills and alternative energy research. Which, of course, will be money poured down the drain of government inefficiency. If these projects were so promising, the private sector would be lining up to launch them. Now, the only ones standing in line will be the lobbyists looking for a piece of the Federal Pie largesse.

Jon S. said...

Scott, I think you're right that they will put a ton of money into eco-projects in the stimulus. Too many of his advisors watch the Sundance Channel and think it's just so easy going green, if only the federal government will 'do' something about it! This will be the SynFuels Corp Redux with a green logo; maybe he'll appoint Jimmy Carter to be his alternative fuels guru.

Scott Grannis said...

That brings up the whole issue of "saving the planet" by reducing carbon emissions. I have avoided that topic so far, since it is endlessly convoluted and fraught with politically-correct overtones. But I have yet to see any evidence that a) mankind's carbon emissions are causing significant warming, b) if warming is occurring it will be a net negative for the world, and/or c) spending gobs of money to reduce carbon marginally is wiser than spending the same money on other pressing global concerns.

SpeakToMe said...

Lower taxes? Total pipe dream. Obama will agressively raise taxes on the wealthy (any household making more than $250k) as soon as he can.

The more you and other financial market participants imagine otherwise, the harder our financial markets will be hit when Obama and his advisors make good on their promises.

Scott Grannis said...

Speak: I share your concern about higher taxes, but I also think that the market is priced to just about the worst that Obama could manage. If he meets expectations, nothing happens. If he pulls back just a bit from his Robin Hood instincts, that could be bullish.

Jon S. said...

I think you'll have to start posting on global warming, since Obama and Co will make going green a big part of their approach to all things budgetary and fiscal. That they follow the Al Gore line in theory, that manmade global warming is a settled fact and not a theory, is a given; what can't be known yet is how ardently they'll fight for specific programs and policies to implement Gore's narcissistic flights of fancy.

I'll simply say here that climate change is always occurring, and that the causes of even the current round of ever so slight warming since the 1970s (although not since 1998) is in much dispute in the real climatology community (not the politicized science community, whose numbers grow all the time). We've had many periods of warming well before the industrial era, and well before the advent of man for that matter, so we know that natural causes are usually the culprit.

In any event, the question for this blog is the economic/financial impact of budgeting for climate change at the federal level. Many Dems in Congress and with Obama often talk about a Manhattan Project for "solving the climate crisis," which demonstrates their scientific illiteracy. For big engineering ventures where much of the science is either known or almost known, Manhattan Projects might work. When we so poorly understand the basic science involved as is the case with climate change, the argument can be nothing more than a silly politically correct platitude.

CDLIC said...

The Real Cost of the 2008 Recession (12/9/08) from

From the article:

"Three months before the recession was officially declared, Paulson and Bernanke have embarked on the largest bailout program ever conceived with the blessing of a lame-duck president and a complicit Congress - a program which so far will cost taxpayers $8.5 trillion. This staggering sum encompasses: loans backed by worthless assets ($2.3T), equity investments in bankrupt companies with negative net worth ($3.0T), and guarantees on crumbling derivatives and other hollow collateral ($3.2T)."

Scott Grannis said...

Jon S: You're preaching to the choir here; I'm with you 100%. As for the impact of all this, it seems clear to me that if we spend a lot of money in order to use less of the cheapest source of energy (hydrocarbons) and more of the more expensive sources of energy (sun, wind, etc.), then we are going to make our economy less efficient and thus slow the rise (or possibly halt it) of our living standards. The way politicians play fast and lose with energy and climate "facts" and the costs of bringing about significant change is appalling to me.

In the end, I'm hoping that Obama will be content to play lip service to all this, and that passing a sweeping reform like the fantatics would want will be politically impossible.

dave said...

Please inform your readers that it is now incorrect to speak of Global Warming, the new name evnviro-cooks use is Climate Change. Apparently they have been embarrassed too many times by snow fall messing up their global warming conferences.
Beside the weather or climate is always changing so it is easier to rally the masses .

Dave Cribbin

Scott Grannis said...

dave: excellent point. Readers, you are so advised!

Scott Grannis said...

CDLIC: I think those figures exaggerate the true cost. The government has bought or guaranteed assets that are not entirely worthless.