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.