Wednesday, January 13, 2010

Fiscal policy update














There's a wealth of information in these charts, and they speak volumes. I'll just highlight a few things:

The federal deficit increased marginally in the 12 months ended December, according to figures released today by Treasury, as revenues declined by more than outlays. Federal revenues as a % of GDP haven't been this low since 1943, even though the top marginal tax rate back then was 88%, and today it is 35%. Tax rates are thus not the major determinant of revenues—the health of the economy is. As a supply-sider, I believe the economy would be healthier today, and revenues would be higher as a result, if Congress and the Obama administration had focused their stimulus efforts on lowering marginal tax rates for individuals and businesses, rather than massively redistributing income and ramping up make-work projects.

Federal spending as a % of GDP hasn't been this high since World War II. If Obama's spending plans aren't cut back, spending is destined to remain at a level of GDP that we have only experienced during wartime. This would be a truly unprecedented (to use O's favorite word) expansion of the government's control of the economy. As Milton Friedman taught us long ago, it's not really the federal deficit that is bad for the economy, it's the level of government spending. The more government spends, and the more it takes out of one person's pocket and puts into another's, the less efficient the economy becomes. Roughly two-thirds of the $3.5 trillion spent last year by the federal government was entitlement spending. That's about $200 billion every month that the federal government collects from some people and hands out to others.

If these trends continue—permanently higher spending that focuses primarily on income redistribution—it is not clear at all that tax receipts can be raised sufficiently by raising tax rates. Our economy has never generated a level of of federal revenues sufficient to finance current spending projections, no matter how high tax rates have been.

As the bottom two charts show, we saw a huge reduction in top marginal rates since the mid-1960s, but tax revenues as a percent of national income have remained basically unchanged (with the exception of the recent recession).

I don't see impending disaster in these charts or in the numbers. But I do see that we are entering uncharted waters, and that the unprecedented expansion of the size and scope of the federal government, and its increasing focus on income redistribution, raise very troubling prospects. While these concern me greatly, I do believe that it is possible to reverse these trends, and I note some major shifts in the politicial winds this past year that are encouraging in that regard. Things look very grim, but I think the changes on the margin going forward will prove to be positive.

8 comments:

Benjamin said...

I love MF, but I never quite agreed with the sentiment that it is the level of government spending only that matters, and that deficits do not.

The USA was paying down debt in the 1950s and 1960s, and again the 1990s. Those are our best decades ever, economically speaking.

That said, I would like to see federal spending as fraction of GDP decline--and a balanced budget, or small surplus.

Jeez, in the 1990s, some people were actually floating out the idea that corporate bond analysts would be a hot ticket, as the "easy choice" of buying federal securities would disappear.

The economy was booming with low inflation back then.

I can't prove cause and effect, but it warrants a look.

W.E. Heasley said...

Mr. Grannis:

As you allude to in your post, and along the lines of the Laffer curve, raising taxation past equilibrium will not generate sufficient revenue to finance the size and scope of the current government. That tax increases will yield a constant taxation revenue or declining revenue (Dr. Art Laffer’s arguments). Which then leaves one option which is the reduction in the size and scope of government?. In other words, what is out of equilibrium is in fact the size and scope of government.

STS said...

Scott,

Could you elaborate on the structural increase in spending? It appears to me that the stimulus bill, large as it *sounds* to folks who would not be able to quote the U.S. GDP to the correct order of magnitude without looking it up, is all "one shot" money.

The healthcare bill (which may well not even pass) promises to *reduce* growth in spending in the out years.

The banking and auto bailout initiatives are mostly capped and in some cases being paid back.

Where is the vast structural increase in government here? Seems to me that Medicare part D (which I suspect you disliked even tho' it was a Republican project) is a far bigger permanent fiscal bleeder than anything O has put forth to date.

I get it that you think the fiscal 'steroids' are VERY BAD both long and short term, but I guess I'm wondering with Mark McGwire -- if the drugs just help you bounce back and compete the next day, why is it "The End of Fair Competition"? Maybe it's the long term pay back in inflation or taxes or both? It seems like we can grow out of temporary increases in gov't spending.

alstry said...

Roughly two-thirds of the $3.5 trillion spent last year by the federal government was entitlement spending. That's about $200 billion every month that the federal government collects from some people and hands out to others.

Scott,

Was much of the entitlement spending simply from borrowing money and not taking it from one "people" and giving to another. And under the principles of fractional reserve banking, there really doesn't need to be the money actually in the account to lend it.

So, is it really taking from one and giving to another or is it simply printing money from thin air and creating a debt burden for all?

Thank you.

Scott Grannis said...

alstry: it should be obvious that money was taken from one and given to another, rather than being printed. There is no evidence whatsoever that the money supply has grown by enough to finance all the spending.

Scott Grannis said...

STS: Much as I detested Bush's expansive fiscal policies (which in turn helped lay out the red carpet for Obama's eventual victory), healthcare reform promises to produce the biggest increase in deficits and government power that we have seen since the days of the New Deal. Obama makes Bush the Profligate look like Scrooge. It takes my breath away. Indeed, I think healthcare reform is so reckless and over the top that I can't believe it will ever see the light of day.

alstry said...

Scott,

If the money was exported, wouldn't it show up on the balance sheet of foreign nations rather than our money supply.

Wouldn't that be consistent with the massive deficit we are running?

W.E. Heasley said...

STS writes:

“I get it that you think the fiscal 'steroids' are VERY BAD both long and short term, but I guess I'm wondering with Mark McGwire -- if the drugs just help you bounce back and compete the next day, why is it "The End of Fair Competition"? Maybe it's the long term pay back in inflation or taxes or both? It seems like we can grow out of temporary increases in gov't spending.”

Try this brief explanation on for size STS……..


The Keynesian jump start theory aka “stimulus” (which is better signified by the term “debt”) always comes with the lovely diagram of the bucket (Keynesians love that bucket diagram).

The bucket represents demand. The bucket's content is household, business, and government demand for goods and services. A recession, according to Keynesians, is a bucket that is not full to the brim. The bucket is no longer full as the demand components of households and businesses has shrunk and hence its the government's responsibility to increase its expenditures (increase its component of the bucket) in order to bring the bucket back to full.

Seems like common sense. However, the increased government expenditures that attempts to fill the bucket is really draining the bucket simultaneously. Its counterintuitive. As the government increases spending, private capital formation leaks out of the bucket. Hence you try and try to fill the bucket but it remains below the brim.

Once you stop filling the bucket with government deficit spending, you now must pay for the deficit spending. Hence Keynesians raise taxes. The taxes then create another leak in the bucket. Hence the bucket goes right back to the level that you began with before you started this wasted exercise.