Thursday, June 10, 2010

Federal budget outlook is improving on the margin

Believe it or not, since January of this year the financial health of the U.S. government is no longer deteriorating. The top chart shows federal spending and revenues on a nominal basis, while the second chart shows spending and revenues as a % of GDP. Revenues (on a rolling 12-month basis) have increased by $50 billion since January (monthly receipts this year have exceeded those of the same month last year on balance), while spending has declined by about $40 billion. The deficit has thus dropped, to just under $1.4 trillion (next chart).

This is not to say we're out of the woods however. Spending remains very elevated by any measure and that is very likely to slow the pace of recovery, since government spends money less efficiently than the private sector. Also, with increased government spending comes increased regulation and control over the activities of the private sector, which is ultimately the main source of growth. Above all, massive spending ultimately requires massive tax burdens, and markets have been struggling to discount these potentially higher tax burdens ever since early last year. Art Laffer made the threat of higher tax burdens very clear in his WSJ op-ed the other day, but I read that more as a warning shot across the bow (i.e., an attempt to persuade the electorate and politicians to avoid allowing the Bush tax cuts to expire) than a flat-out prediction of impending disaster. Finally, spending is likely to move higher in coming years if no action is taken to trim government outlays and cut back entitlement programs. (Though I am hopeful that this will occur thanks to what appears to be a significant rightward shift in the mood of the electorate.)

But for now there is clear improvement in the area of tax collections, with revenues behaving in a manner which is consistent with the early years of prior business cycle recoveries. On a cyclical basis, revenues should continue to pick up and outlays should tend to be relatively subdued for at least awhile, since the economy is growing (and generating higher incomes) and the employment situation is improving (and generation fewer expenditures on things such as unemployment insurance).

The fiscal threat to recovery is still large and ominous, but on the margin it is receding—thank goodness for small favors.

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