Sunday, December 26, 2010

Federal revenue growth is impressive, believe it or not

It strikes me that the recent growth in federal tax revenue is not widely nor sufficiently appreciated, probably due to the pessimism that pervades just about every long-term outlook these days. The chart above, which plots the 6-mo. annualized growth in rolling 12-mo. federal revenues, shows that tax receipts are now rising at double-digit rates. Total federal receipts over the 12 months ended November '10 are more than 10% above (annualized) total receipts over the 12 months ending May '10. This is shown in the chart below: monthly revenues this past year have been consistently higher than they were a year ago. All that progress, without raising a single tax rate! In fact, as the charts above and the second one below document, the major determinant of federal revenues is the business cycle, not tax rates. During recessions, revenues collapse, and during recoveries revenues rise, usually faster than the growth in nominal GDP. Now that we are 18 months into a recovery, it is not surprising at all that tax revenues should be rising at a much faster rate than GDP.

The chart below helps put this into perspective. For 50 years, from 1955 through 2005, revenues on average rose at the same rate as nominal GDP (i.e., revenues as a % of GDP were relatively unchanged), even though tax rates changed dramatically. Revenues are still at a post-war low relative to GDP, of course, but that is mainly because this recession has been deeper than most others.

As the economy picks up, tax receipts accelerate because more people work and pay taxes, corporate profits rise, and incomes rise in our highly progressive tax system—the most progressive of any advanced economy. Recoveries always result in a huge increase in tax revenues. Unfortunately, when revenue growth is at its strongest, politicians inevitably figure out how to spend money even faster.

There is every reason to think that federal (and state and local) revenues will continue to grow at a relatively high rate as long as the economy continues to recover. Balancing the budget doesn't require higher tax rates, it just requires spending restraint and pro-growth policies. Holding spending constant, and assuming revenues grow at their current rate, the federal budget would be balanced in 5-6 years. If the new Congress can't make a significant move in this direction (i.e., holding the line on spending and keeping tax rates as low as possible), they deserve to be trounced in the next election.


Benjamin said...

I think we should be concerned with the total tax bite, perhaps even more than the top tax rate.

I would be happy with a system that limited federal revenues to 16 percent of GDP (about 5 percent lower than present) even if the top tax rate remain unchanged.

In other words, we could cut taxes extensively on the the middle class, or on business.

At this point, I believe the corporate income tax is so convoluted and lawyer-ridden, and such a minor source of income, that we could eliminate it entirely, perhaps offset just a bit by higher gasoline taxes.

The USA had very high top federal income tax rates in the 1950-70s (higher than 90 percent) and yet we prospered. Reason: The total federal tax bite was smaller than today.

I think this is an error that right-wing commentators make today, in that they focus on the top tax rate. It also does the right-wing a disfavor, making righties appear as minions for plutocrats, rather than primarily concerned with economic growth.

jeff said...

Scott, can you chart tax rates vs GDP growth? in addition to tax rates as a % of GDP.

Scott Grannis said...

Jeff: I don't think a chart of tax rates vs. growth would tell you much, since until recently real GDP growth has averaged about 3% per year ever since the mid-60s. You would however see that the big tax cuts of the Reagan years were followed in short order by the strongest rates of growth that we have seen for a long time.

Benjamin said...


There is fun graf here:

As Scott said, good GDP growth in the Reagan 1980s--but even better in 1990s (slight uptick in top tax rate under Clinton).

What is really remarkable is how things calmed down in the Volcker and succeedng eras (until Bush jr., off the chart).

It looks like the country was having heart attacks until Volcker got in (or Reagan, if you prefer).

Victor said...

I wonder what affect people/businesses moving taxable events into 2010 to avoid higher (anticipated) rates in 2011+ had on tax receipts over the last 6 or so months? I.e., is this a short-term "bubble" in tax receipts; will it continue into the future?

Friends of the Winemakers said...

With negligible job growth in 2010 where did the revenue increase come from?

Friends of the Winemakers said...

How to keep spending constant when the first of the baby boomers qualify for Medicare on Jan. 1, 2011?

Friends of the Winemakers said...
This comment has been removed by the author.
Scott Grannis said...

Friends: even with negligible job growth, incomes are rising and equities are rising (e.g., capital gains realizations) and corporate profits are very strong.

Scott Grannis said...

Friends: To keep spending constant would be challenging of course. But it starts with reforming entitlement programs and eliminating a lot of programs that aren't really necessary.

Friends of the Winemakers said...

It would be nice to have some data that supports your claim that incomes have risen as fast as your chart shows. Ditto for the waste in social security/Medicare to keep spending at today's level. For example, there are only 60 million seniors over 65 today. There will be 75 new senior citizens in the next 16 years.

Scott Grannis said...

My claim is based on data that comes directly from Treasury.

That's not to say there won't be problems in the future, however. Medicare and social security desperately need major fixes.