Here's my monthly update of the Federal government's finances. After some 18 months of improvement, during which time spending was restrained and revenues grew at a respectable rate—thanks to rising employment, strong productivity growth, strong corporate profits and a rising stock market—spending has once again perked up, sending the 12-month deficit to $1.4 trillion.
The recent budget agreement will do little to change the reality of a looming fiscal trainwreck. And even if the fiscal gap is eventually closed via higher taxes, the burden of government, as Milton Friedman taught us, is found in spending, not taxes or borrowing. If the government continues to spend 25% of GDP, the impact on the economy will not be mitigated by taxing more and borrowing less. Indeed, taxing more would probably be harmful to the economy in the long run, since it would immediately reduce the after-tax incentive to work and invest. Plus, as my mentor Art Laffer always used to say, if you had the choice of paying more taxes to the government or buying Treasury debt, wouldn't it be much better to lend the government the money? At least then you would have the hope of getting your money back, and with interest. In the end, whether the government borrows 10% of GDP or taxes an extra 10% of GDP, the federal government will end up spending the extra money in a way that will surely be less efficient and more wasteful than if the money had remained under the control of private interests. Friedman also reminded us that you never spend someone else's money as frugally and wisely as you spend your own.
The long-term outlook for the economy will only improve to the extent Congress is able to restrain the growth in spending. As I've pointed out before, simply freezing spending at current levels would balance the budget in about 5 years.
I think this can be done, and I think the recent budget agreement was the first step in the right direction. I note that the whole nature of the fiscal debate has changed 180º: the question now is how much and what to cut, not whether to cut spending. Consider Obama's amazing chutzpah when he praised the recent deficit reduction, just months after proposing the most outrageous deficit-ridden budget in recent memory.