Federal finances update

The above chart summarizes the current state of Federal finances over the most recent 12-month period ending November. The good news is that for the past two years, revenues have been slightly outpacing spending—hard to believe, I know, but nevertheless true. The bad news is that the gap between spending and revenues is still enormous.

This chart contrasts total federal revenues with the portion that comes from individual income tax receipts. Here we see that the biggest source or rising tax revenues has been income taxes, since they have risen at a much faster rate. One reason for the sluggish growth in total revenues, of course, is the cut in social security withholding rates that has been in place for the past year and is quite likely to be continued. The chart also highlights the fact that since the Bush tax cuts were first instituted in mid-2003, income tax receipts are now substantially higher—36% higher (almost $300 billion on an annual basis)—than they were when tax rates were higher. Once again, we see here concrete evidence that Art Laffer's vision (and his famous curve) was anything but crazy: lower tax rates can promote stronger growth, and thus result in higher tax revenues. If it weren't for the 20080-9 recession, which had everything to do with a collapse of the housing bubble and a 6 million decline in the number of private sector jobs, and almost nothing to do with low tax rates, both the economy and tax revenues would now be considerably higher.

The state of federal finances remains abysmal, but nevertheless it is the case that the deficit as a % of GDP has declined from a high of 10.4% at the end of 2009 to 8.1% today. In nominal terms, it peaked at $1.48 trillion in Feb. '10, and in the most recent 12 months is now $1.25 trillion. If current trends continue—which is unlikely unless our major entitlement programs are reformed—then the U.S. could escape the fate that has engulfed the PIIGS countries, where deficits are above 9% of GDP.

This chart (inspired by Brian Wesbury) again bears repeating, since it lends support to claims by the anti-Keynesians (of which I am one) that the biggest factor that has worked to slow economic growth in recent years is the huge increase in federal spending. Instead of "stimulating" the economy, enormous increases—in both nominal and relative terms—in federal spending have ended up "stimulating" the unemployment rate more than anything else. The reason? The public sector spends money much less efficiently than the private sector. And when you consider that over 70% of federal spending takes the form of "payments to individuals" (i.e., transfer payments, see chart below), and that this has been the most rapidly growing portion of total spending, and you understand Milton Friedman's assertion that you don't spend other people's money on yourself nearly as carefully and efficiently as you spend your own money on yourself, then it becomes easier to understand. The vast bulk of government spending these days boils down to transferring money from those who are working and producing the most, to those that are working and producing the least, and that is not a prescription for a strongly growing economy.

While depressing to contemplate how large and inefficient our federal government has become, it is nevertheless the case that spending vs. GDP is slowly declining and the economy is slowly improving. If Congress can see fit to further curtail the growth of federal spending in the years to come, then the future should be much brighter.