Wednesday, February 11, 2015

The good and bad of federal finances

Good news: January's federal budget statement showed that federal revenues continue to exhibit strong growth, rising at an 8-9% rate. The bad news, however, is that federal spending is once again growing, at a 5-6% rate, after five years of no growth. Unless Congress manages to rein in the growth of entitlement spending, the budget deficit is going to start growing again. It's a difficult task, given the huge constituency that thrives on transfer payments, which increased 5.6% last year (in contrast to a 2.1% increase in CY 2013), and which now make up almost 20% of disposable income and consume over 71% of federal spending.

Conventional wisdom has held that the absence of growth in federal spending from 2009 through early last year was a significant drag on growth, since it reflected "austerity." Supply-siders see things differently: zero growth in spending meant a shrinkage in the burden of government on the private sector, and this was a stimulus to growth. A shrinking public sector allfowed the private sector to manage more of the economy's scarce resources more productively than the government could, and this served to strengthen the economy. This shrinking-government "tailwind" to growth is now beginning to fade, albeit very gradually. But if left unchecked, growth in entitlement spending could become a huge problem in the years to come.

Flat growth in spending coupled with strong growth in revenues resulted in a huge reduction in the federal budget deficit. If the deficit were to never grow beyond its current level, we wouldn't have a problem. A deficit of 2-3% of GDP is eminently sustainable, and is arguably even necessary in order to ensure the continued liquidity and efficiency of the Treasury debt market—which serves as the backbone for the world's bond and stock markets. 

Strong growth in federal revenues was driven primarily by individual income tax receipts, which in turn were driven by the growth in jobs, as the chart above shows. In short, economic growth is the main source of revenues for the government.

The chart above shows federal transfer payments as a % of disposable income. This is now by far the largest component of federal spending, comprising 71% of federal outlays. Transfer payments have mushroomed from 32% of federal spending in 1968 to more than twice that today, and from 5% of disposable income in 1951 to almost 20% today. They will continue to rise as baby boomers retire and healthcare subsidies increase, not to mention the myriad other entitlement programs which always seem to exceed expectations (e.g., student loans, food stamps, disability insurance, medicare).

The chart above shows the contribution to the burden of our national debt (total debt held by the public divided by nominal GDP) that can be attributed to various presidential administrations. As of December, 2014, the increase in the federal debt burden under the Obama administration was 26.5 percentage points, rising from 47% when Bush left office to 73.5% today. That was almost as much as the net federal debt burden accumulated by all the presidencies prior to Nixon (29.3%). (Note that the red bars in the chart represent increased debt burdens, while the green bars represent reductions in the debt burden.) In all of our nation's history, today's debt burden was surpassed only by the WWII-related debt burdens of the 1940s which were substantially paid off during the 1950s.


Benjamin Cole said...

Maybe I am too old fashioned, but I do not see the attraction of a permanent annual federal deficit of 2 to 3 percent of GDP. The economy boomed in the 1990s, when the federal government was actually paying off the debt.
While federal transfer payments have exploded in the last 40 years, much of that is actually Social Security and Medicare payments financed through payroll taxes.
National security spending has also exploded and the US now, in real terms, spends double what it spent at the height of the Cold War. National defense outlays must be financed through income taxes.

Like I always say, take a chainsaw to all of it.

steve said...

the federal government is a labyrinth the likes of which no one could possibly get their arms around-and BOTH parties are responsible for it. it's a wonder that the economy functions as well as it does DESPITE the pitiful state of affairs. and bitching about spending is tantamount to pissing is the wind. NOTHING WILL STOP THE GROWTH.

William said...

Bank of England Governor Carney Looks Past Low Inflation to Signal Faster Interest Rate Increases

(Bloomberg) -- Mark Carney insisted the Bank of England can look through an inflation slump as officials signaled interest-rate increases could come sooner than investors anticipated.

While the governor presented forecasts showing the rate of price growth may drop below zero in the coming months, he blamed weakening oil prices and said domestic pressures are building. That means inflation will accelerate at the end of this year and breach the 2 percent target at the end of the three-year forecast period.

“Output growth remains solid and domestic demand growth robust,” Carney said at a press conference on Thursday. The Monetary Policy Committee will look through the effect of energy prices and “the most likely next move in monetary policy is an increase in interest rates.”
For a long time, I have observed that Great Britain's monetary policy leads the US for reasons I don't understand. However, the US Federal Reserve's discussion may be along the same line of reasoning - as Scott has suggested.

Joseph Constable said...

I am subversive. I actively explain SS to young people and seed their minds that they should plan on defaulting on the national debt when they are in power after enough of their parents die off.

In the mean time we could actually means test SS. But it won't happen.

Hans said...

JC, means testing with SS is already happening.

"Strong growth in federal revenues was driven primarily by individual income tax receipts, which in turn were driven by the growth in jobs, as the chart above shows."

Was this not due to higher taxes? After all, taxes revenuse, for the Central governmental unit came in just over 1 trillion, the highest ever recorded.

And the BOCO administration has file for a near 4 trillion dollar budget.

Last but not least, both the Central and state governmental units, they use two different forms of budget, wherein long term debt is not included..If a business did that, it would be charged with a high crime.

WDC, is broken to the point, that only a state convention will fix the problem.

For those whom are young enough, look for around 2025, when the debt issue and all the governmental obligation come to a boiling point.