Thursday, August 13, 2015

Budget deficit down to only 2.2% of GDP

Not too long ago, it looked like the U.S. federal budget deficit would be measured in the trillions of dollars and double-digit percentages of GDP for as far as the eye could see. Fortunately, the future didn't turn out to be nearly as bad as expected. In the 12 months ended July 2015, the federal budget deficit was only $432 billion, or 2.2% of GDP. What was once a source of impending catastrophe is now just business as usual. Although conditions in the U.S. economy are far from optimal (about $3 trillion per year too far), they are orders of magnitude better than they could have been or were expected to be. Here's a brief recap of one of the more promising developments in the U.S. economy in recent years.

The budget gap has narrowed considerably, thanks mainly to spending restraint and growth in federal revenues which has averaged about 8-10% a year since 2009. Most of the latter is due to the fact that jobs and incomes have steadily increased, and corporate profits are very near all-time highs, both nominally and relative to GDP. In other words, thanks to budget austerity and economic growth, the deficit has returned to earth instead of heading for the moon.

Relative to GDP, federal spending and revenues are very close to their long-term averages. It's nice to see that, although things could be a lot better, at least they are no worse than average.

The budget deficit has collapsed to a mere 2.2% of GDP. Five years ago the deficit was $1.5 trillion; today it has fallen by more than two-thirds, to just $432 billion.

The lion's share of increased revenues—which are up by over 50% since 2009—has come from individual income taxes. In the year ended last month, the federal government collected $1.53 trillion in individual income taxes, up 74% from the 2009 low, for an increase of almost three quarters of a trillion dollars.

As election-year politicking picks up, it would be nice to see some candidates using these figures to argue for significant cuts in the top marginal tax rates for individuals and corporations. There's nothing wrong with the deficit today that continued austerity and faster economic growth couldn't cure. The "cost" of cutting marginal tax rates would almost surely be offset by faster growth. That's because, as I've pointed out repeatedly, one of the biggest headwinds the economy has faced in recent years has been high and rising marginal tax rates. That's why business investment and new business formation has been so weak—and what this recovery has been the weakest on record: on an after-tax basis, the rewards to taking risk and working harder are simply not attractive enough. Not to mention, of course, the burdens of increased regulations, which have surged with Obamacare and Dodd-Frank.

Today's federal budget offers very fertile ground for positive changes in fiscal policy going forward, if only savvy politicians would take note.


George Phillies said...

Buried in that graph is the payroll tax. It speaks with fair accuracy to the total wage and salary income of almost everyone, capped at around $110,000, and is thus a perhaps-reliable measure of how the economy is doing for people who work. The graph is a bit small; can you read from it what the annual percent increase is in the last few years, recalling the period when the rate was dropped?

NCFinanceGuy said...

Only a politician would spin this as good news.....LMAO

Benjamin Cole said...

At the very spearpoint of the free enterprise-capitalistic system are people who hire, and people who work. They deserve rewards.

Cut FICA taxes!

BTW, the rapidly shrinking federal deficit, but mediocre economic growth, seems to undercut the call for federal deficits to spur growth. I think monetary policy should be growth-oriented, but balanced federal budgets seem to be a good idea too.

There is "bad news" in this picture however.

The ferocious surge in tax collections in recent years---as Scott Grannis points out, individual income tax collections are up 74% in recent years---has also not resulted in a recession.

That is the flip-side of the "Keynesian doesn't work." Smaller deficits do kill growth, even if tax-based. Evidently, gigantic increases in income taxes did not thwart recovery.

Hard to believe, but Scott Grannis has proved it.

Thus, balancing the federal budget through huge surges in tax collections has also not killed the recovery---this makes the Scott Grannis call for lower marginal income tax rates a bit puzzling. A small decrease in income and capital gains tax collections will make a difference?

That said, I would prefer we drive down federal agency spending, with deep cuts in civilian and military outlays. I think federal outlays at 15% of GDP, not 22%, is a good target.

Still, I think FICA tax cuts could actually spur hiring and the incentive to work, for the tens of millions of people---employers and employees---who decide to contribute to the economy, not sap it.

steve said...

Scott, you've published this several times and every time you do I have to shake my head. the federal DEBT is over $18T! How that can be construed as anything good boggles my mind. That we are piling up debt at a slower pace than a few years ago hardly qualifies as "good news," at least in my feeble mind.

Scott Grannis said...

Steve: The federal debt owed to the public is $13 trillion, not $18 trillion. The latter includes $5 trillion that the government owes itself (e.g., money the government has borrowed from social security), which in the end is just an accounting artifact designed to make it look like social security has a "lockbox" that is full of money (surplus funds)—when in reality that money has been spent. I'm not saying that $13 trillion is OK, as it is over 70% of GDP and that's a lot. But as a percent of GDP, the burden of federal debt is no longer rising, at least for the time being, and that is good because otherwise it could become an enormous problem.

The federal deficit—the amount of new debt required every year—has fallen to manageable levels of 2-3% of GDP. That is good.

If the deficit were to remain around $400 billion or so, the burden of the federal debt would gradually fall. That is good.

So on the margin there have been some welcome developments on the deficit and debt fronts. But that doesn't mean the accumulated debt is good. On the contrary, it represents an enormous sum of money and scarce resources that the government has effectively squandered. It is one of the reasons this recovery has been so slow, and it will act as a headwind to future growth and a drag on our nation's prosperity.

Thinking Hard said...

Scott - As always, thank you for your input. Always enjoy reading your articles even if I don't entirely agree with everything.

Article this morning in the WSJ - "Economists Cite Budget Battle as a Top Threat"

Think we are heading into another government shutdown this fall for political reasons? See any problems in this area? Your thoughts on the proposed balanced budget amendment?

Unknown said...

"they are orders of magnitude better"

One order of magnitude is a factor of 10. Orders of magnitude would be factors or 100, 1000, etc.

Scott Grannis said...

Re another government shutdown: I don't have any special expertise in this area, but I would hope we don't come to that.

Re a balanced budget amendment: I am not in favor of such an amendment. As Milton Friedman said, it's not the debt that matters, it's the spending. If we keep spending in check and reduce it as a % of GDP, whether or not we have a deficit that needs funding with debt becomes almost irrelevant. A balanced budget amendment would wrongly put the focus on the financing of deficits when it is the source of the deficits (too much spending) which is the real problem. Debt financing of responsible spending could actually make a lot of sense in some circumstances.

I believe it is in our best interests as a country to always run a deficit of at least, say, 2% of GDP. That's because the existence of a large and liquid Treasury market is like the backbone of global financial markets. Financial markets need risk-free securities of varying maturities to function well. The value derived from a liquid Treasury market could possibly offset much or all of the cost of servicing the debt. Moreover, investors all over the world are willing to pay a premium to own our Treasury debt: why should we deprive them of something they are willing to pay for?

But what's the optimal size of Treasury debt that is necessary to help global financial markets function smoothly? I'm not sure, but it must be a lot less than what we have today. I'm going to guess that always having outstanding debt equal to, say, 25% of GDP would do the trick. That means the burden of our Treasury debt needs to be cut by almost two-thirds, then held relatively constant.

Benjamin Cole said...

Seems to me the world economy and the US economy did fine in the 1990s when the US government under Clinton and the GOP Congress actually ran federal budget surpluses.

Moreover, I do not understand why it is the obligation of the US taxpayer or government to create a safe investment class for financiers. I want a government that does less, not more.

Surely, the first 50% LTV on a good commercial property is a very safe asset. Leave the private sector alone--- and remember the federal government has the reverse Midas touch. If our federal government sets out to help world investment markets....

Benjamin Cole said...

Atlanta Fed just projected Q3 USA at 1% real GDP growth...

Benjamin Cole said...

Sorry, update: The Atlanta Fed revised Q3 real growth to...0.7%

Lawyer in NJ said...

I think it's reasonable to argue that the ARRA helped lay the groundwork for the recovery.

Should it have been more infrastructure intensive? Of course, but when one side is dedicated from Inauguration Day 2009 to defeat the incoming president no matter what, then bipartisan deals aren't possible.

Scott Grannis said...

Lawyer: I recommend you read my post from a few years ago on the subject of ARRA and stimulus:

As I note there, only 8% of the money went for infrastructure. Over 75% was income redistribution in various disguises. I'm comfortable saying there is NO Way that the ARRA laid the groundwork for the recovery. The best recoveries are built on the efforts of the private sector. This recovery "enjoyed" the most extreme efforts at pump-priming via income redistribution of any in modern memory, and it is not a coincidence that it has been the weakest.

I explain in greater detail why and how these efforts failed here:

The failure of government stimulus had nothing to do with partisan bickering, and everything to do with a failed ideology. Government simply cannot make the economy grow by redistributing income or spending money on "shovel ready" projects.

Hans said...

Steve, Mr Grannis falls into the governmental unit camp, regarding
budget and debt accounting..

They both use bi-budgets, as a form of conveying less spending and debt.
The State of Minnesota does so yearly, with the complete budget, which understated
the operating budget by as much as 50%.

This is also done by corporations in their reports to shareholders, in the form
of non-GAAP quarterly reporting; but NOT so course to the IRS..

I did find the statement of Federal spending austerity - simply beyond my

The fact that federal governmental unit spending is level or up slightly is
considered HARSH or SEVERE - is a misnomer at best..

But then, the current rage of the use of this word, does indeed add to the
world's economist lexicon..

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