Monday, July 15, 2024

How bad is fiscal policy?


It's no secret that federal debt is bigger, relative to the economy, than at any time since WW II, that deficits these days are measured in trillions, and that interest on the debt likely exceeds spending on defense. It's unquestionably bad. But is it out of control? Not yet.

To begin with, Federal Debt Owed to the Public is $27.7 trillion. It's not $34.9 trillion, as many will tell you. The latter figure is Total Public Debt Outstanding, but that includes $7.2 trillion of Intergovernmental Holdings. Those holdings are debt that one part of the government owes another (most of it is owed to Social Security). But to include that in the total is double-counting. Social Security surpluses are "invested" in Treasuries, and in this manner Social Security surpluses effectively reduce Treasury's need to sell bonds to finance the larger government deficit. 

Knowing how much the federal government owes to the world is one thing, but the burden of the debt is quite another. The burden of the debt depends on the level of interest rates and the nominal size of the economy. Today the debt is huge relative to the size of the economy, but interest rates are relatively low, with the result that the burden of the debt today is much less than it was in the 1980s, when federal debt was about 40% of GDP, thanks to interest rates today being much lower than they were in the 80s.

Here are some charts that put deficits and debt into perspective.

Chart #1

Chart #1 is a history of federal debt owed to the public from 1970 through July '24. It's plotted on a logarithmic axis, thanks to which a constant rate of growth shows up as a straight line. It's commonly thought that federal debt has been surging at unprecedented rates in the past 5 or so years, but that's not true. Debt grew at a much faster rate in the mid-1980s. For the past 75 years, our national debt has increased on average by about 8.8% per year, and recent years have proved to exception.

Chart #2

Another common misperception about our national debt is that more debt should push interest rates higher, and less debt should allow interest rates to decline. As Chart #2 shows, the relationship is often just the opposite. The peak in bond yields occurred in the early 1980s, when debt relative to GDP was very small and was growing rapidly. In the 2010s, debt was surging relative to GDP and interest rates collapsed. Lots of debt in the 1940s occurred during a period of low and relatively stable interest rates. As a general rule of thumb, interest rates are not determined by the amount of debt, but rather by the level of inflation and the strength of the economy.

Chart #3

Chart #3 shows the source of our national debt—the difference between spending and revenues. Is our deficit the result of it too much spending or not enough revenues? That, like beauty, is in the eye of the beholder. One thing for sure, however, is that the government chronically spends more than it takes in.

Chart #4

Chart #4 helps answer the question from another perspective, by comparing spending and revenues to the size of the economy. The dashed lines on the chart show the post-War averages for each. Since the mid-00s, spending has been much higher than its post-war average, whereas revenues have been generally closer to their long-term average. This suggests that spending is the problem.

Chart #5

Are revenues too low because tax rates are too low these days? Could higher tax rates boost revenues as a percent of GDP? Not necessarily! According to Chart #5, it seems that federal revenues are not at all a function of the level of tax rates. Reagan slashed tax rates in the early 1980s, but tax revenues proceeded to surge relative to the size of the economy in subsequent years—because the economy enjoyed a surge of growth. Isn't it better to achieve a given level of revenues with lower tax rates than with higher tax rates? Taxes distort behavior and weaken the economy. At the same time, government spending tends to be much less efficient than private sector spending. 

Chart #6

What about the source of federal revenues? As Chart #6 shows, the individual income tax generates about half of federal revenues these days. Payroll taxes account for 34%, corporate taxes about 11%, and estate and gift taxes 0.6%. If I could eliminate only one tax, it would without question be the Estate and Gift Tax. Last year it generated only $30 billion, which was about 0.6% of federal revenue. $30 billion is pretty much a rounding error when it comes to government finances. Yet the Estate and Gift Tax has a profound impact on the economy: the ultra rich spend massive amounts of money hiring accountants and lawyers to find a way around paying the tax, and very few pay anything in the end. But small business and family farms are often forced to liquidate in order to pay the tax. And of course it amounts to double-and triple and even quadruple taxation for many, since any money saved and invested must first pay income tax. 

Chart #7

Chart #7 shows the true burden of our federal debt: interest payments on the debt as a percent of GDP. The debt burden was 25-30% higher in the 1980s than it is today. True, the debt burden is likely to continue to climb, especially if interest rates rise. But if they fall, as the Fed has all but conceded they will, then our debt burden should remain within bearable levels for the foreseeable future.

One important thing is missing from almost every discussion of debt and debt burdens: the burden of the debt from the government's perspective is equal to the payouts received by all those who have purchased Treasury securities. One man's debt is another man's asset. Paying interest on our national debt is not like flushing money down the toilet. In fact, the true cost of the debt can only be calculated by considering the benefits the country has obtained by issuing debt. A business can issue tons of debt and still grow, provided it is using the money raised for productive purposes. But governments—especially ours in recent years—are notoriously inefficient in that regard. (As I noted here, our government is spending an enormous amount of money on transfer payments, which for the most part only fund spending, not investment.)

And this leads to another conclusion: the problem with debt and deficits is not the borrowing, it is the spending that created the deficits in the first place. 

Who spends money better: the person who spends his own money, or the person who spends other people's money?

Chart #8

Chart #8 shows the federal budget deficit as a percent of GDP over time. The nominal amounts at key points are highlighted in green text. Note some amazing things: today's deficit is just about as much relative to GDP as was the deficit in 1983, but in nominal terms, today's budget deficit ($1.6 trillion) is 8 times larger than 1983's deficit!

29 comments:

bmg said...

nice
bmg

Dan said...

One thing I noticed that doesn't seem to be factored in your charts is the growth of the US population.

How does the increase in the US population and thus the number of individual tax payers factor in the revenue generated? Had individual tax rates been higher as the population grew, wouldn't revenue also grow?

Scott Grannis said...

Dan: population growth is automatically factored in by comparing tax revenues to GDP. The economy grows as a result of 1) the number of people working, 2) how productively each worker works, and 3) inflation.

Higher tax rates can result in lower tax revenues even as the economy grows, because higher rates create a greater incentive for non-compliance as well as encouraging people to shift income into the future, and they can even encourage people to vote with their feet (as in leaving the country).

Reagan's tax cuts greatly increased the after-tax returns to working and investing, thus increasing the size of the economy as well as increasing income and capital gains realizations.

Jeff F said...

Thanks for the update and all the charts. I have a question or two and some comments.

The govt has a fair amount of spending off budget. I assume these show up on the debt charts, such as chart 1. But are they included in the spending charts 3, 4, and 8? I don't think so. Chart 3 shows the spending has leveled off in dollar terms but chart 1 shows a continuing increase at around the 8.8% growth line. So, to me chart 3 and 4 are typical of govt efforts to obfuscate the growing debt problem and chart 1 has the better more relevant information.

The importance of viewing these type charts is to understand where we have been so we can predict where we are going. So, I think chart 8 is deceiving and chart 1 gives a better idea of where we are going. And that is about a 9% increase in debt each year with no end in sight. Assuming no recession(no I am not a comedian) and 2% growth the debt is growing at about 7% of GDP per year. A recession is long overdue and when one occurs these numbers will move up. I think a typical recession the last few decades has added 5% or so to the debt/GDP.

Chart 7 shows an increasing level of debt from interest payments and only shows data through Q2 of this year. I think there is a fair amount of debt coming due this year that must be refinanced at higher debt levels. This chart will continue a very steep climb this year unless interest rates drop precipitately. And that will still require the FED to continue to shift the debt from long term bonds to short term bills to keep interest payments down. These numbers are known and a good estimate could be made for the remainder of 2024.

I don't agree that the debt burden will remain within bearable levels for the foreseeable future. It looks like there won't be an issue within the next year, but at 7% yearly growth of debt/gdp the debt burden is unsustainable. At some point the markets will anticipate problems funding the debt and interest rates will rise exacerbating the problem.

Duncan said...

Implied here is that governments uses inflation to inflate debt away, a tax. Most asset classes are defined in nominal terms and will hedge against this. But wages do not always keep up, and bonds may or may not as real yields often go negative. If you have No assets like many, they are indeed worse off. Those holding and shifting around assets do fine in this environment. Clinton administration was the last to care about deficits and debt. Neither party cares out it now. Scott is right the Spending is the real issue. If it is spent wisely the financing is secondary.

wkevinw said...

Clinton administration was implementing financial/economic plans made by congress. The deficit turned to a surplus because of a huge increase in tax collection due to the dot-com bubble (not a good event). Spending, the more important issue, slowed more a couple of times during Reagan's terms and even through the Bush I term.

https://cdn.theatlantic.com/media/mt/meganmcardle/Spending%20and%20Taxes.jpg

Don Harrison said...

It has long been argued by fiscal conservatives that they way out of the too-much-spending, not-enough-revenue dilemma is fairly simple, and relatively painless: just hold federal spending to the rate of inflation each year, while the economy continues to grow. By my back-of-the-envelope calculations based on Scott's charts, current spending is roughly $6.5 trillion while revenues are around $5.8. If we were to hold spending at the level of inflation, and the economy grew by the 2.2% per annually as Scott has estimated it has since 2009, spending and revenues would match up in roughly 5 years. One administration and a cooperative Congress could get this done within a Presidential election cycle.

Grechster said...

I'll take the under on long term economic growth of 2.2% CAGR.

Chris_in_NJ said...

"today's deficit is just about as much relative to GDP as was the deficit in 1983, but in nominal terms, today's budget deficit ($1.6 trillion) is 8 times larger than 1983's deficit!"

Chart #8 is indeed the money shot! All the evidence of sustained American dominance is right there... but the trade-N-Policy rags write strange tunes these days & presume Europe can stand up united to defend against backyard threats -- or even defend its own financial system! Both untrue. America's role as Global Hegemon & Bailout Provider is secure for the next 500 years & it's 100%, absolutely OK to say that out-loud.

Hat-tip, Scott!

Salmo Trutta said...

It's time to drop the FED's 5 policy rates. The federal deficit "is increasing by a trillion dollars every 100 days". The fiscal pump priming needs to stop.

BenRod said...

Been reading your blog for years, first time commenting.

Great info. What can't I find anywhere is a realistic discussion of how this ends. I see no realistic outcome other than some version of what has happened many times, in many other countries (Argentina, Russia, Zimbabwe, etc): higher spending leading to higher debts, which leads to more money printing to pay the debt with increasingly worthless dollars. Ultimately, hyperinflation until there comes a moment when the creditors have had enough and won't loan the USG anymore money knowing they'll be paid back in worthless dollars. This probably results in default then the issuance of a new currency (new U.S. Dollar NUSD) lopping off (you name however many) zeros off the end of the old dollar and we start over.

I acknowledge that it is theoretically (but not actually) possible to pay down the debt to a reasonable level. But having witnessed Congress and presidents of all parties (and yes, I have a preferred party) be simply incapable and unwilling to control themselves, I know they won't suddenly be afflicted by some fiscal reasonability virus.

Do you see any scenario where I'm wrong? If so, how? If I'm not basically wrong, what are practical things ordinary people can do to protect themselves?

Christian S. Herzeca, Esq. said...

Scott, you have a massive blind spot here.

treasuries owned by the SS trust fund are held to defease the obligations it owes to its SS beneficiaries...in other words, the treasuries that SS holds are as much outstanding as if those treasuries were held by JP Morgan to defease outstanding future obligations to its pension beneficiaries.

it is not double counting to say that when the SS trust fund owes trillions of dollars of future obligations to third parties, and purchases treasuries to defease this obligation, the SS trust fund is as much a third party investor/intermediary as any other private investor.

now, if you are willing to extinguish all of SS future obligations, there the treasuries that SS hold are intergovernmental.

csh

Peter C. said...
This comment has been removed by the author.
Peter C. said...

Excellent and educational as always, thanks.
But you're also an artful dodger, if you only show the CORPORATE INCOME TAX since the 1990s, just when they were reduced dramatically.
CORPORATE TAX RATE is only 50% of what it was since 1940!

So here's the deal:
Globalization made everything cheaper but destroyed the middle class. Trump will, if Dominion voting cannot prevent him from taking office, remove neofeudalist free trade policies even more and put huge taxes on imports (like it was, before the globalist coup in the West propping up China in the 1980s).
Once the tariffs are there, national production will increase.

In a few years, once companies have relocated and can no longer import, corporate tax rates can be raised again.

If the real plan is not otherwise: Trump is chosen now to introduce the draft and to scam White males to join the army - and then make war for Israel...
Bibi is escalating as much as he can and wants the war against Iran. And the US is his Golem.
IMO the Republican convention this year did not instill hope, that Americans could escape being sent to the meat grinder in hte Middle East for Israel again.

Dangerous times!

Salmo Trutta said...

What happened to a balanced budget amendment?

C-19, somewhat like 1966, drove the banks out of the savings business. Time deposits dropped by 18%. This shift has heretofore propelled the economy. We'll see whether money flows are still decelerating on the 23rd.

Chris_in_NJ said...

Much higher... for much, much longer!

(& GS _will not_ be getting bailouts! Maybe a merger with JPM, but not another bailout)

Scott Grannis said...

Re: Social Security Trust Fund: The Treasuries held by the SS trust fund do not represent additional debt on the part of the federal government. They merely represent money that SS has lent to the government, of which it is a part. It reflects intra-governmental transfers, not new borrowing.

In sum: the correct measure of federal debt is "Debt Owed to the Public," which now stands at $27.8 trillion.

Scott Grannis said...

Re: Corporate tax rates. As I've tried to point out in this post, tax rates and tax revenues do not necessarily move together. It is quite possible for tax rates to fall, yet for tax revenues to rise and vice versa.

The best explanation of this is the Laffer Curve. You can read more at these posts:

https://scottgrannis.blogspot.com/2014/12/the-laffer-curve-at-40-years.html
https://scottgrannis.blogspot.com/2012/11/the-laffer-curve-is-alive-and-well-in-uk.html
https://scottgrannis.blogspot.com/2018/05/laffer-curve-strikes-again-lower-tax.html

I only have access to corporate tax revenues going back to 1982. Since then, corporate tax revenues have averaged about 9.4% of total federal revenues. In the year ending June '24, they were 10.6% of federal revenues. With the exception of 2005-2008, when they averaged 14% of federal revenues, corporate taxes have ranged from 6% to 12% of federal revenues.

Corporate taxes today are about the same or higher as a percent of federal revenues than they were in the 1990s, when corporate tax revenues averaged 10% of total federal revenues. Conclusion: lower corporate tax rates have produced more revenues.

Salmo Trutta said...

When the debt burden becomes a function of the major portion of the debt, not just the current deficits, the burden, in fact, becomes exponential.

wkevinw said...

Fiscal Policy- It looks clear that the fiscal spending has added to the odd nature of this business cycle. What is disturbing is that all the economics experts are/were evidently mystified by how this would be "transmitted" through the economy, e.g. that inflation wouldn't be a big problem and/or be "transitory". This is yet another failure of the economics profession.

These supposed experts, including people who have the economics version of the Nobel, say things like there is a guaranteed recession, and then one doesn't occur. The Fed says things look good, and then the great recession is back dated to when these remarks are made.

I wonder if there is any reflection by this profession about what a disservice they have done to people for the past few decades.

Is there any good model available how government/fiscal spending impacts the typical economic statistics that people follow to guide business and investment decisions?

wkevinw said...

Canada- a performance to avoid.

"If per-capita GDP does not recover in 2024, this
period may be the longest and largest decline in
per-person GDP over the last four decades."

https://www.fraserinstitute.org/sites/default/files/changes-in-per-person-GDP-Income-1985-to-2023.pdf

Bob said...

As long as we continue to pump out centrist Keynesian trained economists from the major universities we will continue to destroy the American Dream of a strong and vibrant middle class

Charlotte said...

Question: Was the inflation planned? The rate was so high, that it reminds me of Weimer Republic. Paying off devalued dollars against previous debt?

Thank you for your blog.

Roy said...

So, they didn't cut. Is it already too late?

They were late to raising rates and they are late to cutting rates. Probability of a recession?

Adam said...
This comment has been removed by the author.
Adam said...

Hello Scott, what is your take on the shape of US economy?

Chris_in_NJ said...

LOL! RATE CUTS?? <- it's hilarious to listen to Citi panting for cuts! So Desperate. How come??

Return to office is already dwindling... all that overleveraged book won't ever get the marks needed! It's OK-- this is fine. We need to let the system wash the system clean of all the inside trading & dishonesty. Before rate cuts-- more banks (and men) will fall b/c America's Bravest are embedded on the trade desks, watching as Pegasus flies!

:)

(No sobbing).

Clay said...

Scott, Eager for a new post. Clay

wkevinw said...

Politicians and even some famous economists have been saying that price gouging also known as "markups" have been the cause of the inflation in recent years.

San Francisco Fed researchers disagree:
"markup fluctuations have not been a main driver of the ups and downs of inflation during the post-pandemic recovery"

https://www.frbsf.org/research-and-insights/publications/economic-letter/2024/05/are-markups-driving-ups-and-downs-of-inflation/

It's too much money created by government policies, as always.