Monday, December 12, 2011

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.


Donny Baseball said...

I am paying attention to the PPI and CPI numbers later this week. Do you think we could get negative inflation prints and thus could rattle Treasuries??

Kristjan Lepik said...

"then the U.S. could escape the fate that has engulfed the PIIGS countries, where deficits are above 9% of GDP."


Here how PIIGS 2012 budget deficits are looking like:
Portugal -5,1%
Italy -3,5%
Greece -7,2%
Spain -6,0%

Europe is cutting costs right now and trying to get the budget deficit down. And clearly this is not what US is doing now. I would say that at some point during 2012 the markets will notice that as well ..

Thanks for the analysis, just wanted to clear that data issue!

Benjamin Cole said...

Payments to individuals have soared, but have been more than financed by payroll taxes. I would like to see Social Security and Medicare trimmed, by later retirement, and smaller pensions.

Medicare we should try some experiments, like vouchers same for the VA, btw).

The monster eating your income taxes has been Defense-Homeland Security-VA. Real outlays have doubled in last 10 years, and we face no credible military treats whatsoever. VA outlays have tripled in recent years. It is runaway.

In this regards I am tempted to vote for Ron Paul.

EH said...


Not sure how you can make the direct leap from a correlation between Federal Spending, % of GDP and Unemployment Rate to a causation argument. Unemployed individuals receive direct government payments, automatically increasing the Federal Spending if they outlast the State pools. In addition, higher unemployment would likely indicate lower GDP, which decreases the denominator in your Federal Spending, % of GDP data.
You may be correct to question Keynesian ideas, but I don't think this chart provides any evidence without further analysis.

scharfy said...

@ Benjamin,

Gotta ask if you can support your claim that Defense spending as a % of GDP has increased at all recently.

Here's two sources(from both conservative and liberal) that seem to dispute that commonly cited claim.

Krugman on it

And the heritage foundation

And another liberal citing only about 2.9% of GDP

Am i incorrect?

Seems like we are well off the al time highs, not saying its a good thing, but it pales ic comparison to SS and medicare/medicaid obligations...

Coach me up

Benjamin Cole said...


One of the worst ways to judge military outlays is as a fraction of GDP. If our economy grows, our military threats do not grow correspondingly.

The military loves this tripe of comparison, as it assures ever higher military outlays regardless of need or the burden they place on taxpayers.

The right way to determine military outlays is to determine what military threats we face, and what is the least expensive way to counter those threats.

Currently, we spend just about $1 trillion annually on Defense, Homeland Security and the VA. (BTW, that is $3,333 out of the pocket of every resident in the USA, or $13,000 from a family of four--and they want more every year).

Our GDP is now about $15 trillion. So defense-homeland security-VA is about 6.6 percent of GDP.

Some say we should add on debt costs from past wars, and we probably will incur total expenses of $4 trillion from Iraqistan. Probably 7 to 8 percent of GDP is consumed by the defense establishment, as broadly defined.

My guess is that we could stop anyone from ever invading the USA (aside from workers from Mexico) for far less than 1 percent of GDP, and the rest is wasted and parasitic.

Sheesh, if you have a few nuked-up subs, who will invade? What nation plans to invade the USA? Who wants to shut down sea lanes? The sporting China. Russia, who exports oil?

If even a nation wanted to invade the USA, would they risk nukes in their capital cities? (Launched from subs).

Federal bureaucracies never die--that is the sad and expensive story of our military establishment. Our USDA. Our HUD. Commerce.

We have food stamps and all I ever see are fat people.

John said...

"The bad news is that the gap between spending and revenues is still enormous."

Very true and a direct result of the Bush tax cuts. You can't cut taxes, have two wars and a giant Medicare Part D entitlement and balance the books - concrete evidence that the Laffer curve is useless without consideration of other factors, if at all.

By the way, for all the "historians" out there, Clinton raised taxes and the economy grew in leaps and bounds.

Donny Baseball said...

Clinton raised taxes and cut military spending substantially, so SG's argument about gov't spending holds. Clinton also goosed the economy via a cynical "reform" of the telecommunications industry - a reform that gave us such enduring corporate titans as WorldCom, Global Crossing, RCN, Teligent.

McKibbinUSA said...

Said another way, the Federal Reserve's gamble to save Federalism from itself has not saved Federalism afterall -- in the meantime, both monetary and fiscal policy have abandoned Main Street USA as part of their gamble -- the Main Street depression that is still raging across America has the potential to fracture Federalism from within -- therein lies the fallacy underlying the elitist brand of capitalism reigning in America today...

McKibbinUSA said...

PS: All eyes should be focused on California...

Junkyard_hawg1985 said...

"concrete evidence that the Laffer curve is useless without consideration of other factors, if at all."

John, the Laffer curve says there are two known tax revenues at various rates. At 0% taxation you get zero revenue and at 100% taxation you get zero revenue. The problem is that 47% of the population is at a zaro percent tax rate. Actually, let me correct myself we spend $60B/yr of tax refunds to people who have not paid any income tax. While not a big Bachmann fan, I think she is correct that all Americans should pay something in income taxes. They will demand a lot less "free" stuff from the government.

Benjamin Cole said...

Below is list of largest federal agencies financed by income taxes. Where should we cut?

Department of Defense 3,200,000 6
Department of Veterans Affairs 240,000
Department of the Treasury 162,119
Department of Justice 124,870
Department of Agriculture 100,000
Department of Transportation 100,000
Social Security Administration 65,000
Department of Health and Human Services 62,999
Department of the Interior 57,232
Department of Commerce 41,711
NASA 19,198
Environmental Protection Agency 18,879 Department of State 18,000
Department of Labor 16,818
Department of Energy 14,000
General Services Administration 14,000
Tennessee Valley Authority 13,031

Junkyard_hawg1985 said...


The answer is to cut back some in all of them. You should completely eliminate the Department of Agriculture, Department of Education, Deartment of commerce, Department of Energy, HUD, EPA, and privatize TVA and the USPS.