Thursday, May 10, 2012

Federal budget outlook continues to improve

Thanks to April's stronger-than-expected gains in federal tax revenues and weaker-than-expected growth in federal spending, the 12-month federal deficit has shrunk to $1.15 trillion, down significantly from its high of $1.48 trillion in early 2010. By my estimates, the federal budget deficit now has dropped from a high of 10.4% of GDP to 7.4%. This is very good news that I imagine most people are completely unaware of, and it's come about in the best possible way: government is slowly shrinking relative to the economy, and this is allowing the private sector to grow, with the result that tax revenues are rising even though tax rates are not. If these trends were to continue, our spending and deficit problem would fix itself without the need for any political haggling or agonizing.

Here's the big picture. Note that spending has been almost flat since the end of the recession, while revenues have increased by $350 billion. Congressional deadlock can be a wonderful thing: by not increasing spending in recent years, Congress has managed to get federal spending as a % of GDP down from a high of 25.3% to 22.7%.

How many people realize that the federal budget deficit as a % of GDP has declined by almost 30% in the past few years? It's now comfortably below the 9% of GDP level that studies suggest is the tipping point beyond which an economy begins to destabilize.

This chart highlights the progress that has been made in federal revenues. Tax receipts have been much stronger this year, thanks to more people working, rising incomes, rising corporate profits, and increased capital gains realizations. Looked at another way, since government is consuming a smaller portion of the economic pie, the private sector has been able to put those resources to more efficient use, and as a result the pie is growing.

As I've long argued, and as Robert Barro points out in his op-ed in today's WSJ, declining budget deficits are not "austerity," and in fact can be stimulative. Keynesian "stimulus" spending just doesn't work—trimming the size of government and allowing the private sector to expand is a far better way of encouraging economic growth. Here's a key excerpt:

Despite the lack of evidence, it is remarkable how much allegiance the Keynesian approach receives from policy makers and economists. I think it's because the Keynesian model addresses important macroeconomic policy issues and is pedagogically beautiful, no doubt reflecting the genius of Keynes. The basic model—government steps in to spend when others won't—can be presented readily to one's mother, who is then likely to buy the conclusions.
Keynes worshipers' faith in this model has actually been strengthened by the Great Recession and the associated financial crisis. Yet the empirical support for all this is astonishingly thin. The Keynesian model asks one to turn economic common sense on its head in many ways. For instance, more saving is bad because of the resultant drop in consumer demand, and higher productivity is bad because the increased supply of goods tends to lower the price level, thereby raising the real value of debt. Meanwhile, transfer payments that subsidize unemployment are supposed to lower unemployment, and more government spending is good even if it goes to wasteful projects.
Looking forward, there is a lot to say on economic grounds for strengthening fiscal austerity in OECD countries.

We can only hope that more and more policymakers and politicians around the world begin to understand the fallacy of traditional "stimulus" policies. What most countries need these days is less public sector spending, not more, and lower and flatter tax rates. Government needs to get out of the way and let the private sector work its growth magic.


randy said...
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randy said...
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Benjamin Cole said...

I think Keynesians confuse federal deficit stimulus with accommodation by the Fed.

A bullish Fed can much better obtain growth (in concert with lower taxes on productive enterprises and a shrinking federal government) than deficit spending.

The difficulty in austerity and tight money si that the profusion of sacred cows prevents the elimination of structural impediments.

Who is for shrinking federal agencies, when the largest agencies are Defense, Homeland Security and the VA?

Who wants to wipe out the biggest renewable nervy program on Earth---the boondoggle ethanol? Eliminate the USDA?
Raise the retirement age for Social Security?
Eliminate federal pensions, including the military's?
Euthanasia for Medicare patients?
Wipe out the home mortgage interest tax deduction?

Open up the border to hard-working immigrants?

Do we even dare even eliminate rural postal service?

Yeah, tell me when we get the structural reforms we need.

Until then, a roughly balanced budget and a bullish Fed are the best approach.

randy said...

(had to clean up previous post, my bad)

"The Keynesian model asks one to turn economic common sense on its head in many ways."


It's easy for the average person to get lost in the sophisticated economic arguments made by Nobel prize winning theorists like Krugman. But the common person person has the common sense to know things like - you can't pay unproductive people forever, if you do they will never be productive; you can't grow debts faster than your ability to service them forever, if you do you will have a debt crisis; even for the most worthy ideas and programs, cost matters; and finally, there simply isn't enough money for the state to take care of the public from cradle to grave.

To be fair, the same can be said of conservative rationale. In contrast to conservative mantra, common sense tells you that: it's not economically and morally defensible for bankers and CEOs of publicly traded companies to make 100s of millions; the wealthy can bear slightly higher tax burdens (I'd gladly trade that for simplification); that financial regulation is not inherently bad and is in fact necessary; and finally that some safety net is both moral and rational.

Scott Grannis said...

randy: I appreciate your comments, but I disagree with your second paragraph. It absolutely must be morally and economically defensible for anyone to make as much money as they can, because how much you make is ultimately a function of your value added. It is not morally defensible to say that just because one person makes more than another that he or she should therefore pay a higher tax rate. The only "fair" tax structure is a flat one where everyone pays the same rate. Financial regulation is not necessarily good and can often lead to more problems, because regulators are just as fallible as anyone else, and markets (e.g., the bond market) have proven that they can self-regulate just fine. Safety nets are fine, but the private sector (i.e., charity) is far better at doing this than the government.

randy said...

I agree that an entrepreneur, inventor, risk taker, performer should be able to make as much as they can. Public company CEOs too often leverage risk borne by company, shareholders, employees, and even the taxpayers (bailed out financial firms), pursuing speculative short-term growth in place of long-term viability, to earn ridiculous money that bears no relationship to their contribution. Often their success is nothing more than the luck of a rising market, and they bear no real loss when the company fails. Common sense tells you this isn't right.

I agree the fair tax is a flat one and everyone should pay. I guess I should say rather that arguing for lower taxes at this economic position is common-sensically hard to defend. Arguing for tax simplification would be better.

I agree much of the financial regulation is not good - particularly Dodd Frank. But something should control banks from taking highly leveraged speculative bets, ultimately risking the financial system, with taxpayers as a backstop. As far as I know, there is nothing to prevent large investment banks from collectively over-leveraging and creating another 2008. Common sense says some regulation is appropriate.

You are of course very good at consistency and clarity of message, but I think economic conservatives would be better off acknowledging and addressing these issues, at the expense of steadfast messaging. Makes common sense to me anyway!

Benjamin Cole said...

Don't tax you, don't tax me. Tax that man behind that tree.

Richard Long, D-LA Senate Finance Chair, many moons ago.

Ed R said...

" . . . markets (e.g., the bond market) have proven that they can self-regulate just fine."

Alan Greenspan famously said the same thing about the mortgage-backed securities market (a form of bonds). How did that work out??

Frozen in the North said...


While I appreciate your view as to the "slow down in government spending", it is hard to take the argument of gridlock seriously. About 80% of government expenditure is "locke-in" Medicare. medicaid, Social security, defence and interest on the debt.

As far as I know the only "planned"cuts are scheduled to occur in January 2013 -- something your GOP "friends" are fighting tooth and nail to stop!

BTW I agree with Randy, too often I have seen senior management being paid a fortune for absolutely terrible performance (sales, profitability, stock price -- you name it). As a shareholder I find it appalling that they get away with this kind of remuneration; call it kleptocracy.

Very few managers are worth $5 million a year -- funny enough most guys who are (Steve Jobs, uncle Warren) don't pay themselves such princely sums.

randy said...

A clarifying comment - the biggest problem I have with over compensation is that it has distorted management incentives. This is manifested in too many bright people becoming investment bankers, essentially producing nothing; public companies taking outsized risks for short-term gain at the expense of long-term planning; investment capital seeking payday IPOs rather than long-term viability, etc. And I have no idea how to change the model. I don't want the state telling private companies what they can pay, but the existing model isn't very good either. IMO it's a serious drain on the American economic engine.

Squire said...

Randy, you haven’t been in the world of management. Why would a talented manager go to a company with risks when doing so he/she foregoes a safer engagement. Boards offer these guarantees and parachutes because they know things are not necessarily under the CEOs control. Most of the high pay comes from high performance. When management operates for the benefit of management the stock price suffers and, at least eventually, the management gets thrown out. That is the market system working.

The banks as structured today are a creation of the government. JPM Chase creates a phony security which is called a synthetic security, then buys and sells credit default swaps on it to hedge funds. It is more like JPM is a casino, that is, the house. All at the doing of the regulators and government policy makers. You can’t pin the bad bank incentives which encourages speculation to what is happening in the rest of the corporate world. The government, Frank-Dodd specifically, support Too Big To Fail banks.

Squire said...

Benjamin’s position that important cuts to the budget are not happening and in fact will not happen means the Fed should engage in some real expansion. That is a good point.

However, the Fed would be bailing out congress (again and again and again). When there are bailouts, the correct action doesn’t take place because the pressure is off to make it.

Family Man said...


What is your take on so called "fiscal cliff" i.e. expiring tax benefits, it is being assumed that this should reduce 2012 GDP by 4%. That could develop in kind of 2011 "goverment shutdown" volatility creation event.

4katzz said...

What is alarming is the first chart, which shows a twenty year period of spending out growing revenues..


Squire said...

Sheila Blair has the last word.

Benjamin Cole said...


Nothing would make me happier (well, in the policy arena anyway) than roughly balanced federal budgets.

It ain't happening, Jack.

And the GOP has no track record of making it happen---precisely the opposite. The GOP rebrands itself every eight years as "really serious this time" about the deficits, until they decide again that "deficits don't matter."

The feeble-minded D-Party is no better.

We can pare down the national debt through QE, and probably have too---both to expand the economy and simply pay down the debt.

Happily, inflation is dead, and deflation lurks. Great time to execute huge on QE.

I see no sign of inflation. and neither do capital markets. We are inflation rates that are one-half of what used to be "good" in the Reagan Era.

4katzz said...

Squire, thank you for the link...

I agree and have been suggesting this for the past 18 months, for better or worse..

FedZero, is destroying all incentives to save money...In fact, thanks to Greenspam and now Uncle Ben the past twelve years has produced seven years with marginal interest for savers..

This is a killer for retirees, who depend on additional income...But who cares. they are on the way out and no longer a tax honey pots..

It is far more important to support and maintain the I&I class structure...(irresponsible & indolent, helping to build a NEW America)

The micro is an extension of the macro so says, Herr Carl Von Clausewitz.

Yes, the federal budget outlook is improving only to a wait the next breakdown; since no general overhaul was undertaken...

It is a broken record that has been playing for too many decades...


Benjamin Cole said...

Hans and anyone else:

Scott Grannis says there is about $10 trillion in federal debit outstanding (excludes interagency debt).

In last few years, the Fed bought about $2.7 trillion in debt (I think most federal IOUs).

We have been monetizing the debt. Yet no inflation. Debasing the currency

What gives.

John said...

I think I'm coming around to Scott's position on Keynesian stimulus. But we need to be honest about what constitutes Keynesian stimuli.

The Iraq War, the Bush tax cuts ( which did not proportionately cut spening) and the unfunded Medicare Part D program were all massive Keynesian stimuli.

Those fiscally irresponsible events occured when a Republican occupied the White House and Republicans had majorities in Congress. As profligate spending, they make Obama look like a piker

Scott's right. Divided government with some gridlock's a good thing.
The size of government is shrinking under a Democratic administration and we are on a long term trend to eliminate the deficit, as was done during the Clinton administration.

McKibbinUSA said...

While the Federal budget outlook may be improving, the budget outlook for states such as California are grim at best -- the entirety of US fiscal and monetary policy has been committed to saving Federalism since 2008 -- however, Main Street remains in dark times as evidenced by the presistent declines in real working wages, home values, and the employment to population ratio -- all eyes should be on California at this point -- California has two options: a) cut spending dramatically; or b) raise taxes dramatically -- the outcome of the budget crisis in California may very well decide the fate of Federalism at this point...

Benjamin Cole said...

Dr. William:

If CA quit the union, they would net back $50 billion a year.

It is the rural states that are pink-o subsidy havens.

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