Thursday, September 12, 2013

The incredible shrinking budget deficit

Since hitting a high of $1.478 trillion in February 2010, the U.S. federal budget deficit has plunged by 54% to a new, post-recession low of $679 billion in the 12 months ended August 2013. Two factors accounted for the bulk of the decline: federal outlays have declined (both in nominal terms and relative to GDP) and revenues have grown. Virtually no one expected the budget outlook would improve so quickly and so dramatically. Since the decline in spending is without post-war precedent, whereas the rise in revenues is fairly typical of recoveries, the real surprise here is the degree to which spending has declined.

As the chart above shows, there has been no growth in federal spending since the recession ended in mid-2009. Federal revenues, on the other hand, have been rising almost continuously since late 2009. 

Relative to GDP, spending has declined by over 15%, from 24.4% of GDP to 20.6%, while revenues have increased by almost 17%, from 14.2% of GDP to 16.5%. The budget deficit is now a mere 4.1% of GDP, down from a high of 10.2%. In less than 3 years, the federal budget outlook has gone from dire to almost normal. It's nothing short of astonishing.

And despite the unprecedented and almost completely unexpected shrinkage of federal spending, the economy has been growing and the unemployment rate has been declining. Far from precipitating another recession, as Keynesians would have argued just a few years ago, our incredibly shrinking public sector has coincided with a meaningful improvement in the economy. (Yes, I know that the employment situation is still miserable, but it's undeniable that things have improved.)

It's tempting to conclude that the massive fiscal "stimulus" of 2009 was bad for the economy, while the unwinding of that "stimulus"in recent years has been good. (We can't know for certain, of course.) But at the very least, this is a very important example of the Law of Unintended Consequences, which loves to thwart the best intentions of politicians: government spending doesn't always do what it is expected to do.

As I've explained before, this is very good news. As Milton Friedman taught us, spending is taxation, so the big decline in spending means that the expected burden of future taxation is far less today than it was thought to be just a few years ago. This is equivalent to a dramatic reduction in the headwinds facing the economy. It's also a big reduction in the level of uncertainty that has plagued the economy for the past several years. In a supply-side model, this is a good reason to be optimistic about the future, since declining tax burdens and reduced uncertainty should prove to be fertile ground for much-needed new investment.

It may be too much to hope for, given that the healthcare exchanges are supposed to open for business in less than 3 weeks, but I continue to believe that Obamacare will never see the light of day. It's terribly unpopular, more and more unions are against it, the exchanges aren't ready, and the deferral of the employer mandate opens the door to massive fraud unless the individual mandate is also postponed. Even if the exchanges open and the individual mandate takes effect on January 1st, it is inevitable that Obamacare will fail to achieve its objective, all the while creating unpleasant and unintended consequences for tens of millions of citizens. From the very beginning, it was clear that there was almost a zero chance that the government could re-engineer and restructure one-sixth of the U.S. economy in a way that would work to the benefit of the majority of the people. It was hubris to the max, and as such, virtually guaranteed to fail.

If the implementation of Obamacare is delayed, this would result in another boost (by reducing expected tax and regulatory burdens) for the U.S. economy.


W.E. Heasley said...

Regarding the revenue side, how much of the increased revenue was merely the acceleration of income from the future into the present? That is, the massive income reported [accelerated] and hence associated tax revenue increases that occurred 11/2012 and 12/2012 as rational tax avoidance given 1/1/2013 tax increases.

The massive acceleration would be accounted for in the fiscal year you point to. However, since income was accelerated from the future into the present, then future tax receipts will suffer. Hence the revenue number may well be a one and off.

bt1138 said...

Here we go again. Another Democrat President presiding over a shrinking deficit.

It's hard to understand how the GOP has any credibility on the deficit issue at this point. With Reagan and Bush the deficits exploded, even as they predicted that the magic of tax cuts would create a budget surplus. Hat's off to Bush 1, he actually had a realistic view of taxation and revenue, and pursued reasonable and constructive fiscal policies. As a consequence of that and unfortunately, Bush 1 is considered to be the worst president in the history of forever by most republicans.

And if you want to claim that deficit reduction only happens because of republican congressional leadership, why is there no such leadership from the GOP when a republican is in the White House?

It is Bill Clinton II. This is not rocket science: taxes in - spending out.


Here is my not so original theory of why deficits only matter when democrats are in control. Deficits are needed so as to declare that government is out of control and must be slashed. I think Bush 2 deliberately flushed the surplus from the Clinton years because it was very inconvenient to republican policy goals.

Scott Grannis said...

WEH: Federal revenues have been increasing almost every month (compared to year-earlier months) since 2009. Yes, there was a big jump in April of this year, about $70 billion or so, that probably came from accelerated income. But the improvement in revenue has been pretty consistent for several years now. There was a big one-time jump in personal income in late 2012, but personal income continues to rise: July '13 income was up 3.3% vs. July '12 income. So while the acceleration of income was significant, I don't believe it has distorted the picture of an economy that is growing, generating more jobs, more income, and more tax revenues.

Benjamin Cole said...

Great blogging.

I thought a paragraph or two was warranted that the Fed, during this time, has engaged in open-ended QE, and that has had a positive effect, though it should be more aggressive.

We need yet to rein in fededal agency spending, trim Social Security outlays, and do something about Medicare (but what I do not know, although societal acceptance of appropriate euthanasia would help).

On Obamacare, I do not like it as it fails the KISS standard: Keep It Simple Stupid.

We spend more as fraction of GDP on health care than any other nation and get middling results. Obamacare will do little to help that.

Maybe just pay hospitals for uncompensated care and let it go at that.

Anonymous said...

I don't think it is astounding that the deficit has come down so much. It is down so much because it was up so much. It was unnaturally high. It is adjusting to normal.

Deficit reduction has been helped a lot by QE which has created demand dollar for dollar-see M1 multiplier.

The point here that the economy has grown in face of reduced so called fiscal stimulation is most important. Vitally important.

Obama lied and his worshipers continue to seed the media that Obamacare will moderate the cost of healthcare. The number one problem in the country is not that wages are too low it is that prices are too high. The only solution to that is to break up the cartels, especially health care and education, that have such a grip on congress and presidents.

Benjamin will get what he wants with Obamacare as they will, before long, start killing off old people via "reasonable" state fiat what ever that fad trend will be in the next few years. Give me good old price allocation of health care after you kill off the cartel. said...

Just goes to show you, that it helps when the Fed elects to "keep interest rates low for an extended period of time" the government's debt service costs are subsidized.

amritsari said...

My bad. The following comment was supposed to be for this post, not the previous one:

Its weird - going through your blog entries from 2009 onwards, every dip in the markets is attributed to Obama. Well, the markets are up big since then but somehow none of it is due to any of Obama's actions ? At least be consistent in your causality. You sound just as irrational as all the people blaming everything about the '08 financial crisis on Bush.
You think the stimulus bill did nothing, others think it helped stabilize a sinking economy. Tax increases were supposed to kill any growth but lo and behold revenues are up !!

In general you do a good job of dissecting data but your political rants leave a bad taste. Your blog is a good illustration of the principal I have learnt over the last few years that one should divorce investing from political ideals. Nobody, and that includes you and me, seems to really understand the link between specific fiscal actions and economic growth and stock market action. Reminds me of the book "Being right or making money" by Ned Davis. Still trying to get hold of it. Very rare. Currently going for $100+ on amazon.

Hans said...

Hear is the rest of the story...

Tax extortion is up by 50% over the past decade and they still can not balance a budget...

This nation is run by nuts and dolts..

William said...

I'm on a road trip out West {Yellowstone N P} but I check in daily.

bt1138 said...

to Constable:

I await your action plan for the destruction of the Health Care Cartels. I assume you mean the insurance companies, for-profit medical service suppliers and the medical licensing boards.

Who will swing the axe?

My own pet plan for heath care cost reduction is to allow nurses and RN's to compete with doctors. Your comment about cartels sounds very tin hat, but the licensing boards clearly are running cartels whose only real objective is to protect doctors from competition.

steve said...

the real irony of the obama admin is that the people who supported him most in both elections, youth, "minorities", women are faring the WORST with this tepid recovery and those most opposed to him, well off white guys are faring the best. if you're a stock investor, you gotta love him. said...

Amen, Steve. Yep, the young are just greasing the pole they will have to shinny up to attain their economic success. Hoisted by their own petard, you might say.

William said...

At long last, the Aruoba-Diebold-Scotti Business Conditions Index has turned dramatically upward:

Published by the Philly FED.

William said...

ECRI Weekly Leading Index Rises

A measure of future U.S. economic growth hit its highest level in more than three years last week.

The Economic Cycle Research Institute said its Weekly Leading Index rose to 132.3 in the week ended Sept. 6, up from 131.5. The reading was the highest since the week ending April 30, 2010.

The index's annualized growth rate rose to 4.1 percent.

William said...

Schaeffer's Investors Intelligence

However the Mutual Fund Newsletter writers are not enthused.


09/11 37.1 22.7
09/04 37.1 23.7
08/28 38.1 23.8
08/21 43.3 21.6
08/14 47.4 20.6
08/07 51.6 18.5

William said...

OECD Composite leading indicators

09/09/2013 - Composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, continue to signal diverging growth patterns across major economies. The CLIs point to improvements in growth in most major OECD countries but stabilising or slowing momentum in large emerging economies.

The CLIs point to economic growth firming in the United States and the United Kingdom and to growth above trend in Japan. The CLI for Canada indicates a tentative positive change in momentum.

In the Euro Area as a whole, the CLI continues to indicate a gain in growth momentum. In Germany, the CLI points to growth firming. The CLI for Italy continues to signal a positive change in momentum and the CLI for France points to a tentative positive change in momentum.

The CLIs point to growth returning to trend in China and to growth around trend rate in Russia. In Brazil and in India, the CLIs signal growth below trend rates.

The OECD Development Centre's Asian Business Cycle Indicators (ABCIs) suggest mixed growth prospects across Emerging Asia