Tuesday, August 12, 2014

Taxes don't lie

As far as I can tell, the debate over the U.S. economy's health and growth—or lack thereof—still rages. I've argued since late 2008 that the recovery would be a sub-par recovery, mainly due to excessive government spending and inflationary/uncertain monetary policy. (See more references to a sub-par recovery here.) I've consistently argued that even though the economy would likely experience a disappointingly slow recovery, it would nevertheless be a better recovery than the market was expecting, and that would be good for equities. Both of those forecasts have been vindicated, even though I thought we'd see growth of 3-4%, and instead we've seen growth of only 2.1% since the recovery began about 5 years ago.

Meanwhile, there is no shortage of (mostly Keynesian) economists, notably Paul Krugman, arguing that the recovery has been weak because government spending stimulus was insufficient. Lately, there have been a growing number of economists arguing that the recovery has been weak because of a significant decline in government spending. To me the Keynesian arguments are weak, because they all cheered the passage of the ARRA in early 2009, one of the most significant expansions of federal spending in generations. Yet regardless of whether federal spending increased or declined relative to GDP, real growth has been pretty steady at about 2-2.5% on average for the past 5 years. You can see this in the graphs above: despite a gigantic increase in federal spending relative to GDP in 2009, and a huge, subsequent decline in spending relative to GDP, real economic growth since 2009 has been a pokey 2-2.5% throughout. We had a similar decline in spending relative to GDP in the 1990s (though it never went so high as it did in 2009), yet economic growth averaged a solid 4% per year the latter half of the 1990s, thanks in part to lower tax rates.

As a supply sider, I don't see the logic behind the theory that more government spending is stimulative and less is restrictive. How can taking money from those who are working and giving it to those who aren't create a bigger economic pie? It creates perverse incentives, for one thing. And it also channels the economy's scarce resources into the less-productive sectors of the economy. True economic growth only comes about when scarce resources are utilized in a more productive manner. I think the massive amounts of deficit-funded spending we've seen since 2008 are one of the main reasons the economy has been so weak. Bigger government is not better. With spending now having shrunk to historic norms relative to GDP, I'm tempted to say that growth has a chance of picking up.

Be that as it may, it still appears that the debate today centers around the question, Is the economy growing? I think the evidence of growth is significant, even though growth is sub-par. But one sure way to tell if we're growing and prospering is to look at tax receipts. Tax receipts don't lie: they are driven by incomes and profits and the number of people working.

As the graph above shows, federal revenues have been rising for over 4½ years. Annual federal revenues are up by almost $1 trillion from their recession lows. They are up $365 billion from their pre-recession high, for a gain of 13.7%. Most of the gain has come from individual income taxes (including capital gains taxes) and payroll taxes. That is powerful testimony to the fact that the economy is generating more jobs, higher incomes, and higher profits. Corporate taxes probably would have contributed a lot more if our corporate profits tax weren't so high, since more and more companies appear to be avoiding the repatriation of their foreign profits. These days the government is earning 35% on lots of nothing, when instead it could be earning, say, 10-15% on $500 billion or more (of repatriated profits) per year if we had the wisdom to reduce our corporate tax rate.

And in any event, as the graph above shows, federal revenues today as a % of GDP are almost exactly equal to their post-war average. Imagine how much higher they might be if this had been a robust recovery with lower and flatter tax rates!

It's the weakest recovery ever, but it is nevertheless a recovery. Taxes don't lie. And it could be a much stronger recovery if tax rates and transfer payments were reined in.


Unknown said...

I would really like to see what the federal revenue graph looks like in real dollars. Undeniably tax revenues rise but in real terms not nearly as much.

Scott Grannis said...

The only meaningful measure is revenues relative to GDP. That automatically adjusts for inflation and the growth of the economy.

steve said...

"As a supply sider, I don't see the logic behind the theory that more government spending is stimulative and less is restrictive"

since when does LOGIC have anything to do with a liberal's argument? I cannot think of a single mental exercise more useless than attempting to argue with a liberal using sound logic.

mmanagedaccounts said...

"How can taking money from those who are working and giving it to those who aren't create a bigger economic pie?"

Scott, I do not fully understand your argument here. In order for the federal government to spend more now it does not have to take money from those who are working, it borrows it and takes later.

I'm not an economist but I do believe in low taxes and a small federal government, and I have not read Keynes, but didn't he argue that the federal government should borrow and spend during a recession and then balance its budget afterwards?

I have maintained since 2009 that what was needed is fiscal stimulus in the form of lower income taxes so consumers would have more of their own money to spend in whatever way they chose, and that tax cuts should be permanent. Otherwise, consumers will not spend in a way that stimulates. As a business owner I can assure you we are regulated to death and that holds back business and costs excess dollars.

If we want to make more people wealthy, let them hold onto their wealth, and let them own their Social Security.

CMB said...

The Tax Policy Center figures tell a different story from yours.

They show that federal receipts in 2009 dollars for the period 2009-2013 were down 7% from the five-year prior period 2004-2008 ($11.405 trillion vs. $12.269 trillion).

To me that is consistent with declining real GDP, not modestly rising. World Bank figures for real GDP per capita show this to be the case. The average report for that metric under Bush was 1.15%. Under Obama it has fallen to 0.44%.


Benjamin Cole said...

Nice post. It is not PC to say it, but the most corrosive federal spending is for national security. The huge and awful transfer programs largely leave money in the private sector. Defense spending confiscates resources to no economically productive purpose.
Eliminate the corporate income tax and cut defense spending in half.

Scott Grannis said...

Re: the real growth of federal tax receipts. As of July 2014, and relative to their pre-recession peak of Dec. 2007, the 12-month sum of federal tax receipts is up about 13.7% in nominal terms. In real terms it is up 2.6%. That is another way of saying this has been a miserably slow recovery. But it reaffirms my main point: the economy IS growing and IS expanding.

Scott Grannis said...

mmanagedaccounts: Regardless of whether government spending is financed by taxes or by borrowing, the net effect is for the government to take resources from the private sector. Transfer payments funded by debt sales take resources from the private sector and redistribute them according--in many cases--to the whims of politicians.

I should think that Keynes' theories are quite discredited by now. He did argue that government should borrow and spend in order to stimulate the economy. But the evidence of the past five years shows that it doesn't.

Lowering taxes can be stimulative, but not just because it lets people keep and spend more of their own money, which they tend to do more efficiently than the government. One very important thing that lower tax rates do is to increase the after-tax rewards to work and investment. That stimulates more investment. More investment is a very important source of economic growth.

CMB said...

Scott Grannis said:

"As of July 2014, and relative to their pre-recession peak of Dec. 2007, the 12-month sum of federal tax receipts is up about 13.7% in nominal terms. In real terms it is up 2.6%."

The fact of the matter is that peak real revenues in fiscal 2007 haven't been bested in any year since then. You may be right that fiscal 2014 will finally get us over that hump, and I hope you are. Even the Tax Policy Center is expecting that, but frankly I'll believe it only when I see it.


Scott Grannis said...

j m: It's virtually certain that real revenues this FY will surpass those of FY 2007. We only need two more months of data to find out (August and September). Revenues on monthly basis have exceeded those of the prior year in almost every month for the past 5 years.

McKibbinUSA said...

Without a balanced budget (i.e., zero stimulus), any claims of recovery are false -- and make no mistake about it -- what we are witnessing today is a false recovery...

alxwest said...


alxwest said...

sorry pal,

but you numbers on federal revenues are way off.

I dont know where you got them, but no way feds gets ~3 trln $ in taxes.

here's facts there is a report , called daily treassury statement, here last for 2013 fin year


at the bottom, you can see OVERALL GROSS TAXES COLLECTED WERE
2.4 trln $, but you must deduct income tax refunds to get right figure.

overall, net taxes are less then 2 trln $.

good luck

Scott Grannis said...

alex: you would improve your argument if you referred to the Final Monthly Statements of Treasury operations. And it would also help if you looked at data that are more current than Sept. '13. The numbers in my graph are correct. In the 12 months ended July '14, net federal revenues were $2.956 trillion.


alxwest said...

@Scott Grannis
you would improve your argument

i dont need to. I know the numbers.
its my job.

Monthly Statements are basically fake. they are counterfeited.

let me explain.

#1 monthly Statements includes money that FED kick back to treasury.. well its funny money.. where did the fed get 4 trln $, to buy treasuries and on to pay out those money? fed printed them (digitally)

#2 biggest source of funny money

do you know, sir, composition of USA gov debt? I do.


it consits of debt by public, and 'Intragovernmental Holdings '.

do you know what 'Intragovernmental Holdings ' is ??

up until now , SS funds run surplus, so USA federal gov took suprlus and spent that money for general purpose, thats why in motnhly Statements there are 2 set of figures, its called on/off budget. but thats not all.

USA gov pretended that money were put in safe box (hello Al Gore), invested in some interest bearing instruments, so each year USA federal gov also CLAIMED that Intragovernmental Holding made money, and USA gov also includes that interest in general revenue.

btw that percent on 'Intragovernmental Holdings' its not market based. it set by special law in congress.

now, there is no surplus in SS program, but still USA federal gov pretends that each year SS funds make money, so interest made off 'Intragovernmental Holdings ' is included in 'motnhly Statements' too.

thats why there's huge disparity in daily/ Monthly Statements.

let me repeat.. you talked about taxes, figires mentioned by me , ARE ONLY TAXES . rest of is fake money.

good luck

I used sept 30 2013, cause its end of 2013 fin year for USA gov

if you dont believe me, find any professional economist who knows stuff about federal budget. its not a secret.

alxwest said...

@In the 12 months ended July '14, net federal revenues were $2.956 trillion.

well its made up money.
according latest daily statement


august 14 2014

total taxes collected : 2,235,175
refunds : 300+ bln

do you really think for rest of august and september USA gov will collect 1+ trln in taxes more ?

best month is april, and its not even 300 bln $.

sorry, but let me repeat figures in monthly statements are duped.


Wanda Hanson said...

A flatter tax rate is actually a good idea. I love how it will isolate the current tax system and generate better revenue for businesses, while allowing the market to globally compete more evenly. Of course, the downside is having a flatter tax rate will risk the government losing significant revenue, as what many believe. In any case, thanks for sharing such a great read, Scott! All the best to you!

Wanda Hanson @ Tax Tiger