Thursday, September 11, 2014

Federal government finances continue to improve

The latest budget data through August continue to reflect ongoing, gradual improvement in the federal government's finances. Spending growth is very slow, revenue growth is healthy, and the deficit is a very manageable 3% of GDP. 

Fiscal policy has been a significant drag on growth for most of the current recovery—not because of a declining deficit, but because of excessive spending. Spending is taxation, as Milton Friedman taught us, because spending must eventually be paid for by higher taxes. Spending is also bad because government doesn't spend money with the same efficiency as the private sector; you surely spend your own money much more carefully and frugally than you would if you got to spend someone else's money.

The good news is that even though the federal government arguably is still spending way more money than it should (federal spending is running about $3.5 trillion per year), federal spending as a % of GDP has been declining steadily for the past five years, so the drag of fiscal policy today is much less than it was just a few years ago. It's also good because the big decline in the federal budget deficit has all but eliminated the need for higher tax rates. As the public sector shrinks relative to the private sector, the private sector has more room to grow, and it's the private sector that delivers prosperity. 

The following charts illustrate some of the points made above:

Federal spending has been effectively flat for the past five years, thanks mainly to congressional gridlock and an improving economy, which in turn has reduced the need for social safety net spending. Federal revenues have been rising steadily, thanks mainly to more jobs, rising incomes, capital gains, and rising profits, and only partly thanks to higher tax rates imposed beginning last year. In retrospect, we would have been much better off not raising tax rates on anybody.

Federal spending relative to the size of the economy has declined by almost one-fifth, from just under 25% of GDP to just over 20% of GDP. This has reduced expected future tax burdens enormously, and on the margin it has helped to boost the economy's overall efficiency. Revenues are now about 17.2% of GDP, which is only slightly less than the 17.4% they have averaged since 1968.

The result of flat spending and rising revenues has been a two-thirds reduction in the federal budget deficit (from $1.5 trillion to $0.5 trillion). Relative to GDP, the deficit has collapsed from a high of 10.2% to now only 3%. 

The decline in the unemployment rate has correlated very closely to the decline in government spending relative to GDP. A significant decline in government spending relative to the economy did not in anyway harm the economy by this measure. As the graph above suggests, further declines in spending relative to GDP are very likely to coincide with a healthier labor market.

All in all, lots of good news here, even though there is plenty of room for further improvement. Things could be a lot better, of course, but at least they are getting better. 

10 comments: said...


If there had been tax cuts, instead of tax increases, there would have been more tax revenue, albeit at a higher level of economic output.

William said...

NYSE: 43 new highs today AND 43 new lows.

Unknown said...

Spending must be paid off with higher taxes?

Are you even paying attention?
The so-called "debt" (as if there can be such a thing for the Dollar Sovereign) hasn't been paid off Andrew Jackson, which of course led to a depression.

Spending = income

Every dollar the Govt deficit spends is a dollar of net income to the private sector. This stuff is not that complicated.

how can someone believe something so illogical?

Nidhi Singh said...

We can see the demographic effect in the charts mentioned in the post, as by Epic research.

Benjamin Cole said...

Egads---federal agency spending should be falling as fraction of GDP. Do we need a USDA? The VA? Labor Dept? Commerce?
Should not the DoD be cut in half? HUD? said...

Benjamin, not to mention the 'energy' department, the department of 'education' and the 'EPA'.

Benjamin Cole said...

Sgt. Blue:

I agree with you---with the exception of the EPA.

As a free marketeer-libertarianish sort, I recognize that the price signal does not capture the cost of pollution.

Also, who has the right to pollute the air other people breath? The water we drink? Does someone else have the right to pollute your private property?

Lake Erie water recently became undrinkable due to runoff from farms. Who pays for that? I assure you, the farmers never will.

I do not know much about the EPA; it may be terribly managed. But there is a legitimate role for government in limiting pollution.

Some hardcore libertarians say this problem of pollution has to be solved through torts---egads, that strikes me as impossible, and full employment for lawyers. I do not even know who is polluting the air I breath.

When I grew up in Los Angeles, you could see the smog hanging in the air, looking down a city block. The eyes would sting, then water, it hurt to take a deep breath sometimes.

But hey, wipe out the entire HUD and Education and Labor departments and I will cheer you on!

William said...

Three of the most skeptical stock strategists on Wall Street recently ditched their pessimistic forecasts, and one investor survey shows bearish sentiment is on track for its lowest annual reading in 10 years.

The disappearance of negative views is cause for concern, a theme we’ve hit upon repeatedly in recent weeks. With so many bears capitulating, the worry is whenever any shocks do hit the market, the damage could be much worse than if there were more skeptical investors around. And from a contrarian point of view, bears usually disappear at the wrong time, meaning the market could now be due for a pullback. said...

Benjamin, well, I agree with you that, in the beginning, the EPA may have been of value, but, it's like MANY good ideas initially, they may do some good. But, at some point, they get into "mission creep", like limiting what someone can do with their own land when it rains and causes a 'pond' and then the EPA steps in and limits your use because they call it a 'wetland'. These agencies need to be "sunsetted" when the costs they impose outweigh the 'good' they produce.

It's just the ol' "patronage" system we learned about in 'civics', at the national level.

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