$3 trillion in taxes trumps Ebola risks

At a time when the Eurozone is flirting with its third recession in the past six years, the Chinese economy is slowing down measurably, and the Ebola virus has leapfrogged the Atlantic, investors are naturally nervous that the five-and-a-half-year-old equity party could be coming to an end. Fear is entering the range of panic proportions, in fact, with the Vix Index today spiking to 31 today and the 10-yr Treasury yield sinking to almost 1.85% at one point. The Vix/10-yr ratio thus attained its fourth-highest value (16.7) in history today, behind the Lehman collapse ((27), and the two Eurozone debt crises (24 and 18).

I don't pretend to be an expert on pandemic diseases, but I note that Nigeria, Africa's most populous state, located not too far from the Ebola hotspot of Liberia, has not had any new cases of Ebola in over 42 days. (HT Don Luskin) This is not necessarily the pandemic disease that promises to wipe out civilization as we know it, even though it's premature to rule out that possibility. But the mere prospect of a virus that could theoretically mutate and kill 70% of the population of the world in 2 years or less understandably has investors nervous. 

(Might I suggest that if indeed the world population were to collapse in short order, most of those who managed to survive would face bleak prospects at best; the machinery of the global economy would be effectively broken, and modern civilizations would be hard-pressed to survive. What good would it do to sell everything you own today? Investing in anticipation of the "end of the world as we know it" is a questionable exercise at best. If you are convinced we are faced with an inevitable global catastrophe, then buying plenty of guns, ammunition, food, and a private, isolated island is probably your best strategy. Nevertheless, it is worthwhile noting that the world has managed to survive quite a few end-of-the-world-as-we-know-it events: The Cold War, the Crash of '87, Y2K, AIDS, bird flu, the 2008 financial crisis, and the PIGS debt crisis.) 

In any event, the massive size and momentum of the U.S. economy is a force to be reckoned with. Despite all the world's problems, the federal government in the 12 months ended September 2014 collected just over $3 trillion in taxes, mainly because the economy managed to grow just a little over 2% a year. That's an increase in revenues of about 50%, or $1 trillion dollars, in just the past 4 ½ years. And because federal spending has not grown at all in the past five years, the federal budget deficit has collapsed from a high of $1.5 trillion to less than $0.5 trillion, from a max of 10.5% of GDP to only 2.8% of GDP. It wasn't too long ago that the world quaked at the prospect of trillion-dollar federal deficits for as far as the eye could see, yet today the federal deficit is unquestionably manageable and many years from potentially spiraling out of control due to unchecked growth in entitlement programs. 

We have managed to avoid yet another end-of-the-world-as-we-know-it event, and almost totally unexpectedly.

This is not a defense of the Obama administration. I think the good things that have happened have occurred in spite of all the mistakes that have been made (e.g., the ARRA faux-stimulus, Obamacare, Dodd-Frank). This has been the slowest recovery on record not because the government hasn't spent or stimulated enough, but because the government has spent and regulated way too much. My point is that it never pays to underestimate the U.S. economy's ability to overcome adversity. It's probably fair to say as well that one shouldn't underestimate the ability of modern science to check the spread of Ebola.

Some charts to back up the points made above: 

Federal spending has not increased at all in over five years. This is simply amazing, completely unexpected. Excellent news, also, since it means the government is shrinking relative to the economy.

The chart above documents the virtual collapse of the federal deficit. Again, completely unexpected and a cause for celebration. Keynesians have a hard time dealing with this, however, since they view big declines in budget deficits to be contractionary. Supply-siders, in contrast, view declining deficits which result from spending freezes to be a positive force, since the government is consuming fewer of the economy's scarce resources. Moreover, most of the increase in revenues has been due to an expanding tax base (e.g., higher incomes, more profits, more capital gains), not to increased tax rates. The U.S. compares very favorably to the Eurozone on this score, since, as Brian Wesbury notes in today's WSJ, Eurozone public sector spending is about half of GDP, whereas total public sector spending in the U.S. is only 36.5%.

Federal spending relative to GDP is now back to its long-term average (over the period shown in the above chart), as are revenues. Five years ago, nobody would have believed that progress like this was possible. There is now no reason to raise tax rates, another reason for cheer. Indeed, slashing and flattening tax rates (while eliminating deductions and subsidies) would likely have very powerful and positive consequences—exactly what is needed to "jump-start" the economy and get it back to its long-term trend.

The chart above is further proof that big declines in government spending relative to GDP do NOT weaken the economy.

The federal deficit has now shrunk to a size that is manageable, because—at the current level of interest rates—the burden of the federal debt (i.e., total debt relative to GDP) is no longer increasing. Even in a rising interest rate scenario, the increase in the federal debt burden would not likely prove to be exponential, given how relatively small the deficit is today.

As the chart above shows, the Obama administration has overseen the largest post-war increase in the federal debt burden of any administration in history. Thank goodness it is no longer increasing. (Red bars in the chart signify that the debt burden increased over the presidential term, while green bars signify the debt burden fell.) There is hope for the future.