The incredible shrinking budget deficit

I've been posting regularly on this subject for at least the past 5 years, and although it seems old hat, the continued improvement in federal finances caught my eye even while distracted by the pleasures of touring Northern Italy. Here are some updated charts with brief commentary:

The best news of all is that federal government spending has experienced very little or no growth for the past six years (see red line in the chart above)! This has allowed the magnitude of government influence on the economy (mostly via transfer payments (aka income redistribution), which account for almost three fourths of federal expenditures) to shrink from over 24% of GDP to now just over 20%. As Milton Friedman taught us, government spending is equivalent to taxation, regardless of how it is financed. And when the amount of income that gets redistributed by the government shrinks by some 20% in just six years, that is significant. This is already giving the private sector a lot more breathing room, at the same time as it has reduced the expected future burden of taxation. This is the kind of stuff that can juice the private sector's animal spirits.

Thanks to zero growth in spending opposite relatively strong growth in revenues, the federal budget deficit is now approaching 2% by my calculations (see chart above). Six years ago we were staring at budget deficits that would equal or exceed 10% of GDP for the foreseeable future. As usual, it turned out to be difficult to foresee what has actually happened. This dramatic improvement—even though the economy has struggled to grow—is a big reason the equity market has been able to advance as it has. This is also something I've been blogging about since late 2008: markets have rallied because the future has turned out to be much less dire than expected.

Just think what might happen going forward if our government managed to do just a few things right. Like slashing corporate tax rates—which, as the chart below shows, are a very small part of total revenues but currently pose a huge barrier to investment (think of the billions in foreign profits that U.S. corporations refuse to repatriate—living proof that the tax code is distorting the economy). Or reforming entitlement programs—like privatizing social security and raising the retirement age. Or cutting capital gains rates, which, at 30% or so, penalize savings and investment. I'm an optimist because there are so many things that are wrong with our economy today that could be fixed easily and quickly.

We've made significant progress in these past years by gradually starving the government beast, but much more needs to be done. Government simply can't spend $3.6 trillion a year as efficiently as the private sector could. Trying to spend $300 billion a month leads to too much waste, corruption, and inefficiency. To paraphrase one of Obama's advisors, the federal government is simply too vast to be run efficiently.