Thursday, January 14, 2016

Federal finances look good, but threaten to deteriorate

Six years ago the federal budget deficit peaked at almost $1.5 trillion, a staggering 10.2% of GDP. Last year it was only $475 billion, a modest 2.3% of GDP. That's some pretty significant progress that hardly anyone expected, and it was due mainly to spending restraint and the growth of jobs, incomes, and profits. 

Keynesian economists in 2009 would have predicted a massive recession/depression had you asked them to forecast the impact of such a huge reduction in the deficit. At the time (2009), they all predicted that a surge in spending (i.e., the ARRA) would jump-start the economy boost growth for several years, and they disagreed only about the size of stimulus spending, with most arguing for more rather than less. As it turned out, almost $1 trillion of "stimulus" spending gave us the slowest recovery on record. Ditto for the Fed's QE and massive purchases of notes and bonds, which did little if anything to stimulate the economy. All the government and policy intervention was for naught. From a supply-sider's perspective, it's more likely the case that massive government spending and policy intervention contributed to the economy's malaise.

Spending was flat from mid-2009 to late 2014, but since then it has resumed its upward trend, even as the economy slowed last year (which is not surprising from a supply-side point of view). Revenues, in contrast, rose over 60% from their early-2010 low. 

Relative to GDP, the picture looks pretty good. Spending currently is around 20.5% of GDP, just over one percentage point above its post-War average, and way down from its 2009 high. Revenues are coming in around 18.2% of GDP, also about one percentage above their post-War average. Unfortunately, they are unlikely to increase much further relative to GDP, since the growth of revenues has already slowed to 4-5% or less. Unless, of course, policies take a turn for the better (e.g., lower marginal tax rates, reduced regulatory burdens).

Last year's deficit was only slightly above its post-War average. If current conditions were to continue, the outlook for federal government finances would be sustainable for at least several years. Unfortunately, without entitlement reform, spending could rise significantly in the years to come. Transfer payments last year totaled over $2.7 trillion, almost 73% of total federal spending and 15% of GDP! Needless to say, transfer payments don't contribute to GDP, since they involve taking money from taxpayers and giving it to people who likely are not working or not paying much in taxes (e.g., retired, disabled, lower income). We need reform in Washington for the outlook to brighten.

Individual income taxes (which include taxes on dividends and realized capital gains) were the main engine behind revenue growth, rising at an annualized rate of 10.2% over the past six years. Despite disappointingly slow economic growth last year, individual income taxes last year increased 9%. Payroll taxes (FICA) didn't grow nearly as fast, however, thanks mainly to the slow recovery in jobs and a payroll tax holiday in 2011 and 2012, but they rose 5.4% last year, despite the modest 1.9% growth in jobs.


Benjamin Cole said...

Great post.

Cut federal spending to 15% of GDP.

Eliminate the USDA, the Commerce Department, the Labor Department, the VA, and cut defense spending by two-thirds..

Raise the Social Security retirement age to 67. Eliminate the Social Security Disability system.

I would prefer to see a big cut in FICA taxes as opposed to top marginal tax rates, but that is a difference of opinion.

William said...

So looking at your last (bottom) chart of Federal Revenues, each line item is at an all time high except for corporate taxes. Considering that corporate profit margins have been extremely high through out most of this abnormally slow recovery, why have total Federal Revenue from corporations NOT reached a new all time high like the others?

In addition (estimating from your chart), it appears that as a Percent of Total Revenues, the revenues from Corporations have fallen from 13.5% of the Total in 2008 to only 9% of Total Revenues in 2015. This in spite of the loud complaints that taxes are too high and inhibit corporate and US GDP growth - and thus should be lowered.

Makes me wonder if the multinationals found ways to lower their taxes, like through accounts in Ireland, The Netherlands and Bermuda. Many technology companies have their patents owned by a division in Ireland for example so their patent revenues flow to Ireland. (I have read of an intricate tax avoidance system which involves corporate revenue from Ireland moved to The Netherlands then to Bermuda.) It could explain the sudden appearance of unusually high US corporate profit margins in 2010 (which have persisted) - and explain why Federal Revenues paid by corporations have NOT reached a new high.

Benjamin Cole said...

Oh, I forgot: please eliminate HUD and the Department of Education too.

Funny note: Who is a liberal and who is a conservative?

Federal spending grew rapidly under Reagan, and he avoided wars. Inflation was 4-5% and rising when he left office, and the Reaganauts constantly prodded Fed Chairman Volcker to ease up.

Under Obama, federal spending flatlined, although real defense outlays are actually double the level of the Reagan days. Inflation is 1% to 2% and falling, and Obama has prosecuted an unsuccessful war in Afghanistan for his entire presidency. Obama has us in deeper in Syria than Reagan ever got us Lebanon. About 250 Marines died in Lebanon in the terrorist barracks bombing, and after Reagan left and never went back.

Yes, there is more to the picture, but just sayin'.

Johnny Bee Dawg said...


I think it's more useful to look at who controlled Congress than who was President when evaluating spending. Barack's budgets all skyrocketed spending, but didn't receive a single vote from either Party.

PUBs controlled Congress from the 1994 election until Jan 2007. Spending ratios plummeted during that time, and skyrocketed once DEMs took control again.

Hans said...

lBen Jamin, agree with your post with the exception
of Security spending.

The last quarter brought the federal governmental unit
a record tax income of $765 billion, yet America continues
to operate a $215 billion deficit.

When the Fedcession comes, look for large or new record
highs in government misspending.

Johnny Bee Dawg said...

Percent of spending going to defense fell to the lowest since before WW2 under the PUB Congress in 2007. It rose after that.

William said...

@Benjamin & Johnny

Maybe we could get the facts straight. Look at charts 2 and 3.

Reagan 1981 - 1989 When Reagan took office there was a recession during which Federal spending rose. Inflation peaked at 12% per year then fell to 4 - 5%! After the recession, Federal spending as a percent of GDP fell from 1983 through 1989. BTW, after his initial big tax cuts, he and Congress raised various taxes 8 times.

Bush I 1989 - 1993 Spending rose throughout his Presidency while revenues fell resulting in larger budget deficits. But there was a recession!

Clinton 1993 - 2001 Working with the Republican Congress, the "New Democrat" crafted growth policies which resulted in falling federal spending, rising revenues and a budget surplus in 2000 and 2001. It should be pointed out that those years were some of the best economic times this country has ever had thanks to the technology revolution and there was no recession.

On Federal spending maybe we could cut Bush II and Obama some slack since the Financial Crisis was the worst recession since the epic recession of the 1930s. I must remind everyone that many of the extreme actions which Congress and the Treasury took were under President Bush II - Bear Sterns, Lehman Brothers, AIG and emergency spending. Obama inherited the huge Bush I budget deficit for 2008 which was passed by Congress in the fall of 2007 under extreme circumstances!!

I believe that bailout of the auto companies and banks were in early 2008 under the new Obama administration which in the end didn't cost the Treasury anything. Fanny Ma and Fredy Mac have cost the government billions.

kotetu said...

The decreased deficit is misleading. The official numbers were held down by the debt ceiling, but the spending went on. Witness the $800 Billion jump in the national debt since October 30, when they suspended the debt ceiling. With 8 months and change to go in Fiscal 2016, the deficit will be back up to well over a trillion.

The games they play are silly. Even if we go all the way back to Clinton's presidency, the national debt never decreased, it increased. So we never had a real surplus.

William said...

Kotetu - Charts 2 and 3 have to deal with spending and revenue as a percent of GDP. That was what I was referring to.

I question your second paragraph. We must be specific with words. There was a real "Budget Surplus" but indeed the national debt never fell.

Lawyer in NJ said...

Eliminate the USDA?

No, I want food safety inspections to continue because I, as a consumer, do not have the ability to do it.

Benjamin Cole said...

Lawyer--the USDA is just part of the huge Red State Socialist Empire. Everything in rural America is subsidized, from highways to railways to airports to electricity to water system to phone systems to their crops to ethanol---it just goes on and on and on.

Benjamin Cole said...

Looks ugly on Wall Street.

Johnny Bee Dawg said...


If you want to get the "facts straight" I suggest once again looking at who controlled Congress, rather than who was President. Congress controls the spending, not the Executive branch.

And I suggest you look at spending, deficits, debt, etc as a percent of GDP since those are actual measures of what we can afford.

I wouldn't say Bill Clinton "worked with" Congress. PUBs had to take him by the back of the neck and force his reforms. They even shut down the government to curtail his agenda. It worked. Markets soared the minute they took control of Congress in the 1994 election with the Contract With America. Push back from the public once again created massive prosperity as the size of government shrank as a percent of GDP.

Oh how I pine for the PUBs to return to those goals instead of enabling this President.

Benjamin Cole said...

10YR Treasuries under 2% yield. My guess is that the Fed can raise rates, the way a kangaroo can fly.