Thursday, May 12, 2016

The end of declining deficits

On a rolling 12-month basis, the federal budget deficit hit a peak of almost $1.5 trillion in February 2010. From that dizzying height of just over 10% of GDP it fell steadily for six years, hitting a low of $402 billion last February, a mere 2.3% of GDP. It's unlikely to get any lower than that, unfortunately, unless and until we see stronger economic growth and/or significant reform to entitlement programs. For the foreseeable future, the budget deficit is likely to get bigger; it's already jumped to just over $500 billion as of last month. There are several culprits: weaker economic growth, weaker tax collections, and a pickup in spending. 

The chart above shows the nominal level of federal spending and revenues on a rolling 12-month basis. Note that spending was flat from mid-2009 through last year, but is now on a clear uptrend. At the same time, it appears that the strong uptrend in tax revenues, from early 2010 through early last year, is fizzling out. Two virtuous trends have reversed. 

The chart above shows the level of federal spending and revenues as a percent of GDP. Note how both have been trendless over long periods.

It's time for policymakers to revisit Hauser's Law: there is a limit to how much tax revenue can be extracted from the private sector, and we are now approaching that limit. Tax rates have risen in the past year or so, but tax collections have weakened. Raising taxes—as both Clinton and Sanders are proposing—will almost surely fail to close our current and projected budget gap, because higher rates will discourage work and investment, while encouraging more tax evasion. 

As the chart above shows, the weakness in tax collections is concentrated in individual and corporate income tax collections—both of which are driven by weaker profits—while payroll tax collections are rising at a 4% rate that is commensurate with the ongoing rise in payrolls and wages. 

The first of the two charts above shows the nominal level of federal budget surpluses and deficits, while the second shows the level as a % of GDP. There's nothing necessarily scary here, since it will be awhile before the deficit rises meaningfully relative to GDP. The larger message is that the budget deficit is going to be returning to the headlines before too long, and politicians who fail to understand Hauser's Law will mistakenly call for a fix in the form of higher tax rates. The correct fix, of course, would be to reduce tax rates, simplify the tax code, and reform entitlement programs in order to keep spending under control.


Johnny Bee Dawg said...

Republicans did a 180 degree about-face on policy when they signed that omnibus bill in December 2016. They decided to fund 100% of Obama's agenda instead of fighting it like Gingrich showed them how. Stocks fell 700 points in two days despite no pressure from oil or RMB, and have sucked ever since.

This broken PUB Party has created another layer of risk aversion with their appeasement, while they fight their own voter base. The biggest economic stimulus they could do is shrink the size and scope of government. Otherwise we face prolonged 2% GDP with crappy productivity and muted consumer discretionary confidence. PUBs act like they are afraid to stand up to the nitwittery of DEM socialism. Their tepid response and refusal to fight is discouraging to the productive element of society.

A compliant PUB Party removes the required checks and balances of our system.

Hans said...

Record federal "real" tax revenue for the first seven months!

Grechster said...

Johnny: What makes you think the GOP has ever wanted to "shrink the size and scope of government?" Ever since the likes of Bob Taft exited the stage, these turkeys have all been about bigger government. Even St. Reagan was all about bigger government, despite the claptrap. (I'm referring to spending and the non-elimination of any govt programs or departments.)

But in our welfare/warfare state, the GOP is all about growing the warfare side of the equation. As such, about a third of the country is always with them, no matter what; I guess these people somehow think pissing away trillions in the most inefficient way is somehow consistent with smaller and more efficient govt.

The wonder is that our govt was able to keep spending roughly flat for several years recently. Alas, that is now ending as Scott has pointed out. If we were serious about reducing govt and juicing growth, we'd eliminate the payroll tax and cut total "defense" spending from $1T to $500B. Growth would accelerate, hiring would take off. And who wouldn't like this (except for those feeding at the govt trough)? The Dems should be jumping at the opportunity to eliminate the regressive payroll tax and the GOP should be jumping at better growth and smaller govt. But neither side is about any of that. They're about welfare and warfare.

(Please don't interpret this as any sort of endorsement for the Dems' policies. They're at least as idiotic as the GOPers. Actually, I take that back. Both are worse than idiotic. They don't pursue welfare/warfare out of idiocy but, rather, out of pursuit of power, which is worse, and inconsistent with our founding documents.)

Benjamin Cole said...

I agree with Matthew.

The Cato Institute says "national security" spending could be cut in half. I would propose even deeper cuts as I see no military threats to the United States.

Eliminating President Bush's Medicare Part D program would relieve taxpayers of a lot of liabilities as well.

I suppose we can reform entitlements, but Medicare and Social Security are financed by payroll taxes.

If we want to cut income and capital gains taxes, we will have to deeply cut into agency spending, and that means national security, the Department of Commerce, HUD, the Department of Agriculture and deep cuts into federal rural subsidies.

Right-wing or left-wing, in DC they want to put their hands into your wallet.

Johnny Bee Dawg said...

PUBs used to shrink government's economic impact. It's what they were there for. Debt to GDP shrank while PUBs controlled Congress from 1994-2007. It skyrocketed after just two years of DEMs control after that. Voters quickly ejected DEMS from the House after their insane spending and the overreach of Obamacare. Pelosi was the shortest tenured Speaker of the House in US history.

By 2007 even the deficit, as a percent of GDP, had shrunk to less than half of its previous 50 year average. PUBs did that, and fought DEMS the whole way. DEMS increased the deficit by nearly nine times its value n heir short time controlling Congress.

Once PUBs got control of the House again in 2010 (where all spending bills must originate) they kept spending flat for years. In fact, 2013 was the only year in our lifetimes when government spending actually DECLINED. The market blasted off 30% in anticipation of new fiscal restraint. Make no mistake...PUBs did that despite Barack's best efforts. PUBs have actually been pretty good at keeping spending in check while in power. Until now. This is new.

Their new omnibus bill this December which funded everything Obama requested showed markets that the PUBs have abandoned their long time legacy of fiscal controls, and are no longer dependable stewards for keeping insane DEM spending in check. Meanwhile, both DEM candidates are screaming for more spending, more unconstitutional government power, and skyrocketing deficits.

No wonder the deficit is on the rise again, along with risk aversion. And now PUB "leaders" are fighting against their own angry voting base. Where's our advocate, now?? Voters are ready for a reset.

bob wright said...

Scott, how can there be weakness in individual income tax collections while payroll taxes continue to rise at 4%?

Shouldn't individual income tax collections payroll tax collections move in the same direction?

Scott Grannis said...

I think it is likely tied to the fact that capital gains realizations are not as big as they used to be, because the stock market is not rising as much as it used to, which in turn is tied to the fact that corporate profits have stopped rising.

randy said...

Dawg - The voters are going to get a reset. The way I see it, no matter which candidate wins, we risk disaster. You've noted favor for Trump... no disrespect, you must have your own logic. IMO that's an immensely reckless path for voters. Reckless with one's inheritance is your own business. With the country? And Hillary is concerned about the FEDs demographic makeup? Yeah... that's confidence inspiring. What's worse is, they are representative of our civic leadership at all levels. The upside odds over the next decade are low.

steve said...

And yet the 10 year is trading near all time lows in yield. crazy. Oh and by the way, BOTH Hillary and Trump would spend MORE than O. Crazier.

Benjamin Cole said...

Retail sales weak, following sluggish jobs report. Mortgage rates hit three-year low, US Treasuries sub 2%.

I cannot think of any global industry that is straining to meet demand, indeed the opposite is true.

Central bankers are peevishly fixated on inflation, even as deflation is the norm in more of the globe.

Benjamin Cole said...

I thought Scott Grannis and others would get an eyebrow-raise out this report from Japan:

"Another effect of negative rates is being felt on the financing costs of the J-REITs. It is early days, but the policy has so far allowed the downtrend in financing cost to be maintained with REITs largely being able to refinance at lower cost and to extend debt maturities. In February, using interest rate swaps, GLP J-REIT, a landlord in the logistics space, was able to finance at an effective rate of -0.009%, essentially being paid to borrow. While this type of agreement is not yet widespread and remains an isolated case, it showcases what negative interest rates can do and how they could change completely the nature of real estate financing."

So in Japan, some investors are effectively being paid to borrow money to invest in property.

I am not sure the US is on the Japan path, but I think it is possible, and that we are are but one recession away from deflation. It may be worthwhile to look at Japan from time to time.

The Fed appears to be trying to tighten its way to higher interest rates---the way a kangaroo tries to fly.

Hans said...

Credit to you, Ben Jamin, for your all too numerous posts
regarding years of Nippon QE failures.

The results hear in America are much the same, with Fedmonics
the rage of the land; expect either more of the same or some
derivative of the past producing third-world economic gains.

And what the hell, if they go negative, the FRS can stop paying
interest on bank reserves and save billions to pay for all of those
toxic MBS from Fan and Fred and the rest of the bailoutees.

Benjamin Cole said...


You might want to read up on how Japan largely sidestepped the Great Depression of the 1930 s.

You will come across heresy, but it may be a heretical undertaking worth pondering.

(They printed money!)

Hans said...

Ben Jamin, they were industrializing and militarizing for the epic
battle with the great gringo Satan. (why does this spell check(er) approve
god in a lower case but not satan?)

Where are the FRED charts spanling this impeding disaster?!?!?

For those using rose colored glasses, you need to read this econo-aster
which is coming to a "community" near you.

More FREDless charts coming your way.

Hans said...

The last paragraph is the most salient of the entire
piece. It all started with LBJ's War on Morality and
his cronies in CONgress.

"America’s middle class has lost nearly 30% of its wealth over the last four decades. The shrinking of the middle class has reached the point where it may no longer be the economic majority in the U.S. More households make up the middle class than 40 years ago, yet they comprise a smaller share of overall wealth. In early 2015, there were 120.8 million adults in middle-income households versus 70.3 million in lower-income and 51 million in upper-income households, according to Pew. “The hollowing of the American middle class has proceeded steadily for more than four decades since 1971,” researchers Richard Fry and Rakesh Kochhar wrote."

This is compelling and frightful evidence of the vaporization of
the middle class. It will take several decades to reverse this
misfortune, if it ever even happens.

If the MC dies, so will this great republic. Radical changes are needed
now, with the same clarity and rectitude of America's rebellion for

Modest virtues will not stem the final outcome. Those whom
have not realized this course of events over the past two decades, are
either self-serving or comatose.

America has reached the approach of the Rubicon.

Most great civilizations simply fell in place. Let this not be our fate!

Benjamin Cole said...

If you want to help economic growth and the middle class, outlaw property zoning.

There would be a property development boom on the West Coast that would last for decades....

Hans said...

Ben Jamin, that would simply be a start, albeit a good one!

Please, read this article or the simple sentence highlighted in yellow.

The Beltway is toxic to it's inner core.

Benjamin Cole said...

Hans--interesting book. I contend every federal agency should be cut in half, civilian or military.

I sheepishly make an exception for NASA.

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McKibbinUSA said...

Significant entitlement reform is impossible in today's depressed economy. What else can be done? My proposal would be to outlaw interstate banking, return 100% of our troops back to the US for future FEMA duties, close the Departments of Home Land Security, Education, and Energy, and to impose 50% tariffs on all imports of energy, consumer electronics, and textiles. The future deployment of any soldier overseas should be outlawed unless Congress passes a declaration of war. Finally, government salaries to non-uniformed employees should be outlawed. Our borders should be closed and guarded by combat troops returning from the rest of the world. Mandatory conscription of all able-bodies Americans ages 18-36 should be imposed along with deep cuts in military pay and benefits. Truthfully, I doubt much government money will be left for entitlements after all of these urgent reforms. Anyone who disagrees with these ideas is part of the problem with America. Thanks for considering my ideas to save America from itself.

McKibbinUSA said...

PS: A balanced budget amendment to the Constitution should be passed today...

Hans said...

Ben Jamin, not a bad idea. In fact, make them operate
with 1970 dollars or close.

I would send NASA into a climatic orbit; one without budgetary

Dr McKibbin for Secretary of Governmental Restructuring and Decommissioning. The
only needed departments are War, Treasury, and Justice.

We need another Convention of the States.