Desperately Seeking Reality

Writing at the blog of the American Enterprise Institute, John Makin is very concerned about the graph above, which illustrates the growth of federal spending and federal receipts over time:

The approach of the debt ceiling by late February, when the US supposedly can’t pay its bills, has brought the “man bites dog” attention seekers out of the woodwork. Former government lawyers write in the Wall Street Journal that concern is silly because the law mandates that revenues be used to pay interest on the debt first. True, but that means that most other programs are drastically cut — no social security checks, etc — while the economy, deprived of a quick $300 billion per MONTH (over 2% of GDP) goes into cardiac arrest.

and urges Americans to face reality rather than seeking out “gimmicks”, e.g. trillion dollar platinum coins.

Here’s another graph of federal receipts and expenses which to my eye illustrates the problem even more clearly:

That’s the same information from the same source, the St. Louis Federal Reserve, but it’s shown in log scale. Several different interpretations of that are possible but here’s mine. Federal revenues and expenditures grew approximately at the rate of inflation until the 1970s. Revenues fell during recessions; spending increased during recessions. In the late 1970s spending started growing a lot faster than revenues and that separation has continued ever since, expect for a brief, aberrant rejoining of their paths during the dot-com bubble.

Here’s what I think is the real, big question mark. Roosevelt, Truman, Eisenhower, Kennedy, Johnson, Nixon, etc. all failed at extracting more than 20% of GDP in revenues over any extended period of time. Marginal rates, population, etc. made no difference. Occasionally, it would go over 20% very briefly and then decline again. Expenditures have exceeded 24% of GDP for some time. Under the most optimistic scenario those would fall to just over 22% of GDP. Under less optimistic scenarios they would remain at around 24% of GDP or even increase. Realistically, that means between $500 billion in annual deficit (the optimistic scenario) and $800 billion in annual deficit (the less optimistic scenario). It’s not difficult to imagine trillion dollar deficits extending into the indefinite future, especially if the economy slips into recession again, which seems more than likely over the next few years.

It’s mathematically impossible to make up that difference just by taxing the top 1% of income earners which seems to be the present plan. I don’t much care whether it’s politics, economics, psychology, or phrenology that makes it impossible to extract more than 20% of GDP as federal revenues. It’s never been done successfully over an extended period so, if that’s your plan, I want to know how you’re going to do it.

It seems to me that would take either a substantial sales job or enormously increased enforcement along with a broadening of the tax base to accomplish the feat. What’s your plan?

Alternatively, we can reduce spending. My candidate for doing that is, was, and always has been some combination of reduced defense spending and reduced healthcare spending. I don’t see any way to get where we need to go without reducing healthcare spending. Not reducing its growth; reducing the spending.

25 comments… add one
  • steve Link

    You seem to be assuming that people do not value some spending more than others. Social Security and Medicare have been very popular. Part of that popularity probably comes from the starve the beast plan which has kept spending high while cutting taxes. So, we dont really know if they are popular enough that people would be willing to pay more for them. However, we do know that people have been willing to pay more and more for private health care insurance (even here the tax expenditure clouds things).

    I think it plausible that we might be willing to pay a bit more to maintain these two programs, but we need to put it to a vote. So far, neither party is willing to offer cuts for us to vote on.

    Steve

  • I don’t think you’re reading, steve. Over the period of the last 200 years, we have never extracted more than 20% of GDP in taxes over any extended period. You can’t just wave that away by saying “Of course we can”. The burden of proof is one you. If you think we can, you’ve got to say how. Right now neither party is willing to tax the bottom 99% at a higher level full stop.

    I do wonder how in the world you would determine people’s preference for things they don’t pay for. Of course Medicare is popular. People are receiving benefits they’ve never paid for. Free beer is always popular.

  • Andy Link

    steve,

    You seem to be assuming that people do not value some spending more than others. Social Security and Medicare have been very popular.

    Sure they’ve been popular. And, until very recently, the tax revenues designed to fund those programs exceeded costs and provided a windfall to the general fund. That’s no longer the case. It remains to be seen whether those program are popular enough to allow increases in OASDI and HI tax rates. Now that the flow is reversed and entitlements are pulling money from the general fund things may change. Or things may just get ugly. But no one (that I know of at least) is proposing increasing taxes targeted to entitlements. If these programs are so popular, then wouldn’t that kind of proposal have the best chance at passage? Why then, is that proposal not on the table politically?

    As an aside, the “starve the beast” so-called strategy never made much sense to me. The logical way to “starve the beast” is to reduce OASDI and HI tax rates and thereby cut the funding for SS and Medicare. As far as I know, the GoP never proposed such cuts and most of them opposed the 2% tax holiday that recently expired. The GoP didn’t seem to want to even erase the surpluses these revenue streams generated for years. Instead, with the Bush tax cuts, they pocketed that bonus revenue from entitlement taxes and instead cut income taxes.

    Dave,

    I’ll go back to my generational theory and suggest it’s mostly about the boomers. I linked to research in other threads (too laze to look it up and link again) which show that the boomer generation, much more that its predecessors, believe government has more responsibilities to citizens but, at the same time, that boomers individually owe less to society in terms of service, paying taxes, etc. So they want more from government but are less willing to pay for it or sacrifice in other ways (like military service). As you point out, spending in the late 1970’s starts to consistently outpace revenues and that’s about the time the boomers really begin to become a political force. Might be a coincidence, but I don’t think so.

    If I’m right, then we’re probably screwed – or at least my kids and grand-kids are screwed. As long as boomers remain the dominant political demographic, I don’t think the mismatch between spending and revenues will close until there’s no other option. I think the farce that was the fiscal cliff negotiation reflects the underlying reality that many people in this country expect the government to do a lot as long as they don’t have to pay for it. I don’t really see a solution to that – the problem is us.

  • Icepick Link

    We’re going to get more taxes from all the additional commerce generated by the best economic recovery in the history of the Universe. Look at all the extra jobs we’ve already created!

    We’re not going to need to get more than 20% on the revenue side, because with the denominator (GDP) growing at such a rapid pace, that will shrink the government portion of the economy down to 20% as well. I mean, look at the vast increase in jobs that have nothing to do with the government in the report I linked above. Why, Mining, Quarrying, and Oil and Gas Extraction alone have added almost 108,000 jobs all by itself, and in just five years! Thank God we have leaders such as Barack Obama to lead us to the promised land of wealth and happiness for all. I expect to get a job again any decade now.

  • You bring up a good point, Icepick. The projections of rapid GDP growth are, essentially, pie-in-the-sky wool-gathering.

    Recently, there’s been a CBO graph making the rounds illustrating how the deficit is going to shrink over the next few years. What those promoting it don’t recognize is that the CBO is a creature of Congress and operates under the constraints that Congress imposes on it.

    If the Congress tells CBO to assume 4% growth, that’s what they do. Those are their constraints. Which means that excellent as CBO’s info may be for past events, their analyses are highly suspect in predicting the future.

  • jan Link

    As long as boomers remain the dominant political demographic, I don’t think the mismatch between spending and revenues will close until there’s no other option. I think the farce that was the fiscal cliff negotiation reflects the underlying reality that many people in this country expect the government to do a lot as long as they don’t have to pay for it. I don’t really see a solution to that – the problem is us.

    Andy

    The boomers are a contradictory generation — free-spirited and open-minded in their philosophies, but very dependent-oriented in having their needs met by big government programs, which are fed by the fruits of anonymous ‘others’ labor. However, because they compose a massive budge in our demographics, their skewed outlook continues to dominate and drive the agenda of this country into an unsustainable future.

    I agree that the younger generations are at a set-point to have said boomer’s misguided conduct rain down on their lives. It doesn’t seem fair. But, according to Obama, ‘fairness’ is more an ideological concept, rather than one actually gauged and/or measured to create a thriving economical reality allowing fairness to reign through broad equal opportunity without government help.

    Icepick,

    The problem with Mish is that he is a realist. His numbers just don’t mesh with an ideologue’s economic computer models.

  • jan Link

    The title of this thread, ‘Desperately seeking reality,’ could also be applied to the CBO’s ACA projections. Basically, garbage in is garbage out.

    ObamaCare’s Health-Insurance Sticker Shock

    Although President Obama repeatedly claimed that health-insurance premiums for a family would be $2,500 lower by the end of his first term, they are actually about $3,000 higher—a spread of about $5,500 per family.

    Health insurers have been understandably reluctant to discuss the coming price hikes that are driven by the Affordable Care Act. Mark Bertolini, CEO of Aetna, the country’s third-largest health insurer, broke the silence on Dec. 12. “We’re going to see some markets go up by as much as 100%,” he told the company’s annual investor conference in New York City.

    Insurers know that the Obama administration will denounce the premium increases as the result of greedy health insurers, greedy doctors, greedy somebody. The Department of Health and Human Services will likely begin to threaten, arm-twist or investigate health insurers in an effort to force them into keeping their premiums more in line with Democratic promises—just as HHS bureaucrats have already started doing when insurers want premium increases larger than 10%.

  • steve Link

    @Dave- Prior to 1920, federal revenues ran less than 10% of GDP AFAICT. I wonder if someone ever wrote a piece claiming that they could never go above 10%? Note that we just had a tax raise and that both parties are willing to talk about taxes. They have both been avoiding SS and Medicare like the plague. I noted in my comment that people arent paying the full amount for Medicare, however I also note that people have been paying continually increasing payments for private insurance.

    Steve

  • I wonder if someone ever wrote a piece claiming that they could never go above 10%

    You’re misstating what I wrote. What I wrote is that they haven’t gone above 20%, except for very brief periods. That was true even when federal spending rose above 22% of GDP. To me that means that some sort of affirmative steps must be taken to make that happen. What steps are you advocating?

  • Andy Link

    steve,

    Interesting that it took a series of major crises to essentially double 1920’s federal revenues over the the next century. Another big shift will probably require another major crisis (or crises) and perhaps one isn’t too far off.

  • Drew Link

    I think the point steve misses is that its always popular to tax the proverbial “other guy.” Recall, the income tax was originally designed only for the very wealthy. And how did that work out?

    We are coming full circle. Despite all kinds of variously eculpatory to flat out dishonest arguments the tax base of neccessity had to go down the income spectrum. And despite all dishonest arguments from the left the code is extremely progressive, payroll taxes not withstanding. As I’ve pointed out repeatedly, when the economic and political realities of killing/taxing the golden goose became reality, we started using our debt capacity. A country like ours can go along time doing that. No different than the debt capacity of Apple vs Joes Pizza Parlor. But there are limits even for an Apple. One S&P downgrade so far. Anyone believe the inflation stat?

    And so Obama can insist we have no spending problem. He can posture about “tax fairness.” But he’s proving what I have been saying for some time. Great politician. Financial fool. Dave is making the point that a lender/finance/LBO guy finds so fundamental you want to pull your hair out that it is not widely understood or acknowledged. Drunken calls for “free beer” indeed.

    But there is no free lunch. The rich and powerful will always find a way. Why is 20% “THE” number? I don’t know. But its a very powerful and longstanding empirical result. But did anyone notice the payroll tax holiday ended? The brackets increased? But………the inheritance tax exemption sayed at $5MM per?? Think the Kennedys, Rockefellers etc had anything to do with that? Ya think?

    Just today I heard pure bull from Obama on what he most assuredly knows: $4.7 trillion can’t be fixed right after a hard fought $600B tax increase. We all know its just BS posturing, but the numbers are so far apart as to boggle the mind.

    Obama is going to have to place the biggest knife in the back of the middle class in decades, or hope and pray he can scoot out of town before our debt capacity is exhausted. Dave points out the inevitable recession. The drum beats are starting. And last time I looked they don’t sell interest rate caps on government debt. If anyone has the sense to get rid of Helicopter Ben look out. Cut defense spending if you like. I’m no expert and therefore agnostic on the “right” amount. But can it go down more than 1% of GDP?? We have a spending problem of the first order and in no way shape or form can taxing the top 1-2-3% fix it. Dishonest or mendacious politicians like Obama can get elected by promising candy, er, “free beer,” but only so long. (Remember the famous “Obama Girl” video who thought he was going to pay her mortgage and car payment with cash “from his stash?” That’s the mentality we are dealing with.) If you have kids, look them in the eye and tell them why you are doing this. Then look at your brother and sister’s kids and the neighbors kids…..

  • steve Link

    @Dave- I have long advocated cutting Medicare costs. However, given our demographic bulge, we could also increase the Medicare deduction to cover the costs incurred. If this were really something people were unwilling to pay for, the opposition could run on repeal and do so if elected.

    @Andy- Yes. It lead to a large standing army, and the need to pay for it and Social Security among other things. I think a lot of this current crisis is artificial, notice bond rates arent moving, but if it is perceived as such, I dont see why it couldnt result in a shift up, or down, in spending and taxing.

    “As I’ve pointed out repeatedly, when the economic and political realities of killing/taxing the golden goose became reality, we started using our debt capacity.”

    As has been documented many times, and you have the resources to check the numbers yourself, our debt binge started in the late 70s or early 80s. That does not correlate with taxing golden geese. While a tax increase, or spending cuts, could cause a recession now, I dont think they need to take place right now.

    At any rate, these segmented discussions are difficult. I think we need to cut medical spending. For policy reasons I would cut DoD also. That takes care of most of our future debt. A smallish increase in revenue would let us maintain SS and maintain a broader range of care for Medicare patients. I have not read anything that convinces me that revenues at 22% of GDP instead of 20% will crush us.

    Steve

  • I have long advocated cutting Medicare costs. However, given our demographic bulge

    There are any number of ways of dealing with the “demographic bulge”. The most prudent, of course, is, since we’ve known about it for sixty years, planning for it in advance, something we’ve steadfastly refused to do. I began advocating that, maybe, forty years ago.

    That’s water under the bridge now. The question now is not whether revenues at 22% of GDP will “crush” us. The question is how it can be accomplished. There are ways we can be fairly confident won’t work since they haven’t worked in the past: increasing marginal tax rates, more population, faster GDP growth.

    We know that increasing the highest marginal tax rate doesn’t necessarily bring in more revenue since 40 years ago the top marginal tax rate was 90% and it didn’t bring in much more revenue as a percent of GDP and certainly not over any extended period. The population has almost doubled since then and that hasn’t increased revenue to GDP. We’ve had faster GDP growth and that hasn’t done it. Our present slower GDP growth hasn’t, either.

    So, what’s the plan?

  • I might add that we haven’t even started discussing healthcare costs that proceed at two or three times the non-healthcare rate of inflation. CBO projections don’t include that or its implications for growth in the non-healthcare economy. Their assumptions, given by Congress, are just wrong.

  • jan Link

    ” I’m no expert and therefore agnostic on the “right” amount. But can it go down more than 1% of GDP?? We have a spending problem of the first order and in no way shape or form can taxing the top 1-2-3% fix it. Dishonest or mendacious politicians like Obama can get elected by promising candy, er, “free beer,” but only so long. “

    Well said, Drew. However, no matter how vociferously the opposition party points out our spending problem, Obama not only ignores their concerns, but continues to blame them for our continuing economic malfunction. In the meantime, the president’s only remedy is to burden the country with more debt, raising rates on a few special taxpayers, to extract some money to pay for it. Bleeding a country’s wealth, though, does not help it grow stronger or become healthier. But, maybe we have to die first before people realize that.

  • steve,

    Going from 10% to 20% might be far easier than going from 20% to 30%. The higher the taxes the greater the returns to tax avoiding behavior up to and including not earning extra income. You assume linearity, when there is plenty of evidence to suggest otherwise. Marginal rates were at one time near 90%, but we got pretty much the same amount of revenues, 20% give or take a bit here and there.

    I have not read anything that convinces me that revenues at 22% of GDP instead of 20% will crush us.

    Heh…impressive.

    Guy #1: We have a problem we need to solve. We have very large and unsustainable spending obligations into the future.
    Guy #2: Hmmm, you’re right. Here is my solution: “the solution”.
    Guy #1: Uhhhmmmm…and the specifics?
    Guy #2: Right there: “the solution”.
    Guy #1: No offense, but there aren’t any specifics, heck there aren’t even broad strokes here.
    Guy #2: Come on, I’ve given you “the solution”.
    Guy #1: But we need something with a bit more detail.
    Guy #2: Come on, “the solution” shouldn’t be a problem to implement at all.
    Guy #1: Okay, maybe we should just let this go…..

    You can fill in which person in this thread is Guy #1 and who is Guy #2.

  • I have not read anything that convinces me that revenues at 22% of GDP instead of 20% will crush us.

    And bringing spending down closer to 20% of GDP wont crush us either.

    Just saying.

    We know that increasing the highest marginal tax rate doesn’t necessarily bring in more revenue since 40 years ago the top marginal tax rate was 90% and it didn’t bring in much more revenue as a percent of GDP and certainly not over any extended period.

    Bah, facts schmacts. Jesus Dave, what is wrong with you. Pie in the sky dude, that is where we’ll get more for our economic pie. Duh.

    Also, lets look at this:

    There are any number of ways of dealing with the “demographic bulge”. The most prudent, of course, is, since we’ve known about it for sixty years, planning for it in advance, something we’ve steadfastly refused to do. I began advocating that, maybe, forty years ago.–Dave Schuler

    And this:

    As has been documented many times, and you have the resources to check the numbers yourself, our debt binge started in the late 70s or early 80s. That does not correlate with taxing golden geese. While a tax increase, or spending cuts, could cause a recession now, I dont think they need to take place right now.

    And never the twain shall meet.

    One says, “Lets do the prudent thing and tackle this problem now.” The other responds with, “Mañana .”

    I know steve will feel a bit put out by that. He might argue something a bit more sophisticated, but it is still a variant of mañana. He might say, “Lets wait till the economy is on stronger footing.” Okay, exactly what does that mean? Is it 3% growth, over 3% growth? What if growth doesn’t get that high for an extended period? Granted growth right now is anemic, but we are more likely to go into another recession vs. a phase with high economic growth. So it really is just a mañana argument.

  • jan Link

    Most growth predictions I’ve heard are no more than 2% — nothing that will get this economy out of stagnation, only help it tread water for a while longer.

  • TastyBits Link

    @Steve Verdon

    Going from 10% to 20% might be far easier than going from 20% to 30%. The higher the taxes the greater the returns to tax avoiding behavior up to and including not earning extra income. You assume linearity, when there is plenty of evidence to suggest otherwise. …

    There is a tipping point or “the straw that broke the camel’s back” for most people. It is too much work to shelter one’s income up to some point.

  • jan Link

    TastyBits,

    TastyBits,

    The government, though, rarely takes into consideration the weight of their policies versus where they will meet active resistance from the people. Most law-abiding people, though, have higher thresholds, than those who disengage from laws they find too onerous.

    Consequently, government hubris is driven by the majority of those who don’t contest or are too late in their contesting. It is these ‘adaptable’ people who lay the ground work for future tyrannies — something labeled as such, usually from the rearview mirror of history.

  • steve Link

    “We know that increasing the highest marginal tax rate doesn’t necessarily bring in more revenue since 40 years ago the top marginal tax rate was 90% and it didn’t bring in much more revenue as a percent of GDP and certainly not over any extended period. ”

    And as we all know, it had even more loopholes than the current tax code. We have never collected more than about 20% for very long, but have we tried to do so? I would say no. We certainly had no need to do so. What popular program would we have spent it on? Now, we have two very popular programs that we could spend more on.

    “And bringing spending down closer to 20% of GDP wont crush us either.”

    I agree with this. maybe that will be the outcome of this impending crisis. WE have two universally popular programs and a need to fund them if we want them to continue. If we decide to cut them, we can stay at 20% in revenue. If we want them to continue, we will need more. We can raise rates or eliminate tax expenditures. I would prefer more of the latter. We can add new revenue sources. Meh. We have never tried to collect more, but if it is a priority, I think we will. Surely we cant be the only country to not know how to collect taxes.

    “One says, “Lets do the prudent thing and tackle this problem now.””

    Prudent now because? I just got home. Let me go check the bond markets. Pause. Ok, no big change. Our big threat is our future debt, which is really health care driven. I wanted this resolved a long time ago. It is a building problem that has been apparent for years. The sooner we fix it the smaller the disruptive changes will need to be. But, no one anywhere in the world has completely solved this problem. Other places are doing better than we are, and I think they have a better chance of solving it because of the way their systems are set up. I think we need to be working on this now. As long as we have plans to start working this down, I think we will be ok.

    My gut feeling is that it will take some increase in revenue AND a major overhaul of our health care system. While politicians may not be good for much, I think they have a pretty keen sense of what will and will not get them re-elected or booted out of office. Since they are all scared to tackle Medicare, I think they have deduced it is suicide to make drastic cuts in Medicare spending.

    Steve

  • TastyBits Link

    @steve

    The PPACA was supposed to solve the problem by increasing the pool of money by increasing the people paying. The people using the ER for routine healthcare were causing the problem. The PPACA would correct this. Everybody would be covered, and with preventive healthcare, people would become healthier. Healthier people would use the system less, and between the cost savings and additional paying users, the US healthcare system cost curve would bend down.

    It now turns out that this is not the problem. The problem is with 15-25% of the people, and these are mostly older folks. Furthermore, few cost saving attempts will succeed. There are enough additional services that could be charged to cover any reduction in income, and if I understand correctly, any additional measures would require additional administrative costs anyway.

    I realize I must be missing something.

  • steve, your answer reminds me of the old wisecrack, in answer to “Do you play the violin?”, “I don’t know, I’ve never tried.” If you haven’t tried, you can’t.

    And as we all know, it had even more loopholes than the current tax code.

    I’m amazed that you don’t see the causal relationship between those two things.

    Let me try to respond in a more satisfying way than that. Since 1960 in all but a few years the deficit has exceeded 2% of GDP, particularly over the last ten or so years. In many of those years the deficit as a percentage of GDP has been larger than the increase in GDP. I don’t think that’s a winning formula.

    What I’m saying is that we had lots of popular programs. We just borrowed to finance them.

    There are two big differences between now and the past. The first is that according to the CBO interest on the debt will only become a larger part of the budget. The second is that unemployment are high and GDP growth is slow and they’re likely to stay that way.

  • jan Link

    The bottom line is that growing social programs, like Obama wants to do, not reforming entitlements, and leveling more and more regulations and restrictions at business is not an economic recipe for growth, which is the pathway out of this mess!

  • And as we all know, it had even more loopholes than the current tax code. We have never collected more than about 20% for very long, but have we tried to do so? I would say no.

    Where is Michael and his harangue about liberals being in touch with reality? Of course we tried, that is why marginal rates were so high. Problem is that the higher the marginal rates, the more effort people expend on tax avoidance….which includes things like lobbying for tax “loop holes”.

    That is why lowering taxes and closing loop holes can work. It works because with lower marginal rates people don’t find the effort/cost of lobbying for said loop holes to be worth it any more.

    We certainly had no need to do so. What popular program would we have spent it on? Now, we have two very popular programs that we could spend more on.

    We certainly did, Social Security and Medicare. We needed higher revenue collections early to ensure that the programs would be sustainable and we had massive debt from WWII.

    WE have two universally popular programs and a need to fund them if we want them to continue. If we decide to cut them, we can stay at 20% in revenue. If we want them to continue, we will need more.

    Good luck with that. I don’t think it will work out that way. People always have the option of just not earning as much…especially the rich. Those people at the 0.1% can live just fine by dropping into the 1% range of income. Would they like it? Of course not, which is why they’d spend money lobbying for loop holes, but baring that they could always just opt to make less.

    Prudent now because? I just got home. Let me go check the bond markets. Pause. Ok, no big change. Our big threat is our future debt, which is really health care driven.

    Wow. I didn’t expect a doubling down on the mañana strategy. So lets wait until the problem becomes so large that even a doctor who intermittently checks the bond will finally see something bad in said bond market. Yeah…that’s a great idea. Never mind that if we tackled this problem 10 years ago it wouldn’t be as burdensome as now. And 20 years ago it would have been even easier. Lets wait until if really freaking hurts.

    I wanted this resolved a long time ago.

    Really? But there are no warning signs in the bond market. We got time. Lets procrastinate some more.

    As long as we have plans to start working this down, I think we will be ok.

    Dude…WTF…we have no plans. In fact, the last attempt (bahahahahaha) at a plan, is likely going to make things worse not better.

    While politicians may not be good for much, I think they have a pretty keen sense of what will and will not get them re-elected or booted out of office. Since they are all scared to tackle Medicare, I think they have deduced it is suicide to make drastic cuts in Medicare spending.

    Which is why we have no plan. We can’t get out of this mess by avoiding cutting Medicare however it is accomplished (means testing, changes in care for those terminally ill, whatever).

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