How?

Rather than responding to the various articles and editorials, pro and con, on the massive spending bills being drafted in the House, let’s talk ways and means a bit, shall we? To start out let’s look at a couple of graphs, courtesy of the Tax Foundation. The first is a graph of federal revenues as a percentage of gross domestic product:

and the second is state and local government revenues as a percent of GDP:

I want to point out some interesting things about them. The first is how constant the proportion of the private sector income the federal government has been extracting since 1950—it’s hovered right around 18%. Similarly, after 1970 the amount of private income state and local governments have extract has been right around 13%. What caused the sharp uptick in state and local taxing in the 1960s? I’m not really certain but it could possibly be related to the introduction of Medicaid. I’m open to suggestions.

The key point is that when the highest marginal rate on private income was around 90%, federal taxes brought in about 18% of GDP and when they declined to less than 40% they still brought in about 18% of GDP. What has varied over that period is spending and most of the difference was supplied by borrowing. Why has that amount been so persistent? Again, I don’t know. I think that some of it is political and some is practical. The practical part is that it becomes increasingly difficult to get Americans to pay taxes as they rise about 18% of GDP. The political part is that people start voting against tax-raisers at about that level.

So, Mr. or Ms. Congresscritter, you want to extract more than 18% in taxes for the federal government. There’s a lot you’d like to spend it on. How are you going to do it? Don’t tell me you’re going to raise the highest marginal tax rate—that won’t be enough. What else are you going to do? Or, more precisely, how are you going to keep your job if you do what you actually need to do to extract that much in taxes?

The Congressional Budget Office says we’re likely to run a $1.5 trillion this year. Unlike some I agree with the Modern Monetary Theorists to the extent that I believe we can run small deficits in perpetuity without adverse consequences. How small? No more than the increase in aggregate product which is running about 3%. $1.5 trillion is quite a bit more than 3%.

What do I think? I think that we should be willing to pay for what we want and we should constrain what we want to about 21% of GDP. There’s a lot you can’t when you maintain that level of discipline just as there’s a lot you can’t eat when you’re holding to a diet of fewer than 2,000 calories per day. Refusing to pick and choose is popular; making choices is hard. Which is why we’ll continue to live beyond our means.

What does that mean in practical terms today? It means that the progressives who are pushing the massive spending bills should be willing to try to extract an additional $350 or $500 billion per year in taxes and do whatever they need to do to accomplish that. I don’t think they will. I think they’d prefer to borrow us into default or inflation.

2 comments… add one
  • bob sykes Link

    My copy of Samuelson did not discuss the current situation when I was taking Econ 101 in the early 60’s. Modern Money Theorists might be right, although they don’t convince me.

    I think the real problem with the deficits is the interest rate. If it is low, and nowadays it is historically low, then rolling over old debt into new debt isn’t really a problem. But I do remember the interest rate explosion under Volker, when only variable rate house mortgages were available, and they peaked out around 21% apr. Those rates wreaked Unholy Hell in the economy.

    If rates were to return to more common levels, say 6%, the annual interest payment on the federal, state and local debts would more or less double. And that would squeeze out a lot of spending. It would also crush the stock market.

    Just how much control does the Federal Reserve have over interest rates? What happens if Evergrande does go belly up? The correspondents at Asia Times are pretty sanguine this morning, and seem to think that Xi’s intervention will lead to a gentle, but still painful, correction to the real estate giants problems.

    I would be happier if the US federal debt were much less than 100% of GDP. I think the size of the debt puts real constraints on how the US government can respond to either bad times or higher interest rates.

    The US isn’t the only actor in the world. There are many other actors out there with agency. Any one of them could start some sort of crisis. The Ukrainians are itching to fight Russia, with us doing the heavy part, of course. Taiwan’s governing party might still go crazy, egged on by our neocons, and declare independence. There are many way the current budget situation could get much worse real quick.

  • Modern Money Theorists might be right, although they don’t convince me.

    I didn’t pick it up in Econ 101, either. More like 301 at about the same time as you. A banking course.

    Just how much control does the Federal Reserve have over interest rates?

    Again, it’s a banking issue. The Fed sets the interbank lending rate.

    I would be happier if the US federal debt were much less than 100% of GDP.

    There is plenty of empirical evidence that the higher the public debt, the slower is economic growth. It is no longer believed that there’s a “cliff” at 100% of GDP but the evidence is still that the relationship between debt and growth is inverse and furthermore the evidence supports the conclusion that the the causality runs in that direction. Shorter: debt is bad.

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