Here’s the conclusion that Megan McArdle draws in her post on the relationship between federal revenues and federal spending:
A number of my readers are claiming that the only reason Obama is running such a big deficit is that revenue has collapsed. I don’t see that in the data…
Her post is interesting if only for the graphs one of which I’ve reproduced above. She’s certainly right in that whether you believe that the explanation for the source of the federal deficit (not to mention its intractability) depends on your assumptions. A number of things struck me as I looked at the graphs.
First, I think that we need to take the role of bubbles in economic growth much more seriously. I see three bubbles in that graph or, at least, two bubbles and a bubblet.
There’s the dot-com bubble and the housing bubble, of course. Those are represented by the two peaks in the revenue side on the right hand side of the graph. Note that each peak, the latter just slightly higher than the former, is followed by a valley, the latter just slightly lower than the former.
However, over on the left hand side of the graph there’s another much small peak followed by an even smaller valley. That’s the bull market of the 80s.
The spending side is interesting, too. Throughout the 90s, under Democratic Congresses and Republican Congresses, Republican president and Democratic president, spending trends upward at a very low, steady, supportable rate. And then something happens. Spending just goes crazy.
What happened was two things. There were the attacks on September 11, 2001 and our responses to them. During the Aughts President Bush managed to recapitulate virtually every error made by his predecessor Lyndon Johnson during the 1960s. He increased spending to pay for war without reducing domestic spending or raising revenues to pay for it and, not unrelated, he failed to engage the American people in the war effort adequately enough to support the war effort.
I probably should repeat my views here: I opposed the invasions of Afghanistan and Iraq. I don’t want to dwell on this but in the case of Afghanistan in particular I see very little that has been accomplished in going on ten years that couldn’t have been accomplished at vastly lower cost with a punitive raid in force.
Obviously, President Obama hasn’t done a great deal either to reduce the spending on our ongoing wars or to decrease domestic spending or increase revenues to pay for them. I should mention in passing something I’ve documented here previously: maintaining an American soldier in Afghanistan costs three times what maintaining that soldier in Iraq does. Consequently, drawing forces down in Iraq while building them up in Afghanistan will inevitably increase costs even if you withdraw two soldiers from Iraq for every additional soldier you deploy in Afghanistan.
In President Obama’s defense he had to deal with the ongoing wars while contending with an economic slowdown. So did President Bush.
Back to the graphs. Why would anyone assume that the revenue peak of 1999 would continue in linear fashion forever? I can’t see any good reason to assume that and it’s the only way you see revenues staying persistently over expenditures. I see no better reason to assume that the second peak would be expended in linear fashion forever. Indeed, if there’s a trend it’s not a linear one—it’s cyclic one with, on average, revenue not growing at all.
Also, that slow growth during the 1990s is an illusion created by the scale of the graph. Look at the trend since 1950. That’s not a linear graph. To my eye at best that appears to illustrate the effects of compounding, growth at a fixed percentage.
At the beginning a 2, 3, or 5% growth per year doesn’t look like a lot. But when that percentage increase is piled year on year it can become enormous. And if the rate at which expenditures grow exceeds the rate at which revenues grow, it’s a formula for disaster.
There are two different strategies for dealing with such a problem. Either you can expand your revenues to pay for your wants or you can limit your wants to what your revenues will support.
In the interest of balance we should look at federal revenues over the same period. As you can see, they’re not linear either but there’s obviously something seriously wrong starting in 2000. I think that reflects excessive dependence on revenues that are the result of bubbles.
It seems to me that the idea that spending must be counter-cyclical is well established. Receipts fall in downturns, and many assistance programs naturally rise. That is even before governments implement special responses, like tax cuts, or spending increases.
The most frustrating thing in American politics today are those who “play dumb” to that. At its dumbest, the whole gap, including loss of revenue from business contraction, increased welfare and food stamps, lost revenue from ongoing tax cuts, it is all just lumped in with actual post-2008 legislative changes and called “Obama’s deficit.”
McArdle’s piece isn’t quite that dumb. She says “My purpose was simply to argue against the notion that the current deficit is overwhelmingly due to collapsing tax revenues.”
Well, obviously not. The real question is much harder. It is in The Great Recession how much should we spend? We must go counter-cyclical, but how far?
I don’t think that’s the only question. I think that an equally important question is in the absence of adequate forces for pro-cyclical spending reduction is there any responsible way to engage in Keynesian counter-cyclical spending?
Sure, part of the misunderstanding is that to truly achieve counter-cyclical spending we must make hay when the sun shines(*).
* – I had to read “Making Hay” by Verlyn Klinkenborg before I really got that saying.
I’ve spent more time with graphs like this than I care to admit. I usually download constant dollar data and then make sure everything is measured as a percent of GDP, which I think is usually appropriate.
Some observations in addition to Daves:
1. The Fed govt has run a deficit in every years since 1961 0r 1962, I can’t remember which. (And even if you deny the acctg chicanery that produced the “Clinton surplus,” as Dave points out, it was a bubble phenomenon, plus the peace dividend. The social spending juggernaut never missed a beat.)
2. There has been a 50 year trend of spending displacement as defense spending has fallen as a pct of GDP from the teens to the low single digits. Dave recently pointed out that it can be reduced further. I have no quarrel with that, but when a spending category has fallen five fold while its replacement spending category increases unabated you can look over the horizon at financial calamity.
3. There has been downshifting of cost and taxes to state and local government over time. There is more than just the Feds at work here.
I also agree with JP, we have had no discipline to use the good times to establish a rainy day fund, or reduce our financial leverage. That’s terrible fiscal management, and leaves us in an impaired condition.
Related to that, one legit function (IMHO) of government has been infrastructure maintenance, which has been neglected for decades, while money was doled out to people. Shameful.
Tax cuts, tax reform, and a recession…i.e. no bubble. Spotting bubbles by looking at government receipts is going to be dodgy at best, IMO.
Actually, looking very carefully at that graph it is my opinion that we could fit a spline function to the spending data and that there are 5 regions or “splines” that would have to be tied together.
From about 1980 – 1990 is one region. From 1990/91 to 1996/97 is another. Then from 1997/98 to about 2001. The last two are 2001 – 2008 and from 2008 onwards. The first region has trend slope of, eyeballing it, about 50 billion a year. The slope then drops in the next region and picks up again later. The slope again increases in each of the two succeeding regions as well. Conclusion: spending has been accelerating since the mid 1990’s while receipts have not. In short, deficit spending is not a partisan issue, both sides do it. A corollary is that neither side is serious about fixing the issue either.
Yes it is cyclical, but when you account for those cycles I bet the trend variable still has a positive slope. A quick regression using a trend variable shows a trend slope of 98.8–i.e. each years revenues go up by almost $99 billion. Now including some dummy variables for the various recessions the trend variable is 103.8–i.e. each year revenues go up by almost 104 billion. So there is growth over time and even, but that growth is not sufficient to “catch up” to spending–i.e. deficits as far as the eye can see.
Also, the reason for the positive slope is due to the earlier observations. If we limit to the data by cutting it in half, a bit dodgy since it doesn’t give us that many data points to work with, the trend is still positive.
That there is a positive trend isn’t surprising. The lack of trend to the visual eye in the above graph is due to the business cycle. That is the trend is being obscured by another variable. The only way to not have a positive trend in the data is to carefully select your starting and ending points–e.g. selecting a starting point of 2000 and an end point of 2009/2010 would likely give you a negative trend…however why get rid of all the information from previous years?
You can only do that if you really believe that from here on out government receipts are going to be roughly stagnant and for that to be the case economic growth has to be stagnant. And if that is your belief you need something far more convincing that carefully selected points from a time series. You know, something like a valid argument…i.e. an explanation as to why growth from here on out is going to be pretty much near zero. (See below by the way)
Try a log transformation.
y = x(1+r) where r is in (0,1). Taking logs of both sides:
log(y) = log(x) + log(1+r)
Its linear now. In other words, if you transform the space you are working in then you can use linear representations.
True, but if the deficit was just a fixed amount and not too small it wouldn’t be a bid deal. That is if we had extended both the receipts and outlays from their 2007 levels with linear projections we’d see deficits that were say…mmmm….$350 billion. If we had deficits like that projected for 10 years we’d be in an infinitely better position than we are now. Instead we are in one where we have trillion dollar deficits with Medicare and Social Security about to add even larger amounts to that deficit. More and more tax revenues will go towards servicing the debt vs. gov’t activities that help promote economic growth. Taxes will likely also have to go up meaning more money going to servicing the debt/paying transfer payments than going into productive activities. With less money going into productive activities you’ll have lower economic growth which only adds to the problem.
In other words, our fiscal situation is such that the low to zero growth you need for your claim that receipts are going to be be, at the very least growing at a slower rate may very well be true. We have set up a fiscal train wreck with pretty much zero way out. Try to cut Medicare and the doctors and old people will kill you in the next election (mostly the old people, but doctors have lots of money and can run lots of adds). Try to mess with Social Security and your opponent will run a cartoon of you pushing an elderly woman over a cliff (as what happened to George Bush). And now with the ACA governments health care obligations have gone up, not down. Chances are that will only accelerate government spending. And if we have a fiscal crisis–i.e. people become increasingly reluctant to lend to us–then it gets even worse even faster as interest rates go up. Servicing the debt becomes more costly and people looking to borrow to make investments in economically productive activities will go down.
But by all means go vote like it means something and will help the situation.
Steve:
Good analysis. I have a few quibbles. For example:
The deficit is the difference between revenue and expenditures. If expenditures are increasing faster than revenues there is no year n for which the difference between expnditures and revenues will in year n+1 be less than or equal to their difference in n.
To accomplish that you’d need to put a ceiling on expenditures relative to revenues (something I’d be in favor of). I seriously doubt that such a system would prove administrable.
My point (which I may not have put forward very clearly…”bid”?) was that if the deficit is relatively small over time, then it isn’t that big a deal, even if we run one most of the time or even all of the time. If we had deficits that were say, 2% of GDP from now to whenever, we’d be in much, much better shape. I don’t think anyone would be all that worried. It might not be great, but it wouldn’t be awful either.
The situation we are in is where the deficit isn’t just going to be large, but also growing over time. Yes, projections under the current law is for deficits to decline over the next 10 years. Problem is nobody really believes them. The CBO doesn’t, the chief actuary of Medicare doesn’t, you Dave, don’t. And that isn’t a list of crazy minarchists such as myself. And Hell, I bet if you got Obama good and drunk he’d admit he doesn’t believe it either.
We are in a situation, as you note where the deficits are likely to be a rising share of GDP and the political willpower to deal with such a problem is virtually non-existent. The best analogy is we’ve set up a fiscal train wreck and there is no siding onto which we can switch one or the other trains involved because to do so would likely mean political suicide not just for those politicians who did it, but their entire party. Neither party is going to be willing to spend possibly decades in the wilderness to prevent this calamity from happening.
it’s the only way you see revenues staying persistently over expenditures.
I find it amazing that the myth of the surplus of the late ’90s has taken root and been accepted as fact.
For the life of me I don’t understand the math which enables total national debt to climb every year that a surplus is declared. Wouldn’t a surplus result in a lowering of the total national debt?
Here is a website which shows you the total national debt on any given day. You can check fiscal yearends across the 90s and you see the total national debt growing every year.
Now the gimmick that is used in order to support the myth of the surplus is that total public debt held went down in the years FY 1998- FY 2001, but there there was a corresponding increase, plus some, in the total of intergovernmental debt being held. After all, this was the period of the employment boom so the FICA receipts were rolling in.
Sorry to derail, but it just rubs me the wrong way to see myth accepted as reality.
Justin Fox ran the actual numbers. Graphs are misleading sometimes. Your graph above does not extend the trend line for both sets. It skews the appearance. Fox goes back to 2001.
http://blogs.reuters.com/justinfox/2010/10/25/whats-really-behind-that-1-3-trillion-deficit/
He shows that if we had continued the same trends since 2001, we would be looking at a deficit mostly from lack of revenue.
“I find it amazing that the myth of the surplus of the late ’90s has taken root and been accepted as fact.”
As Drew pointed out above, most people look at numbers as a percentage of GDP. Using that metric, debt decreased.
Steve
Justin Fox’s “numbers” are dishonest tripe. Sure one could argue that due to the recession and the spending in response we have sky high deficits. But as many critics of the “response spending” noted much of it will take place after the recession is over. Further, the realistic scenarios from the CBO, Medicare’s chief actuary, etc. are for trillion dollar deficits for quite sometime.