The Micawber Problem

There’s a memorable statement made by one of Dickens’s most memorable characters in the novel David Copperfield. Mr. Micawber (masterfully played by W. C. Fields in the 1935 movie adaptation) says “Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” In his column in the Washington Post Jared Bernstein attributes the federal deficit unequivocally to not enough revenue:

Let’s begin by asking why the budget deficit of about -4 percent of GDP is unusually large. Historically, late in an expansion such as the current one, with unemployment this low, the budget deficit has been close to zero. This expansion, however, has seen both tax cuts and spending increases financed by borrowing. So, relative to what we’d expect, what’s driving the deficit: less revenue or more spending?

Congressional Budget Office data suggests it’s a revenue shortfall. In the summer of 2017, before the tax cuts and spending deal, the budget office predicted that we’d spend 20.5 percent of GDP in 2018, which turned out to be about right, as the actual spending-to-GDP rate last year was 20.3 percent. But CBO also thought — and remember, this was before the tax cut — that we’d collect 17.7 percent of GDP in revenue. The actual share came in well below that, at just 16.4 percent. By the way, that 20.3 percent spending share: It’s precisely equal to the 50-year average, i.e., it’s no outlier. What’s unusual is the low revenue number.

A look at longer-term CBO projections further underscores the revenue shortfall. The figure below shows CBO’s forecasts for spending other than interest payments and revenue from two different vintages of its long-term budget outlook, one from 2010 and its most recent, from last year. Spending net of interest is appropriate because our alleged spending problem refers to spending on government programs, not on servicing the debt (note, however, that the general finding is the same if I use total spending).

He continues by demonstrating that if present trends continue the budget deficit will only increase. Check his reasoning carefully. It’s a masterful piece of legerdemain. The key phrase is “relative to what we’d expect”.

There’s another way to look at it, expressed here at The Balance. Check the attractive infographic there. Federal revenues are increasing. So is federal spending. Federal spending is rising faster than revenues are increasing. I would submit that as long as that’s the case the deficit will only broaden. I would also observe that increasing taxes and spending will increase deadweight loss, i.e. less economic growth than would otherwise have been the case and, consequently, less revenue than would otherwise have been the case.

Let me make my views clear. I opposed both the GWB and the more recent Trump cuts in the personal income tax rate because to my eye the evidence was extremely clear. Personal consumption expenditures were increasing and, indeed, PCE comprised the largest percentage of the U. S. economy in history. Domestic business investment on the other hand was inadequate to produce enough growth for us to do all the things we want to do and that can’t be explained by inadequate consumption since PCE was so high.

I have also opposed all of the foreign adventurism in which we have engaged over the last 25 years. War is not only hell, it’s expensive hell. I’m under no illusion that we can balance our budget by cutting military spending but we could economize a bit by only spending money on things that are necessary.

Don’t blame the present situation on the Baby Boomers. That’s fatuous. When has the Congress been dominated by Baby Boomers? Answer: never. And we’ve known that the Baby Boom generation was large and would get old and retire for 70 years. It didn’t suddenly sneak up on us. The Congress, led by the Greatest Generation and now by the Silent Generation, just failed to prepare.

Simplifying things to the greatest degree possible there are three courses of action: more revenue, less spending, or it doesn’t matter. Mr. Bernstein is clearly in the “more revenue” camp. I think that would be the right answer but for history. When faced with increased revenue the Congress always increases spending not merely in proportion to the increase in revenue but to the universe and beyond.

If you’re in the “less spending” camp there are some realities you need to confront: most people rely on Social Security as their primary income after they’re too old to work, health care costs (not just spending) need to be reduced, and we’ve got to stop wasting money on foreign wars that can’t be won. Today most of those in the “less spending” camp are Republicans and they have steadfastly refused to come to terms with any of those realities.

There is also a growing “it doesn’t matter” camp. If you hold that view, you believe that we can simply issue ourselves credit for whatever we choose to spend without adverse repercussions. They may be right but in my view that’s risky and there is no way to mitigate the risks. If they materialize they will be catastrophic.

Where I come down in all of this is that we need to raise taxes a bit (pick your preferred strategy) while holding the line on spending which will require a drastically different Congress and sharply different politics, we need to restrain defense spending to actual defense and cut health care costs which will also require a drastically different Congress and sharply different politics, and continue issuing ourselves credit which we can do with impunity as long as we a) do it more slowly than the economy is growing and b) don’t spend it on operating expenses. Health care, education, defense, interest on the debt, and Social Security spending are all operating expenses.