A Look at Government Spending Trends. Not What the Deficit-Fearers Claim. It’s Really A Jobs Deficit.

Rebecca Wilder at AngryBearBlog.com explains why the current deficit hysteria that has gripped Washington is misplaced (and offers some great graphs of historical spending patterns).  A little terminology for some readers.  “cyclically endogenous” means the cause of the spending/revenue is not from some budget decision of this year’s Congress or President, but rather that the spending or revenue amount is the result of whatever the GDP and the economy did.  If GDP goes down and that causes some spending to go up, for example unemployment compensation, then that’s cyclically endogenous. (The bold emphasis is mine. You can click on graphs to enlarge them)

Readers here will know more about the US federal government income statement than I. However, given the near ubiquitous deficit hysteria, I wanted to illustrate the truth about the budget deficit. …

First things first, the fiscal deficit – receipts minus net outlays as a % of GDP – is big [by historical comparison]. In June 2011, the 12-month rolling sum of net receipts (the budget deficit) was roughly 8.5% of a rolling average of GDP. This is down from its 10.6% peak in February 2010, but the level of deficit spending clearly makes some nervous.

Why should they be nervous about the ‘level’ of the deficit? I don’t know, since recent ‘excess’ deficits are cyclically endogenous. The chart below illustrates the spending and tax receipt components of the US Treasury’s net borrowing (see Table 9 of the Monthly Treasury Statement). Weak tax receipts and big spending are driving the federal deficits (spending, as we will see below, has surged on items directly related to the business cycle).


In June, the 12-month rolling sum of tax receipts – mostly corporate and individual income taxes and social insurance and retirement receipts – was 15.6%, which is up from its 14.5% cyclical low in January 2010. On the spending side, net outlays in June 2010 were a large 24.2% of GDP and down just slightly from the 25.3% peak in February 2010.

Deficit hysteria should be more appropriately placed as “lack of jobs and tax receipts hysteria”. At this point, the budget could just as easily worsen as it could improve, given the fragile state of the US economy (see Tim Duy’s recent post at Economist’s View).

Why the wrong hysteria?

Reason 1. Taxes. Some would love to increase taxes – but the fact of the matter is, that tax receipts remain well below their long-term average of 18% of GDP. Tax receipts will not improve without new jobs since individual income taxes account for near 50% of total receipts.

Reason 2. The spending has been on cyclical items.

The best time to ‘worry’ about government spending is NOT when the economy is barely moving.

The chart below illustrates the big ticket items of the monthly outlays – roughly 87% of total outlays. The broad spending components are listed in Table 9 of theMonthly Treasury Statement. The long-term average shares of total spending are indicated in the legend.


The items health, medicare, and income security (inc security) are all above their respective long-term averages. But spending on income security outlays is the only spending component to have broken its trend, i.e., surge. According to the GAO’s budget glossary (link here, .pdf), this item includes the following cyclical spending:

Support payments (including associated administrative expenses) to persons for whom no current service is rendered. Includes retirement, disability, unemployment, welfare, and similar programs, except for Social Security and income security for veterans, which are in other functions. Also includes the Food Stamp, Special Milk, and Child Nutrition programs (whether the benefits are in cash or in kind); both federal and trust fund unemployment compensation and workers’ compensation; public assistance cash payments; benefits to the elderly and to coal miners; and low- and moderate-income housing benefits.

It’s spending on unemployment and food stamps that’s driving spending at the margin.

The same deal exists with the ‘smaller ticket items’. Of these <5% of total spending items, energy, environment, and veterans have arguably broken trend. I would surmise that some of the ‘veterans’ spending is tied to the business cycle, given the timing of the surge.

OK – so deficit hysteria is about, but it’s misplaced. One could argue for more, not less, spending to get the jobs growth, hence tax receipts, up.

There Is An Efffective Way to Reduce Government Deficit: Employment. But They Won’t Take That Route.

In the whole crazy, unnecessary debate over raising the debt-ceiling law, politicians, reporters, and commentators all spoke as if there were only two ways to reduce the government deficits.  Nearly everyone took it as an article of “serious thinking” that to reduce a deficit requires either reducing spending or increasing taxes.  But rather than being evidence of “serious thinking”, such talk is evidence of sloppy, imprecise, and ignorant thinking.  Such talk totally ignores the role of economic growth in determining government budgets and it ignores the role of the government in the economy.  It’s evidence of the government-as-household fallacy, the idea that government is just like a big household and subject to the same constraints as you and I.

There is a way to balance the budget that doesn’t require cutting major spending programs.  And it doesn’t require big tax increases.  It’s called economic growth and putting people back to work.  The major cause of the deficit is because we have very high unemployment.  We have over 9% reported unemployment.  That number rises to approximately 16% if we count all the people working part-time jobs but that desperately want full-time work and more hours.  And finally, both numbers totally ignore the fact that since we fell into this depression in 2007 well over 5% of adult Americans have chosen to drop out of the labor force altogether for now.  If we put those people back to work, they pay taxes. Government revenues will increase even without a tax rate increase.  If we put those people back to work, then government spending on unemployment compensation, Medicaid, welfare, and a host of other safety net programs goes down.  Automatically. Without cutting any programs or harming anyone.

This idea that economic growth and full employment will reduce deficits isn’t some theoretical possibility that only exists in the models of some economists.  We’ve done it before.  Other countries have done it.  In fact, everytime the U.S. has reduced it’s deficit it’s been by increasing employment.  The route to a small deficit or even a balanced budget lies in achieving full employment first, not in contrived artificial balanced budget amendments.

It wasn’t until the debt-ceiling debate was practically finished (for now – it will be back like zombie or vampire) that any in the media took notice that growth and employment is the key.  Last Sunday, July 31, as the President and the Republican Speaker announced their deal to cut spending and raise the debt ceiling, the New York Times finally runs a decent article about how growth is the real answer (bold emphases are mine):

 We wouldn’t need any of that [reduce spending, raise taxes, inflation, or default] if we could restore economic growth. If that happened, Americans would become richer and pay more taxes. Et voilà! — we’d pay down the debt painlessly.

Crazy as that might sound, particularly given Friday’s figures, the possibility isn’t some economic equivalent of that nice big farm where your childhood dog Skip was sent to run free. There are precedents.

Before its economy crashed, Ireland was a star of this sort of debt reduction. In the 1980s, Ireland’s debt dwarfed its economy. Over the next two decades, though, that debt shrank to about a quarter of gross domestic product, largely because the economy went gangbusters.

“Ireland went from being, you know, the emerging market in a European context, to a very dynamic economy,” says Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics and co-author of “This Time Is Different,” a history of debt crises.

The United States has done the same in the past, too. After World War II, gross federal debt reached 122 percent of G.D.P., the highest ratio on record. But over the next 40 years, it fell to about 33 percent. That wasn’t because some blue-ribbon panel prescribed austerity; it was because the American economy became much, much richer.

The same happened during the prosperous 1990s, which began with deficits and ended with surpluses. Former President Bill Clinton is often credited for that turnabout, as he engineered higher tax rates. But most economists attribute the surplus years primarily to extraordinarily rapid growth.

It would be lovely to repeat that experience today, and send our federal debt off to that farm with Skip…

Usually after a recession, growth snaps back quickly and the economy makes up for ground lost — and then some. That’s not the case this time, at least so far. In the 60 years before the Great Recession, the economy expanded at an average annual rate of 3.5 percent. In the second quarter of this year, it grew at less than half of that pace, putting us further and further behind where we would be if the economy were functioning normally.

Unfortunately the article still tries to give the reader the impression that growth/full employment is difficult or unlikely this time.  It tries to give the impression that the growth during the Clinton years was somehow extraordinarily fast.  It was only fast by comparison with either the Bush I, Bush II or the first Reagan terms.  In fact, the growth during the Clinton years was only average at best when compared to what was achieved routinely during 1950-1973 or even during the Carter years.  The article also falsely claims that our “aging population” will require unusually large demands on government resources.  In fact the demands of the aging baby boomers on either Social Security or Medicare aren’t any greater than the resources we devoted to educating those baby boomers in the 1950′s and 1960′s.

Nonetheless, the point of the article is right on:  growth and growth in employment is the way to go if you’re worried about the deficit & debt (which I’m not, but that’s another issue).  The deficit we have is a jobs deficit, not a fiscal or budget deficit.  That’s what we need to worry about.

Washington and the chattering political classes have it wrong.  Their “serious” talk is anything but.