July 15, 2010
POLITICS: Deficits Are A Symptom. The Problem Is Spending.
Do deficits matter?
The Obama Administration has been in something of a quandary lately as to whether to primarily emphasize its plans to spend more taxpayer money as "stimulus" or to paint itself as fighting against deficits. The former has the advantage of looking like the White House is doing - or trying against GOP opposition to do - something about the economy and its still-listless rates of growth and job recovery; the latter has the advantage of allaying voter fears that the Democrats have been doing too much and digging us into a fiscal hole, as well as offering at least the possibility of bipartisanship or faux bipartisanship that helps (whether Republicans accept or reject Obama's offers) blur the lines between the parties on deficits and spending. Remember that the one thing Obama has sought from Day One of his stimulus strategy, and has largely failed at, is to avoid presenting a clear contrast between the two parties on spending and the size of government, that being an argument he cannot win.
With a deficit commission working on proposals that will be delivered after the fall election, some liberal pundits/activists like Ezra Klein of the Washington Post and Matthew Yglesias of ThinkProgress are trying to keep both options open by arguing that conservatives are somehow hypocritical for complaining about massive deficits under Obama and the Democratic Congress while promoting tax cuts to help with the lack of economic growth. But read their work and notice, as with Obama, what's missing: they talk only about deficits, not about spending - you will search Klein's column in vain for any indication that anyone should care how obese government gets, as long as it's feasting on current tax revenues instead of on deficit financing. And naturally, when and if Obama tries to do something about the deficit, he too will view it mainly as a revenue problem, not a problem with spending and the size of government. Indeed, history shows that even Beltway Republicans have tended to fall into the trap of assuming that the problem is mainly one of raising revenue, or at least that any deal to fix the deficit can only attract Democratic support if it includes Democrats' beloved tax hikes.
This is going about the question all wrong. Would you rather have a federal government that spends 15 cents of every dollar earned in this country, while taxing 12 and making up the difference by issuing debt - or a federal government that takes in and spends 30 cents of every dollar? I'd much prefer the former. The Democrats don't want to have that conversation at all.
Either way the spending is financed, the amount spent by government is a portion of the economy that cannot produce meaningful growth. Yes, wise government can play a role in a better growth environment, and yes, at times the government produces a little growth on its own, e.g., government scientists invent things that can help the economy grow. But by and large, a dollar invested in the public sector is a dollar that will never bear more than a dollar in fruit, and next year the government comes looking for another dollar, while a dollar left in the private sector can grow and be used later in either private or public hands. (In Biblical terms, the dollar in the public sector is like the servant who buried his master's money in the back yard) All of the growth we take for granted as producing increasing wealth over time comes from the portion of the economy that is not consumed by government. So, using our oversimplified example, which obviously excludes the state and local public sector, you have one economy in which 70 cents of every dollar goes back to the private sector to grow, and one in which 85 cents does. Which economy do you think will have more money after a couple of generations of this? Even at a paltry private-sector growth rate of 2% per year, the first economy has produced $1.59 at the end of three years for every dollar, and the second has produced $2.27. As I said, this is a vast oversimplification, but there's simply no way for the first economy to grow faster unless you believe - contrary to the most fundamental tenets of economics and history - that the public sector can produce economic growth at a rate comparable to the private sector.
Moreover, within reason, running a modest deficit can make sense, for reasons somewhat analogous to why a corporation issues bonds as well as stock to raise capital, or why even well-off families (especially under the present tax code) may take out a mortgage: sometimes, debt is cost-effective. As long as it is a safe bet to repay its debts, the US federal government can borrow funds more cheaply than any other entity on earth, and while debt requires us to pay interest, which means mandated spending, if the money not taxed is growing in the private sector at a faster rate than the interest rate paid by the government, then deficit spending makes sense for the same reason why you might buy stocks instead of paying down your mortgage - the rate of return is better. Also, the federal government should never run a surplus, since if the government is collecting, say, 20% in taxes and spending 18%, it's the 20% figure that represents the bite taken out of the private sector. So, the target for revenue should always aim for a little below spending.
But the fact that deficits can make economic sense under the right conditions does not mean that all deficits do - the bigger the debt, the more interest is paid on it (thus, more spending), and the higher rates must be paid (because too-large debt makes bond markets worry about credit risk); and the higher proportion of government spending that's financed by deficits, the worse are your odds that the money left in private hands will grow faster than the interest rate. At some point, deficit financing becomes a very bad bet. And of course, there are situations where the government may need to run a surplus if it needs to use the difference to pay down enough debt to get back to its usual position of running a manageable deficit, a strategy used in the past after the federal government took on excessive debts in a short stretch to fight wars.
So, why are conservatives up in arms now over deficits? Two reasons. One - which the Democrats seem determined to ignore - is that public concern about deficits is often linked to concern about spending and the size of government. Huge deficits can be a major symptom of overspending. But they're the symptom, not the disease. I have a chart below the fold showing federal revenue, spending, deficits, debt and interest as a percentage of GDP, as well as deficits and interest as a percentage of spending (the Def% and Int % columns) and partisan control of the White House, House and Senate from 1947 through 2011.
Until the 2006 elections, we hadn't been over spending 21% of GDP since the 1994 GOP takeover of Congress, and hadn't been over spending 23.5% of GDP in the postwar period. But the first year of the new Democratic Congress took us to 20.7%, then 24.7%, with spending projected to crack 25% for 2010 and 2011 for the first time, as the deficit - never above 6% before, below 4% since 1993 and often below 2% during the era of GOP control of Congress - soars to 9.9% in 2009 and projected 10.6% in 2010. This is simply more spending than the economy can bear, and the deficit is a symptom of that problem.
And two, we're in a situation now where the proportion of deficit spending is itself out of hand. Check the Def% column in the chart - in fiscal years 2009 and (projected) 2010, we're paying for over 40% of government spending by issuing debt, while it had topped out at 18.1% during the years the GOP controlled Congress and 25.5% as the postwar high. It's not at all unreasonable to be unconcerned when you're borrowing 10% or 15% of your budget - when you're borrowing 40%, you're living beyond your means. And anybody who thinks you can fix that by collecting a quarter of GDP in federal taxes is insane.
Spending has to come down. That's the only way to fix the deficit problem and the growth problem.
Here's the chart:
Sources here, here and here, from the master budget-history site which has now been moved to the White House website. House/Senate historical partisan breakdowns here and here, including this note on fiscal years:
The Federal fiscal year begins on October 1 and ends on the subsequent September 30. It is designated by the year in which it ends; for example, fiscal year 2007 began on October 1, 2006, and ended on September 30, 2007. Prior to fiscal year 1977 the Federal fiscal years began on July 1 and ended on June 30. In calendar year 1976 the July-September period was a separate accounting period (known as the transition quarter or TQ) to bridge the period required to shift to the new fiscal year.
As with the prior iteration of this chart, I use 1947 as a starting point, as it's the first year after full demobilization from World War II; the war budgets were colossal - in Fiscal Year 1943, the deficit was over 30% of GDP. And before the New Deal, federal spending was generally less than 10% of GDP. The OMB site has projections beyond 2011, but since we don't even have a 2011 budget yet, much less the Congress that will vote on the 2012 budget, the projections further out than that are useless even if you assume that the federal budget forecasters have perfect clairvoyance about the state of the economy two or more years out (hint: I don't).
So the question is, will the next Congress cut spending and/or pare back the size of Government?
Based on what happened after the 1994 election I am not optimistic.
They should do both, while at the same time cutting taxes, especially on businesses.
We are in agreement on the mechanics of spending, growth and the deficit/debt. There is no doubt we need to reduce government spending. But there are a number of serious problems with your argument.
First, you respond only to part of the argument as to why liberals and others consider conservatives hypocrites on the deficit. It's not just that they want to cut (social) spending and lower taxes, but also that they want to -increase- military spending (or oppose cuts in military spending) at the same time. It's the combination of the three that makes conservatives look very bad on the deficit, certainly for me.
There is the counterargument that military spending is a temporary phenomenon (usually), while social spending tends to be more permanent. This would be a compelling argument if not for the tendency for conservatives to see every international incident as a threat to US security and leadership and to view every cut in military spending as a disaster.
Second, conservatives, in opposing the stimulus, have been way too dismissive of it. Keynesian theory has its problems, but it makes sense in these kind of severe situations when the monetary authorities have fired nearly all their weapons. The stimulus passed by Obama definitely helped and it was necessary, but it was never going to singlehandedly pull the US out of the recession - at best it helped keep deflation at bay and prevented a much worse situation. It would have required a massive stimulus package to achieve the kind of results people are expecting, and it was collosally stupid of Obama to try to put a number on it, and that is part of makes him look bad.
Third, you are way, way too smart to be trotting out that superficial chart to say anything meaningful about parties, growth and debt. My objections are the same as last time. There are so many problems with this, it's difficult to know where to start.
You assume a superficial cause-and-effect relationship between political parties and the fluctuations you mention, ignoring countless other economic factors, lag times between when policies are enacted and when they take effect, exogenous shocks, the list goes on and on.
Even if you accept that assumption, you can't just eyeball the chart, you'd need to do some statistical analysis.
And by the way, which numbers do you consider definitive?? For example, if you like debt/GDP, why not credit a unified democratic establishment for lowering our debt/GDP ratio from 53.4% in 1962 to 19.4% in 1969? And the republicans had the presidency AND the senate from 1982 to 1987 and the debt-to-GDP went from 35.2% to 50.5%? Why not crucify the republicans for this?
This is amateur stuff, you can do better than that.
the amount spent by government is a portion of the economy that cannot produce meaningful growth
This is where you will get violent opposition from the Keynesians, who will look utterly baffled at you when you point out the fundamental flaw of testability in their hypothesis, i.e.
1) If the economy recovered, deficit spending worked to revive it!
2) If it didn't recover, the cure wasn't large enough!
The big problem the Keynesians suffer from these days is trying to identify a mechanism through which it could possibly work. As former California Democratic Senate hopeful Mickey Kaus pointed out recently, even the President himself had no idea that the government couldn't simply wave a wand and pour cash into construction projects. Those days are long gone.
Concern about deficit spending is certainly well-placed, but one wonders just how much of it stems from the current occupant in the White House (and who controls Congress) versus something resembling actual principles.
First of all, bravo for pointing out that the blathering deficit hawks we're hearing from are full of it. If they cared a whit about deficits, they would denounce their support for tax cuts for the rich (which you pointed out in your May 25th post, do not spur job growth) while waging two wars.
The discussion now should be between government spending to assist the citizens (who desperately need the help) vs. government spending to assist the few who are connected.
Care to fill us in on which of those you support?
Let's see. We have basic subtraction: a-b=c, where a = revenues, b = spending, and c == deficit or surplus.
All that matters to the wingnuts is -- drum roll, wait for the big surprise -- GOVERNMENT SPENDING. I think back to the ealry clinton years, when his tax increases were so certain to wreck the economy that not one republican voted "yes." What happened? A huge surplus that Bush pissed away on tax breaks for the wealthy and a stupid war against a fictional enemy.
Until the right comes to grip with its own horrendous economic record, you should all just shut up and let the adults run the country.
Magrooder, Clintons tax increases had caused the beginnings of a recession before Bush took office. Then there was 9/11. The Bush tax cuts brought us back out of both of those situations. Check governments revenues, there have been substantial increases in revenue after Kennedy, Reagan and Bush cut taxes. It has worked every time it has been tried, just like socialism has failed every time it has been tried.
MVH - I agree that the chart is only one piece of the answer about the parties. But I do think the broad-based trend is pretty obvious that spending was lower under the GOP Congress than before or since, and that that has a bigger impact on spending than who controls the White House.
We can safely classify Magrooder's as a complete non-response on the spending issue. I still maintain that the Clinton tax hikes were unhelpful to the economy, but in the end they were outweighed by the other things happening during that time period:
1-Massive expansion in world trade, due to free trade agreements and the benefits of victory in the Cold War (by far the largest factor in driving the boom years of the 1990s);
2-Defeat of Clinton's healthcare takeover and energy tax, which would have been crippling;
3-Spending discipline imposed by GOP Congress;
4-Capital gains tax cut and other Congressional initiatives later in the decade.
And even so, as the chart shows, by the end of the 90s taxes were at an all-time high share of GDP. That may make you happy, but it was at the point where taxes crossed 20% that the boom receded, the NASDAQ (in 1999) and Dow (in 2000) started plunging, and we ended up headed into recession even before 9/11.
Saw the "D" after Clinton's name, and maintained his tax hikes were unhelpful to the economy. (yawn).
Crank, how many conservatives will try to rein in defense (sic) spending?
I know the answer. I just want to see if you can count all the way to zero.
Conservatives don't care about deficits or spending. It's a red herring, designed to handcuff the President during an economic crisis. ("country first" don't ya know).
Notice how Crank NEVER brought up these issues under GWB (who, coincidentally, stopped being a conservative the very moment his conservative policies cratered the economy). Can you imagine his screed if a guy with a "D" after his name had misplaced $8+ Billion, like Bush did in Iraq?
magrooder nailed it. Listening to the economic advice of the GOP is like reading George Custer's version of The Art of War.
You write: "there have been substantial increases in revenue after Kennedy, Reagan and Bush cut taxes."
Do you have any reputable (i.e., NOT RedState, Hot Air, Faux News, etc.) sources for this assertion?
If you go to the official source here, you can work through the numbers. In each case there's a lag of a few years (recall that the cuts got passed at different stages of the presidencies and, in Bush's case, the immediately-effective cuts didn't come online in a big way until FY 2004). The "current dollars" column shows significant growth in receipts starting in 1962, 1984 and 2004, albeit the 60s was following an upward trend from the late 50s. The effect is less dramatic when you use the adjusted "constant 2005 dollars" column, but it's still there. I leave it to you to decide if the White House website is a reputable source.
The big driver in receipts is growth, in any event, as is illustrated throughout the chart. That's why those same time periods don't show rising receipts as a percentage of GDP. The economy was growing faster than the government's receipts, which to conservatives at least is a good thing.
Another separate point about tax rates that we've seen yet again in this recession is that the more dependent your tax base is on high-income earners and especially capital gains taxes, the more volatile and unpredictable your revenue stream. While the wealthy may not suffer the most in a recession in human terms, they invariably take a disproportionately large hit off the top right at the point that is most heavily taxed (think of bonuses and stock profits/losses) and that hits the federal and especially state governments brutally hard. If the tax codes weren't so dependent on steeply progressive taxation, governments wouldn't have that problem.
Can we replace "In God We Trust" with "We care more about bank account suffering then we do human suffering"?
"This is where you will get violent opposition from the Keynesians, who will look utterly baffled at you when you point out the fundamental flaw of testability in their hypothesis"
Well, Keyensians such as Krugman said from the very beginning that a stimulus of Obama's size was much too small to fill the hole. And frankly, that much should have been obvious - there is no way the government could hope to fill such massive hole in the private marketplace without a completely massive spending package - which would have been way too much in my mind - to make a really big dent in the unemployment numbers. The best the stimulus could hope to do was keep the economy from absolutely cratering.
In an environment where -no- economic theory has proven to be perfect and the only sensible approach is eclectic, liberals have doubled down on Keynesianism and conservatives have doubled down on Friedman. It's crazy - and it has more to do with their political beliefs than the quality of the theories themselves.
As for the chart, I stand by my analysis that it is much too superficial. The fact that lag times (assuming you can agree on the correct lag time) is factored in only eliminates one problem. Here's another: the major elements of your table are expressed as a percentage of GDP, yet you have nothing about how GDP fluctuated throughout those years or why it fluctuated. For example, if spending as % of GDP rose because GDP cratered because of an international economic shock or increased because of technogical innovation or stock market speculation, would you really be crediting or blaming that on political parties?? Sorry, this is a really superficial chart, and there are too many variables for which you don't account.
Magrooder, did you even read my comment? Bartlett's citing the same data I did. (And Bartlett is not exactly a Republican, hasn't been for a long time now).
I have never argued that tax cuts always & everywhere pay for themselves in full in terms of lost government revenue. They always help pay for themselves, and they sometimes pay for themselves in full in extreme cases, but I'm only here defending the point that total tax receipts went up following each of the major waves of tax cuts in the 60s, 80s and 00s.
If, except in "extreme cases" (whatever they are), tax cuts do not pay for themselves, then they increase the deficit.
I agree, generally, that there is room to cut government spending (farm subsidies, tobacco subsidies, redundant military equipment, excessive bureacratic personnnel). The public (even the Tea Partiers, though maybe that shoulde be "especially" the Tea Partiers) do not have the stomach for cuts in entitlements that impact them.
At least some these areas of cutting should be offset by budget increases for certain government functions. For example, private project developers that require permits to develop their projects are harmed by delays resulting from lack of resources to process permits. (Of course, not all delays are caused by lack of resources, but I've seen many that are.)
Deficit control must include both tax increases and spending cuts. Those who assert that spending MUST be cut ignore political realities and they bear the burden of identifying specific cuts. So, what spending should be cut?
You are again approaching this backward. My point from the beginning is about limiting the footprint of government spending as a % of GDP. Do that, and your deficit problems will be largely resolved; fail, and the deficit will be only a symptom of the larger problem of crowding out the private sector.
The extreme case would be a 90% tax bracket, like there was in the 1960's. At that end of the curve, the tax cut will produce more revenue. How much is an open question, but the Laffer curve analysis works very well at the extremes. The middle of the curve is a muddled gray area. Once you are in the middle, there is no compelling evidence that tax cuts work any better to increase tax revenue than government deficit spending or tax increases.
As for the other side of the equation, GDP growth, tax cuts will pump money back into the private economy and generate growth, but that's not saying much, because government deficit spending will do the same thing. In the 80's, for example, you had both, which is why I roll my eyes whenever a conservative mentions Reagan's economic achievements.
Where you and I persistently disagree on this, MVH, is that you seem to attribute the value of tax cuts solely to "pump[ing] money back into the economy" and underrate the incentive-altering value of marginal rate cuts in promoting economic growth even in the lower reaches of the Laffer Curve. You don't have to believe that tax cuts pay for themselves (in govt revenue terms) 100% to recognize that.
I think you wildly over-estimate the "incentive-altering value of marginal rate cuts."
I entered the adult work force at the beginning of the Reagan Administration. neither his three-year tax cuts, his TEFRA tax increases, Bush I, Clinton, nor Bush II revisions to the tax code had any impact on my effort to increase my income or wealth. Who in their right mind would say to themselves, "well I get to keep only 73 cents of my next dollars, so I'm going to stop working"?
As to investors, increases in marginal rates potentially impact their investment decisions, but most of those gains are taxed as capital gains and not impacted by changes in rates for ordinary income.
Your argument seems to be, people aren't incentivized if they take home less of the dollars they've earned due to tax increases.
Conversely, the private sector should increase workers wages to incentivize them to take more private sector jobs. Or are you suggesting that people only react to how much money they take home when the government is the one keeping their earnings low?
Berto, private sector employers can definitely attract more & better employees with better pay. That's elementary economics. Obviously, that fact contends with the cost incentives of employers to pay as little as they need to.
Question - what incentive-altering behavior do you mean?
"Berto, private sector employers can definitely attract more & better employees with better pay. That's elementary economics."
Well, Crank, if the private sector would step-up with better wages (we know they have it. Compare the growth in corporate profits to the growth in employee wages in real terms over the last 30 years), the government wouldn't have to be the ones supplying the economy with good jobs at good wages.
This would solve the spending crisis (as you see it) and reduce the imbalance between government and private sector wages, which you see as a coming catastrophe.
How do you propose we get the private sector to act on behalf of the nation as a whole? In the current set-up, the nation means nothing when compared to stockholders. Do we need a structural change in the way businesses are incorporated?
I'm assuming that you are mainly talking about incentive altering activities for businesses - namely their willingness to locate here, and for those who already here, to invest more in the US as opposed to elsewhere. We persistently disagree (but not totally disagree) for two reasons: (1) the law of diminishing returns as you get to the low end of the Laffer Curve - that applies to these incentive altering activities as well, and thus includes the feedback effect to GDP growth. I don't deny that there is an effect - but it's the size of the effect and the shape of the curve that I question. Economic theory does not know the size of the effect or the shape of the curve, but conservatives take it as an article of faith that it works favorably. Moreover, the empirical efforts to prove its true are fairly crude and don't take into account any number of variables apart from taxes.
Our second disagreement is what should happen during a severe downturn such as this one with a threat of deflation. I think this is an entirely different scenario where even if the effects described above are large at the low end of the curve, businesses do not have the same incentives to invest and expand. They have a strong incentive to hoard cash and lay off workers. Here is where I expect to see some Keynesian stimulus, especially when monetary policy has reached its limits.
If cutting taxes actually increases revenue (as Crank asserts it does), why would conservatives support it? Their stated goal is to reduce government and make it smaller (small enough to drown in a bath tub, says Grover Nordquist).
The reality is that cutting taxes does NOT increase revenues, and that's why conservatives support it.
You've misconstrued the argument. Conservatives do want smaller government in many ways, but even conservatives want the government to pay for some things, like defense, and we do have a lot of debt to drawn down. Crank's argument is that cutting taxes will (1) raise GDP by incentivizing private economic activity, and (2) will help (emphasize help) pay for themselves, thus the US's debt-to-GDP ratio becomes more favorable.
I have no problem cutting taxes, especially business taxes, as long as there are spending cuts to go with them.