Government Budget Note (Yes, that's the most interesting title I could think up for this)

As of the end of 2013, our Federal government is spending about ~$700-800 billion more than it takes in in revenue.  That's down from a persistent and unprecedented $1-1.5 trillion deficit per year over the past several years, but still pretty high.

A portion of the deficit reduction is from revenue, some from an uptick in economic activity, some from the increase in the highest marginal personal income tax rates and an expiration of the reduced payroll tax rates.

On the spending side, a good portion of that is Dept of Defense, which is to be expected as we wind down two wars.  A good chunk came from the reduction of unemployment subsidies and wind down of TARP spending (the emergency fund put in place to support the economy during the financial crisis) as the economy improves and unemployment declines.  Another good chunk is from robbing public employee retirement funds and jiggling around other offsetting receipts from the public, which include cash flow received from Fannie Mae and Freddie Mac which were nationalized in the financial crisis (people they made housing loans to are actually starting to get current on their mortgages; again, a result of improving economy).  But otherwise, there is no substantive real budget cutting going on here, beyond the already expected Defense reduction.

So largely, our deficits contracting have far more to do with the economy coming back than anything else.  I have created a table below from some of my data (source: publicly available Treasury statements issued monthly) that show the larger categories of government spending over the past several decades.

 

[1] "Upper" and "lower" bounds of the range are defined as +/- 0.5 standard deviations.

[2] Net debt, which excludes debt held by agencies within the US government (mostly the Social Security trust funds).

[3] Covers housing, nutrition, energy assistance to low-income persons; persons with disabilities and the unemployed.

[4] Excludes Veterans' benefits and other subsidies for military and related personnel.

[5] Adjusted to today's dollars. 

Red or green indicates outside the bad or good bounds of the range, respectively.

There are numerous observations to make from the above data, but some of mine are: 

Higher income tax rates don't necessarily generate more revenue dollars for the government.  Notice on the tables that, when marginal income tax rates were very high decades ago, actual revenue dollars taken in by the government as a % of GDP were actually at the lower ends of historical comparison.  (Personal income tax is the lion's share of all government receipts.  All the other categories are too small for there to be anything else moving around enough to account for this.)  Higher rates when the economy is strong absolutely do bring in more revenue.  But that's much more a factor of a strong economy.  And as tax rates go higher, it encourages exploiting loopholes and shelters and other avoidance that generally pushes investment outside of the US, defeating the whole purpose and actually aiding our foreign competitors.

Defense spending isn't anywhere near the present-day culprit to our budgetary problems that some suggest.  In the past couple decades, it's at the lowest ends of its share of government receipts.  In the 1950-60s part of the Cold War, we spent double the share of today.  And it's been coming down consistently as a % of receipts ever since - yes, even Reagan crushing the Soviet Evil Empire years weren't anywhere near Ike, Kennedy or Johnson defense budgets.  Having said that, just because something is lower, doesn't mean we still can't find unnecessary spending to eliminate in there.  And especially when combining defense with overall security apparatus spending, it's still a really big number that can be further culled.

It's all about social subsidies.  Social Security, Medicare and other income security (the wide variety of Johnson "war on poverty" styled programs which include housing, nutrition and energy assistance to low-income persons; persons with disabilities and the unemployed) consumed ~40% of federal revenues in the 1970s.  Now they consume ~55-65%.  Taken with defense spending, ~75-85% of all government receipts are consumed by either a handout or the military.  And again, defense spending is historically low.

That's where all the money is going.  So to the extent we need to make meaningful cuts to get our house in order, there simply is no other place to cut that will move the needle other than subsidies.  And that's the rub, because to suggest cutting any of that social subsidy is characterized as cruel or uncaring.  Let's just say, the Scrooge-Darwin ticket isn't polling very well right now.  But if we don't raise revenue a butt-load, that's simply what we have to do.  And raising taxes on the rich a lot - people that already contribute the vast lion's share of tax receipts - at a point doesn't raise any more revenues and begins to stifle the economy.  Growing the economy is the most immediate and productive source of government revenue.

As you peruse the table - where I've colored in red those sub-par budget periods - almost all of those bad budget periods are much more the result of economic downturns and not actual policy.  Over the decades, the trends are set by policy for sure.  But they are also set by long-term demographic shifts as well - like having to care for a bunch of people that are living WAY longer than we originally ever thought they might.  When we vastly expanded Social Security and instituted Medicare in the 1960s for example, people on average lived 3 years past the age of retirement.  And they were 8% of population.  Now they live 13 years past retirement.  And those over 65 (becoming mostly Baby Boomers) are 13% of population on their way to 20% in the next 15 years.

In shorter term periods however, it's really just about economic ebbs and flows, as expenditure levels are static (and actually increase in recessions) while revenue sources decline.  The across the board really bad numbers during Obama's tenure for example are almost 100% the result of the Great Recession and its lingering effects.  But that's the whole point.  The economy has far more to do with the failure AND success of any budget than actual policy.  Obama's budgets don't suck.  They're almost the exact same as W Bush's (other than one year of higher tax rates in 2013).  They just exist in a sucky economy.

W Bush didn't really spend in any unprecedented fashion.  Even though he put us into fighting two decade-long wars and expanding Medicare Part D while cutting tax rates, his average deficits were in line with Clinton's or Carter's.  So where's the excess?  Yes, he reversed a surplus that happened under Clinton, and went back to borrowing to spend.  Which is not bad - actually it's beneficial - if it doesn't get too excessive.

The definition of a surplus is the government having more money than it needs.  Read: It took more money from us than it should have, which we otherwise could have been using to expand the economy.  Modest deficit spending, paid for through modest borrowing at the lowest possible interest rates, levers a competitive advantage v. other nations.  And then the financial crisis showed up and tanked all the numbers (to-date), which had no more to do with W Bush being President at that moment than 9-11 did.  Period.

Clinton didn't really balance the budget in the 1990s.  The unprecedented drive in the private sector from the dot-com/tech booms and one of the best economic environments in a generation did.  I've run the numbers: I believe the budget would have balanced itself about ~4.75-6.5 years later if Clinton never raised tax rates.

So let's focus on growing and investing in the actual economy more than just finding ways to suck more out of it.  And government can play a role in that through public-private partnerships incubating nascent technologies, growing them into new 21st Century industries and jobs.  If you're reading this via the Internet and/or off your cell phone right now, the government was a partner in the development of both those technologies/industries.  Raise the economy, and those revenue dollars will come flooding into government coffers.

Finally, debt and the interest we pay on it.  Right now, we pay about 15% of all Federal receipts just on the interest we pay to borrow.  That's roughly where Greece's interest expense was to revenues in 2010 when the world lost faith in it and its markets collapsed.  But Greece is a far more troubled place, so it isn't suggestive.  Just for comparison.

And we've been that high before.  But when the size of our debts were far smaller.  Because interest rates were a lot higher.  Right now the interest rate our government is charged to borrow is unprecedentedly low.  As low as near-0% to about ~3% on average right now.  That is a product of the Federal Reserve forcing them to stay low, combined with the lingering depressive effects of the worst recession of the modern era.

But now, our debt held by the public is ~75% of GDP, or about $12.3 trillion.  Adjusting that to gross debt and adding in other government debt (state and local) to be apples-to-apples, that is about 10% debt to GDP below where Greece was before its total collapse began.  Again, just sayin'.

(The Greek drachma - not that it exists anymore - is not the world's reserve currency.  Greece is not the world's largest market.  Greece does not boast the most advanced and powerful military on the planet, capable of projecting its influence anywhere.  Greece is not the most financially, economically, geopolitically influential nation on Earth.  The US is.  So don't get too flustered about the comparison.  Just be aware that even the mighty can fall.  It just takes a bigger push.  And we are presently being pushed.)

In 2007, our debt held by the public was ~35% of GDP, or about $5.1 trillion.  Interest on the debt in 2007 was about 9.5% of revenues.  After seven years of W Bush in office at that point (meaning pre-financial crisis, before where all numbers get out of whack), that's a historically plain-vanilla level of debt (only 2% of GDP higher than where Clinton left it; 7% below what it's averaged 1929-2007), and a rather lower share of interest expense.  At the end of his Administration (end of 2008, the worst point of the crisis), debt was 43% of a severely depressed GDP, which is in line with the average of the last 8-decade or 4-decade averages of 42% and 38%, respectively, for comparison.

So now at 2014 with several $trillion more in debt outstanding, if interest rates were to start to rise back to more normal levels (which will happen when the economy gets back to more normal looking), we're going to have a problem pretty quickly.  If rates rose by 2%, from our current effective 3%, to 5%, on now with $12.3 trillion in debt (and don't forget, $700-800 billion in budget deficit means we are increasing debt by $700-800 billion more each year), interest expense would rise by ~$250 billion.

Which is about 9% of current Federal receipts.  Which means interest would go from 15% of receipts to 24% with just a 2% rise in interest rates to 5%.  And they've been as high as double-digits, and have for the past two decade been considered normal around ~5-7%.  So that's not at all an outlandish supposition to go back to 5%.

(Not completely fair, as presumably a rising interest rate environment is occurring during an improving economy, so government receipts would be rising faster too.  But then there's stagflation - inflation without growth.  Which is exactly what will happen if we, say, raise the minimum wage in the middle of a weak economic environment.  Which is exactly the discussion right now, since it's popular and no one seems to have a better idea.)

In this already depressed economic period, interest on our debt plus social subsidies plus defense spending already consume 103% of government revenues.  Add in all the rest of government, and spending is about 128% of revenue.  If interest rates rise 2%, that will become 137%; 3% and it's 141%.  The more that goes on, the more nervous markets get about lending us money.  Which raises interest rates more.  Which makes it worse.  Which makes them more nervous.

So it all gets back to improve the economy.  More money flows into the government.  All this expenditure and debt becomes smaller in proportion, and thus a smaller problem.  Then you can afford to buy your boy that G.I. Joe with the kung fu grip...  And we all know what that means.