2006 October 15 Sunday
US Federal Budget Deficit Reduction Seen As Temporary

The narrowing of the US federal government deficit is a transitory phenomenon until long term drivers of spending increases overwhelm attempts to boost revenue and cut discretionary spending.

MACON, Ga., Oct. 10 -- The federal budget deficit shrank from $318 billion to less than $260 billion in the fiscal year that concluded in September, officials disclosed yesterday. It marks the second year in a row that the deficit has declined after ballooning in the early years of the Bush administration.

Note that if we withdrew from Iraq we could cut the deficit by another $100 billion per year.

The budget deficit got narrower due to much larger sums of money collected as taxes.

Still, the budget deficit is declining, in large measure because corporate and individual tax receipts have surged at a much faster rate than the government originally projected. The Congressional Budget Office estimated last week that government receipts were up 11.8 percent in 2006, to $2.4 trillion, the second-highest increase since 1981, surpassed only by the 14.5 percent increase last year.

Come the next recession tax receipts could fall wihile spending would continue to rise.

The tax collection increases had to be in the double digits because the rate of spending increase was very high. Spending increased by a phenomenal 9%.

Despite the good news about last year -- largely the result of a remarkable 12% surge in tax receipts from individuals and corporations that overwhelmed a nearly 9% increase in spending -- the smart money says the deficit is very likely to get deeper from here. "The world doesn't end, but the deficit goes in the other direction next year," says Douglas Holtz-Eakin, a former CBO director. Interest rates are rising, adding to the government's annual interest tab. Iraq continues to be costly. The revenue surge already is beginning to fade. And a slowing economy is likely to restrain revenue growth even further. A one-percentage-point drop in economic growth for a full year increases the deficit by about $35 billion.

There is no way for tax revenue increases to keep up with such a rapid growth in spending. The upper classes are experiencing a more rapid growth in income than the lower classes and the upper classes are in higher tax brackets. But the overall economy isn't going to grow fast enough for tax revenues to keep up with such a rapid rate of increase in spending.

As the baby boomers retire the big fiscal crunch will hit. Federal spending will continue to grow rapidly due to old age retirement benefits. Medical care costs will rise rapidly. At the same time, the younger population does not have as great a potential for high incomes and high productivity. As the population becomes less white and more Hispanic the average education level and skill level will decline. Lower earnings ability will translate into lower tax paying and more use of social services such as Medicaid due to much lower medical insurance rates among Hispanics.

When the battle over unfunded liabilities for retirement becomes joined in the 2010s how much of the financial shortfalls will get paid in tax increases and how much in raised reitirement ages, means testing of benefits, and outright cuts in benefits? If politicians attempt to close the shortfalls with large tax increases then the economy could stagnate and the shortfalls could grow even as living standards decline.

Share |      By Randall Parker at 2006 October 15 09:02 PM  Economics Government Costs


Comments
Ned said at October 16, 2006 6:54 AM:

As always, the problem is too much spending, not too little tax revenue. The last year the federal budget was in surplus was 2001. If the increases since then had been held to inflation plus population growth, the current federal outlays would be about $2.2 trillion and the budget would still be in surplus. Now approximately one tax dollar in six ($400 billion out of $2.4 trillion) goes for debt service.

From 1998 to 2001, or for most of Clinton's second term, the federal budget was in surplus. This was not due to any sudden burst of fiscal discipline on Clinton's part; remember, he was the one who tried to nationalize health care - how much would that be costing nowadays? Rather, Clinton was preoccupied with scandals and avoiding impeachment, and the Republicans who controlled Congress certainly weren't going to approve any new programs for him. The result? A budget surplus and a period of great prosperity.

This period ended when GWB became president and the Republicans abandoned all fiscal restraint to embark upon the biggest spending spree since LBJ was in office. Partly as a result of this sort of nonsense, they might lose control of Congress in next month's elections, which they richly deserve, but the Democrats historically have been bigger spenders than the Republicans, so things may not get much better. From a purely fiscal point of view, the best outcome might be to have some ultra-leftist like Hillary win the presidency in 2008 but have the Republicans control Congress. President Hillary would undoubtedly propose all sorts of new big-spending government programs, but the Republicans in Congress would sneeringly turn down every one.

Randall Parker said at October 16, 2006 5:54 PM:

Ned,

An inflation adjustment is not adequate for projecting budget growth in a more fiscally disciplined regime. Population grows too. Plus, demographic shifts put more people into the net liability category. We have more without medical insurance. We have more old folks. The higher productivity people are a shrinking portion of the total populace.

As for Clinton's years, you are missing the biggest cause of lower total government growth under Clinton: The collapse of the Soviet Union. That allowed for a large reduction in defense spending. So Clinton was able to increase social spending. He also raised taxes. Plus, the dot com boom brought in big revenue from capital gains taxes.

Also, our problem is the existing and rapidly growing entitlements programs. Whether Hillary or a Republican gets elected in 2008 we are faced with continued rapid growth in government spending.

crush41 said at October 16, 2006 9:52 PM:

Will old fogies consider the economic reprecussions of the old age entitlements they vote to defend/increase in the future? In 2001 only 13% of the US population was over the age of 65 and we still had a GOP-controlled Congress and White House deliver us a profligate prescription drug plan that is so bad the government has had to take out radio spots just to get people signed up for it. In a quarter-century, when the end of the baby-boomer generation hits retirement, that percentage will have doubled to around 25%. Factor in this cohort's affluence, the low turnout rate of Hispanics (who vote at about half the rate their sheer numbers would indicate), and the 12%-15% of the population under voting age, and it's fair to expect that senior citizens will comprise somewhere between 40%-45% of the voting electorate and will be even more highly represented in the individual donor category.

As a 'skilled' young white male, I dread a future with relatively youthful, (the median age of non-white Hispanics in the US was 37.7 in 2000, and 24.6 for Hispanics) disadvantaged Hispanics fighting with a prodigious AARP for the fruits of a shrinking professional class.

Ned,

Well put. Economic growth over the last four decades has been greatest with a GOP-controlled Senate and a Democratic President. The political stagnation that occurs is good for the economy!

Ned said at October 17, 2006 7:25 AM:

RP -

As I stated in my original post on this topic, the $2.2 trillion figure accounts for both inflation and population growth. This would give us exactly the same amount of government we had in 2001, without such "essentials" as the Medicare drug benefit, the Iraq war and No Child Left Behind, plus all those wonderful earmarks. We seemed to be doing just fine in 2001 without all this extra spending. Demographic shifts have not been a big factor lately - the percentage of the population over 65 actually declined from 7.5% to 7.3% between the 1990 and 2000 censuses. Of course, this is going to change dramatically when the Baby Boomers start to retire. We are already getting a taste of what is going to happen then with the new means test for Medicare benefits. This has turned Medicare from a social insurance program into just another welfare program - those who pay in the most money get the least benefits. The thresholds are pretty high now, but just watch what happens to them as the demographics really start to bite. How the politicians deal with this will be interesting - senior citizens love to vote.

Your assertion about lower defense spending as a cause of the budget surpluses from 1998-2001 is only partly correct. During the Clinton years, from 1993-2001, defense spending actually increased from $292.4 billion to $306.1 billion. But this was much less than the rate of inflation, which would have yielded a defense budget of $354.5 billion in 2001, so, in effect, real defense spending did decline. It also declined as an overall percentage of the federal budget, from 20.7% (1993) to 16.4% (2001). During this period, the greatest budget surplus was in 2000, when revenues totalled $2,025.5 billion and expenditures totalled $1,789.2 billion, for a surplus of $236.3 billion, or 13.2% of the budget. The defense budget in 2000 was $295.0 billion, and, if this had kept up with inflation to maintain 1993 levels, it would have been $346.2 billion, or a saving of $51.2 billion. This $51.2 billion saving accounted for 21.7% of the overall budget surplus, not a trivial amount, to be sure, but also not the biggest cause of the surplus. During the period 1993-2001, federal expenditures increased by $453.7 billion, or 32.2% (about 4% per year), while revenues increased by $836.9 billion, or 72.5% (about 9% per year). Yes, there was a tax increase during that time, which helped reduce the deficit, and the extra tax revenues from the boom of the late 90's also helped, although it could be argued that the newfound fiscal restraint was as much a cause of the boom as a result.

From 2001 to 2005, revenues grew by $162.5 billion, or 8% (about 2% per year), while expenditures grew by $609 billion, or 30.6% (about 7.7% per year). Recent surges in revenue have helped reduce the deficit, but, as you say, this isn't going to last forever. I think we can see where the problem lies.

Crush -

I agree completely. For decades, Republicans believed that if they could only control both Congress and the White House, things would be different. Now we see that they are not. Although I despise Hillary, I must admit that it would probably be best for the country if she became president in 2009, as long as the GOP keeps control of Congress. You see, we have a lot of problems in this country, but too little government isn't one of them. The stagnation that would result from a Democrat in the White House and a Republican Congress would be just what the country needs.

crush41 said at October 17, 2006 10:16 PM:

Ned,

The 65+ proportion of the US population is higher than 7.3%. The latest Census data puts it at 12% and another source puts it at 13%.

Ned said at October 18, 2006 7:32 AM:

Crush -

You are correct. I took the figures from the 2000 census web site, but I mistakenly copied down the numbers for females instead of the total (males plus females). Here are the correct ones - proportion of US population age 65 or greater: 1990 - 12.5%; 2000 - 12.4%. But my original point is still valid - demographic shifts have not played a major role in budgeting in recent years. This will change substantially in the near future as the Baby Boomers age. Thanks for pointing that out.

nz conservative said at October 20, 2006 4:22 PM:

I guess the irony of the Clinton years was that the Democrats could cut defence spending, due to the end of cold war, while at the same time taking in more tax revenue thanks to commercial pay-offs from 1980s defence spending spin-offs like the internet.


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