Sunday, July 24, 2011

More on Spending Cuts and Tax Increases

By Lewis Sage


First off, an apologia: I’m going to have to use numbers – quite a few of them, in fact – but they are absolutely unavoidable when discussing an issue that is, by its very nature, numeric.  The numbers are all calculated from Tables B-1 and B-80 of the 2011 edition of the Economic Report of the President, published every February and available on-line at http://www.gpoaccess.gov/eop/tables11.html.
Here are the questions I want to address.  “Where do federal budget deficits come from?” “Where did the current deficit come from?” and "How might we reduce it?" The answer to the second is an instance of the answer to the first.  The answer to the third is political and unpleasant.
1. Deficits grow when we spend more on programs and wars we like and when we decide to tax ourselves less.  Period.  No exceptions.  An arithmetically obvious solution, then, is to undo the spending increases and the tax cuts.  Trouble is, politics seem to be making that task Augean.
2. Now come the details, first on the spending side of the ledger, then on the tax receipts'.

Year
Military/GDP
Medicare/GDP
SS/GDP
Total/GDP
1980
4.7%
1.2%
4.3%
21.2%
1985
7.0%
1.6%
4.5%
22.4%
1990
5.0%
1.7%
4.3%
21.6%
1995
3.5%
2.2%
4.5%
20.4%
1998
2.9%
2.2%
4.3%
18.8%
1999
2.8%
2.0%
4.2%
18.2%
2000
2.8%
2.0%
4.1%
18.0%
2001
2.8%
2.1%
4.2%
18.1%
2002
3.1%
2.2%
4.3%
18.9%
2003
3.5%
2.2%
4.3%
19.4%
2004
3.7%
2.3%
4.2%
19.3%
2005
3.8%
2.4%
4.1%
19.6%
2006
3.7%
2.5%
4.1%
19.8%
2007
3.8%
2.7%
4.2%
19.4%
2008
4.1%
2.7%
4.3%
20.8%
2009
4.5%
3.0%
4.8%
24.9%

Counting both on- and off-budget items, the federal government has run a surplus only four times since 1969: 1998-2001.  By contrast, the budget deficit for 2002-2007 totaled $1.67 trillion.  Not at all coincidentally, military spending was just over 2.8% of GDP in the surplus years, compared to 3.8% in 2007, the last pre-recession year.  The same can be said for Medicare spending, which averaged just below 2.1% of GDP during the years of budgetary surplus and rose to 2.67% in 2007.  Notably, Social Security outlays were unchanged as a percentage of GDP.  One last comparison: total spending as a fraction of GDP averaged below 18.3% from 1998-2001 and passed 19.4% in 2007.  Increases in military and health spending, then, were only partially offset by exceptional declines in interest payments made possible by loose monetary policy.  Takeaway?  Focus on military and health spending.
To maintain the modest surpluses of a decade ago, tax receipts would have had to rise proportionally.  But they didn’t.  During the surplus years, tax receipts averaged about 19.7% of GDP; because of rate reductions, by 2004, they had fallen below 16% and had only recovered to 18.3% by 2007.  Takeaway? Focus on tax cuts.
3. So if we really want to balance the federal budget – a project we will have to undertake eventually – we could do a lot worse than to check where the deficits came from.  Spending has risen by 1.1% of GDP (largely attributable to military and health) while taxes have fallen by 1.4% (largely attributable to the Bush tax cuts).
I was just thinking out loud…




Dr. Lewis C. Sage likes intersections. Since 1991, he has taught Law and Economics, Mathematical Economics, and the Economics of Healthcare. A former Fulbright Fellow (Bulgaria 1995-6), he teaches an interdisciplinary Honors seminar, Enduring Questions, and is studying strategy in the NFL draft with faculty and students in Sports Management and Psychology. E-mail: lsage@bw.edu

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This blog lives under the auspices of the Department of Economics whose mission has been to hold high the lantern beaming an "economic way of thinking" onto the world. Selfishness, rationality and equilibrium have been central to the teaching of an economic way of thinking rooted in the Renaissance. And, in this regard, the department has faithfully stayed the course. The intent of this blog, thinking out loud..., however, is to entertain exchanges which may challenge the centrality of economics as we teach it.