If You Don't Want to Increase Revenues, Where Do You Want to Cut Spending?

January 6, 2013

If You Don’t Want to Increase Revenues, Where Do You Want to Cut Spending?

The table below is from the September 2012 U.S. Treasury monthly statement. It shows by function Treasury receipts and outlays. I want to concentrate on the middle column, which shows Treasury receipts and outlays for fiscal year 2012. Total receipts in FY 2012 were $2,449.093 billion and total outlays were $3,538.446 billion, resulting in a budget deficit of $1,089.353 billion. 

Let’s add up what was spent in FY 2012 on defense, veterans’ benefits/services, Social Security, Medicare and interest on the public debt. This sum, which I will call the untouchables, totals $2,272.563 billion. This sum, the untouchables, represents 64.2% of total outlays and 92.8% of total receipts. Let’s look at the untouchables in another way. Total revenues minus the untouchables amounted to $176.530 billion. Total outlays minus the untouchables amounted to $1,265.883 billion. So, assuming that the majority of American households does not want to cut spending on defense, veterans’ benefits, Social Security and Medicare and further assuming that the majority of American households views servicing the public debt as the long-run beneficial thing to do, there is not much left over of tax revenues to fund the other 35.8% of federal outlays. In FY 2012, “left over” tax revenues represented just 13.9% of residual outlays, i.e., total outlays minus the untouchables.

For the sake of argument, let’s assume that the following governmental functions were eliminated: expenditures on international affairs (e.g., foreign aid and defense of our foreign embassies), natural resource/environment (the EPA, ugh!), agriculture (who needs food inspectors?) and education/training/employment/social services (we don’t need those Washington bureaucrats telling us how to turn out world-class scholars in Mississippi). How much would the elimination of these functions saved in FY 2012? $197.853 billion. Let’s keep cutting. Let’s eliminate expenditures on science/space/technology, energy, transportation, community & regional development, justice and general government. What would this have saved us in FY 2012? $282.631 billion. So, eliminating all of this would have knocked $480.484 billion off the $1,265.883 billion of non-untouchable expenditures in FY 2012. Where’s the really big money in the non-untouchables category? Health (Medicaid) and income security (unemployment insurance), which totaled $888.934 billion.

So, the really big categories of federal spending are welfare to senior citizens regardless of their income and/or wealth, welfare to poor “junior citizens”, defense and servicing the public debt built up due to persistent federal budget deficits over the past decades. This is not to say that cutting federal spending by just one dollar is a wasted effort. But if one is serious about significant federal budget deficit reduction, one will have to get serious about cutting welfare for seniors, welfare for juniors and welfare for defense contractors. As I showed in my January 3, 2013 blog post, growth in total federal revenues in the past 10 fiscal years has been considerably below its long-run median growth. So, if one is serious about significant federal budget deficit reduction, one will have to get serious about raising more federal revenues – more revenues from households with incomes below $450,000. Keep in mind that with the passage of the American Tax Relief Act of 2012 (that’s what all the drama was about in Washington last week) and with the new taxes going into effect in this year associated with the Affordable Care Act, our federal tax rate schedule for individuals will now be more graduated (or, as some prefer to say, more progressive) than it has been in decades.

Paul L. Kasriel

econtrarian@gmail.com

 

Have the Democrats just been Br'er Rabbited?

January 3, 2013

“Do Anything You Want to Us, Br’er Democrat, but Please Don’t Force Us to Make Permanent the Bush Tax Rates for 98% of Households,” Pleaded Br’er Republican

(with apologies to Joel Chandler Harris)

This is not intended as a politically-partisan note, but rather a description of strategic bargaining in action. To wit, did the Democrats just get Br’er Rabbited by the Republicans with the enactment of the American Taxpayer Relief Act (ATRA) of 2012, the legislation that made permanent the Bush 43-era individual income tax rates for the first $450k of household income? The CBO estimates that ATRA will reduce individual federal income tax revenues by $3.75 trillion in the 10 years ended fiscal 2022 compared to what would have been.

Both Democrats and Republicans have been advocating a roughly $4 trillion cumulative 10-year reduction in deficits projected under tax-and-spend schedules prevailing in 2012.  The Democrats have been arguing for an approach to long-run deficit reduction that is “balanced” between increased revenues and decreased expenditures. But if you have just reduced 10 years of revenues by $3.75 trillion compared to what they would have been with the expiration of Bush 43 tax rates for all, how are you going to come close to $4 trillion in 10-year deficit reduction without massive cuts in federal expenditures?

With the enactment of ATRA, the exceptionally low individual tax rates that apply to most households are permanent (until legislation is passed to change them) – something Republicans have long sought.  Something else that the Republicans have long sought is a reduction in future deficit by curbing expenditures. If the body politic is serious about slowing down the growth in public debt (I am not sure it really is) and $3.75 trillion of revenues have been forfeited to that end, then massive expenditure cuts are the alternative by default, or there will be a default.  Br’er Republican pleaded not to be thrown in the ATRA “briar patch” by Br’er Democrat to no avail. It would appear that Br’er Democrat just got outfoxed by Br’er Republican.  

Br’er Democrat, however, might be able to win the day with his own briar-patch ploy. Republicans want to cut government expenditures by “reforming” entitlements such as Social Security and Medicare. In the past, this has been anathema (I have always wanted to use this word) to Democrats. But what if after a token protest by the Democrats to the “concept” of entitlement reform, the Democrats succumbed with a caveat. That caveat being to means test Social Security and Medicare. That is, as one’s retirement income increased, one’s Social Security benefit would decrease and one’s Medicare premium, including and especially, one’s Medicare Part A premium, would rise. If means testing senior-citizen entitlements were to occur, then not only would upper-income retirees be paying higher tax rates than they were in 2012, but they would be receiving effectively lower entitlement benefits. So, perhaps Br’er Democrat should plead not to be thrown into the entitlement-reform briar patch by Br’er Republican.

Now to some facts. The Republicans argue that “Washington” does not have a revenue problem, but a spending problem. The chart below speaks to this issue. Plotted in the chart are the 10-year compound annual growth rates of total federal government receipts and outlays. In the 10 years ended FY 2012, the compound annual growth rate in federal receipts was 2.83%, considerably below its FY 1965 – 2012 median of 6.75%. Notice that since FY 2003, about the time of the second round of Bush 43’s tax cuts, growth in federal receipts has been much below its longer-run median rate.  In the 10 years ended FY 2012, the compound annual growth in federal outlays was 5.81%, below its FY 1965 – 2012 median of 7.31%, but not as much below its median as was receipts growth. In the 10 years ended FY 2009, compound annual growth in federal outlays hit a recent high of 7.51% , in part because of TARP expenditures, increases in automatic-stabilizer expenditures such as food stamps and unemployment insurance benefits and, of course, Obama’s “stimulus” expenditures.  Since FY 2009, however, growth in federal outlays has been trending lower.

I conclude from these data that the explosion in deficits in the past 10 years has more to do with Washington having a revenue “problem” than a spending “problem.” In the next 20 years, Washington is, however, likely to have a spending problem as more and more of my baby-boomer generation belly up to the entitlement trough. And now with the bulk of the Bush 43 tax rates permanent, Washington will continue to have a revenue problem, too.

Paul L. Kasriel

Econtrarian@gmail.com

http://www.the-econtrarian.blogspot.com

1-920-818-0236

Paul L. Kasriel

Econtrarian, LLC

econtrarian@gmail.com

1-920-818-0236

December 21, 2012

Festivus Stocking Stuffers

Since I retired at the end of April, I have been having a lot of problems with you people. So, as Festivus is nearly upon us, it is time for the airing of grievances. Here are I few of mine.

Fiscal and Mayan Armageddon

As this is being written, both economists and other quacks are predicting the end of the world as we know it. The economist quacks are forecasting that another recession will occur in the U.S. in 2013 if the scheduled return to the Clinton-era federal personal income-tax levels and if the scheduled sequestration of federal government expenditures occur on January 1. Some other quacks are predicting the end of times today (or is it tomorrow?) as the Mayan calendar runs out of dates. So far, it is not looking too good for the Mayan calendar quacks. And my bet is that if we ever get to test the fiscal quacks’ hypothesis, we’ll shuffle them off with the Mayan quacksters.

What is the logic for fiscal Armageddon? Let’s talk about tax increase first. I keep hearing that if tax rates and revenues rise, there will be a huge amount of spending power sucked out of the economy. Really? You mean that the Treasury is going to collect all of these taxes and just let its cash balance rise by this amount? I don’t think so. I think the Treasury is going to collect higher taxes from me and either transfer them to you or buy something from you. In other words, an increase in tax revenues is not going to “suck” spending power out of the economy, but rather redistribute that spending power. Now, you may not like the outcome of this redistribution, but don’t confuse a redistribution of a given amount of spending in the economy with a net decline in spending.

What about the cut in federal spending due to the sequestration that Congress voted for? Surely, that will reduce total spending in the economy, right? Probably wrong. If the government spends less, all else the same, it will need to borrow less. If it borrows less, those folks – households, financial institutions, feriners – who were planning to lend to the government will now find themselves with excess funds. What are they going to do with these funds? There are three things they can do with these excess funds and two of them will result in offsetting the government’s decline in spending.

One thing they can do with their excess funds is lend them to some other entity – a household, a business or municipal government. These recipients of funds will then spend them, offsetting the decline in federal government spending.

Another thing these otherwise lenders to the federal government can do with their excess funds is spend the funds themselves. If interest rates are too low and/or the credit risk of other borrowers is too high, they won’t lend; they will spend. This increased spending by the otherwise lenders will offset the decreased spending of the federal government.

A third thing these otherwise lenders can do is simply hold more cash than they had previously planned to do. For the nonbank public, this means an increased demand for bank deposits and currency, also known as a decline in the velocity of money. For banks, an increased demand for cash means an increased demand for excess reserves. If the decrease in federal government borrowing results in a decrease in velocity / an increase in banks’ demand for excess reserves, then, and only then, will there be no offsetting increased spending to match the decline in government spending.

So, logically, there is not much of a case to expect an increase in taxes and/or a decrease in government spending to have a significant impact on aggregate spending in the economy. But according to the fiscal quacksters, a reduction in the budget deficit brought on by a “tightening” in fiscal policy should be associated with slower nominal GDP growth. Conversely, an increase in the budget deficit resulting from a decrease in taxes and/or an increase in government spending should be associated with faster nominal GDP growth. Thus, the fiscal quacksters would expect there to be a negative correlation between changes in the budget deficit and growth in nominal GDP.

Let’s go to the tape, i.e., Chart 1. As everyone, except those with a political bias, knows, the federal budget deficit can change because of the pace of economic activity. For example, when the economy crashes into the deepest recession in the post-WWII era, federal government expenditures increase because of income maintenance programs for the unemployed – e.g., unemployment insurance benefits, food stamps, etc. Also when the economy crashes, tax revenues fall. So, when the economy crashes, the federal budget deficit tends to widen because of these automatic stabilizers. Symmetrically, when the economy booms, all else the same, the budget deficit shrinks or, once in a Mayan calendar, maybe even moves into a surplus. If we are going to test for the effect on GDP of changes in the budget unrelated to these automatic stabilizers, we need to cyclically-adjust the budget deficit. The experts on the budget, the Congressional Budget Office (CBO) staff, are kind enough to do this for us. The red bars in Chart 1 are the fiscal year-to-fiscal year percentage point changes in the cyclically-adjusted budget deficits/surpluses as a percent of CBO-estimated potential nominal GDP. Whew! The blue line in Chart 1 is the fiscal year-to-fiscal year percent change in nominal GDP. According to the fiscal quacksters, as the cyclically-adjusted budget deficit gets smaller, i.e., the red bar moves higher toward the zero line or even higher above it, nominal GDP growth should weaken, i.e., the blue line should move down. In other words, there should be a negative relationship or correlation between these two series. But alas, we find another beautiful theory of the economic quacksters spoiled by some ugly facts. The contemporaneous correlation between changes in the cyclically-adjusted budget deficit/surplus and nominal GDP growth is not negative from 1973 through 2011, but positive at a value of 0.3 out of a possible 1.0. The ugly facts, then, suggest that increases in taxes and/or decreases in government spending are associated with faster nominal GDP growth, not the slower growth predicted by the fiscal quacksters.

Chart 1

Now, you might argue that it is not fair to expect a change in fiscal policy this year to have a large impact on GDP growth in the same year. Policy changes might have their maximum effect in later years. This, of course is not what the fiscal quacksters are arguing now. They are predicting a recession in 2013 if the scheduled tax increases and spending cuts commence and persist in 2013. But I did test for lags in the effect of fiscal policy changes. I found that the first negative correlation between changes in fiscal policy and nominal GDP growth occurs after three years and even then the absolute value of the correlation coefficient is small at 0.1. In sum, the historical data simply do not support the view that going over and staying over the fiscal cliff will have a material effect on the pace of economic activity.

Is Federal Government Spending Out of Control?

That’s what I keep hearing. Does anyone ever look at the data? As shown in Chart 2, growth in federal government spending flared up in the second half of 2008 through early 2010. Why? Does anyone remember the $700 billion authorization for TARP spending back in October 2008? And then there were those automatic stabilizers I talked about earlier. And yes, there was about $500 billion of extra stimulus spending. But since early 2010, growth in total federal government spending – entitlements, defense, interest, waste & fraud – has been quite tame, especially when measured against the median annualized growth in total federal spending of 5.1%. Remember that $1 trillion reduction in spending over a 10-year period authorized by Congress back in 2011? Well, the data suggest that this spending reduction is biting.

Chart 2

Are Banks Going to Suffer a Deposit Outflow on January 1?

That’s the talk around the wood stove at the general store up here in the Wisconsin tundra. Yes, that special FDIC insurance on non-interest-bearing bank deposits is due to expire in 2013. Without this insurance, pension funds and large corporations are expected to pull their funds out of banks and put them in some other federally-insured instrument, such as a Treasury bill. (Where will the funds go if Congress does not increase the debt limit?). But if this happens, will the banking system actually lose deposits? Not unless the pension funds et.al. decide to hold actual folding money. Suppose that a pension fund decides to buy a new T-bill from the Treasury, paying for it by drawing down an account at its bank. The pension fund’s bank does see its deposits fall, all else the same. But what does the Treasury do with its new funds? It spends them. So, the deposits come back into the banking system. There may be real things to worry about with regard to our financial system, but this isn’t one of them.

Discouraged Dropouts Are Largely Responsible for the Declining Unemployment Rate?

Again, doesn’t anyone look at the relevant data? The BLS has a measure of the unemployment rate that adds back in so-called discouraged workers. It is called the U-5 measure. The first measure of the unemployment rate to hit CNBC’s crawl is the U-3 rate that the talking heads then disparage because of a declining labor force – “thought” to be declining because of discouraged workers. I put thought in quotes because the talking heads never look at U-5, which includes the discouraged to see how it changed. But if they did look at Chart 3, they would see that both the “headline” unemployment rate, U-3, and the more inclusive unemployment rate,

U-5, both have fallen by one whole percentage point in the 12 months ended November 12. What the talking heads fail to take into consideration is that more and more of us baby boomers are voluntarily dropping out of the labor force. It is called retirement. And so long as Congress doesn’t means test our Social Security and Medicare A benefits, more and more of the luckiest generation will continue to voluntarily drop out of the labor force.

Chart 3

Alright, now it’s time for the feats of strength. You can pin Paul (Ron, that is), Bernanke!