Tuesday, July 12, 2011

Budget realities

In 2001, revenues were at 19.5 percent of gross domestic product and spending was at 18.6 percent of GDP. That was our surplus. In 2010, revenues were at 14.9 percent of GDP while spending was at 23.9 percent. That’s our deficit: Revenues are down and spending is up. It’s “and,” not “or.”

If you’re worried about the deficit, then, the solution is plain: some mix of tax increases and spending cuts.
While this would appear to be the "sensible center" of the debt ceiling debate, these figures are actually quite deceptive. Here's why:

Plainly the current level of tax revenue as a percentage of GDP is incredibly low, plumbing depths only previously seen in the immediate aftermath of World War II. When paired with this list of US recessions, however, what becomes immediately obvious is that tax revenue corresponds not with tax rates, but rather the business cycle and overall state of the economy.

Indeed, keep in mind that in 1950 -- when revenue collection last dipped below 15 percent of GDP -- marginal tax rates varied from 20 to 91 percent. In comparison, when the federal revenues were 20 percent of GDP in 1998, rates began at 15 percent and maxed out at 39.6 percent.

The current historically low rate of federal tax collection is a product of the poor state of the economy, not any reduction in tax rates. Indeed, marginal income tax rates have not been touched since 2003 (although President Obama did succeed in pushing through a number of temporary tax cuts and deductions for various constituencies as part of the stimulus package).

The inescapable conclusion is that for the budget to be brought into anything approaching balance that two things must occur: a reduction in spending by a minimum of 5 percent of GDP (roughly $700 billion per year) and a significant improvement in economic growth. Measures to accomplish the latter  include deregulation, tax reform and the passage of outstanding free trade agreements with South Korea, Colombia and Panama.

The Democratic party, incapable of stomaching any reduction in the scope and power of the federal government (save perhaps the military), will entertain none of this. Rather their preferred approach is to raise taxes in the midst of economic torpor (even though President Obama implicitly admits taxes are not conducive to growth) while paying lip service to unspecified budget cuts. Their ideology is butting heads with reality, and ideology is prevailing.

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