Spending AND Taxes Got Us Into This Mess, And Only BOTH Can Get Us Out

Since we are right in the heat of the debt ceiling/budget deficit debate, I made a point to devote a section of my July quarterly client letter to the topic, but I also wanted to share some of that publicly as well. As old as these arguments back and forth in Washington are getting, they are important issues for our economic and financial futures. To try and boil it down to something (relatively) simple, below are two graphs I created to help people visualize exactly how we got into this deficit mess, and more importantly, the only way we can get out.

The first chart shows tax collections and government spending, as a percentage of GDP, in fiscal 2001 (the last year we had a balanced budget in the U.S.) compared with the projections for fiscal 2012 (which begins on October 1st of this year).

You can clearly see how we have gone from a surplus of 1% of GDP to a deficit of 7% of GDP; taxes went down by 4% of GDP and spending went up by 4% of GDP. If there was ever a question of whether the federal government has a spending problem or a taxation problem, this should end that debate. We have both, and each has contributed equally to our budget deficit woes over the course of the last decade.

To counter one of the most common rebuttals to this conclusion (that taxes are too high) consider that federal taxes (payroll taxes, income taxes, gift and estate taxes, etc) today are at their lowest point since 1950 (again, as a percentage of GDP). In order to balance the budget, we need to close an annual deficit of $1.4 trillion, the product of $3.6 trillion in spending versus just $2.2 trillion in tax collections. If we do not raise taxes at all, government spending would have to be cut by that $1.4 trillion figure, which would be a cut of 40% (and is impossible).

The second chart below shows the sources of our budget deficit, by comparing our finances in 2001 to those that the CBO projects for fiscal 2012. It shows in another way how increased spending and tax cuts are equally responsible for the fiscal problem we have, but it goes a step further by showing that nearly half of the increase on the spending side is due to huge increases in defense spending (which has more than doubled since 2001, from $300 billion in 2001 to $700 billion today).

So not only do we have to get taxes up and cut spending, but we have to cut defense spending meaningfully within that context. If we don’t increase taxes and we don’t cut defense spending, a balanced budget would require we cut the non-defense portion of the government’s budget by a whopping 50% (again, impossible).

If you weren’t ticked off at the childish crap going on now on Capitol Hill, you probably should be after reviewing these numbers. The solution to the problem is easy to identify if you want to be honest about it. But without even admitting to that in public, how will our politicians ever actually solve the problem? A depressing thought indeed.

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5 Thoughts on “Spending AND Taxes Got Us Into This Mess, And Only BOTH Can Get Us Out

  1. Chad, I completely respect your opinion here, but I can’t resist to point out a few mistakes (* alleged mistakes). First, the starting chart date of FY2001 feels slightly cherry picked to me. While there would be worse choices for a starting date (by picking, say, FY2000), FY2001 is still one of the highest revenue years in the past 30 years and not at all representative of a trend. Second, the chart overemphasizes the trends by not plotting more than two datapoints. In fact, FY2003 has revenue numbers that are very close to our current numbers while the spending numbers are completely different (~5% of GDP).

    While none of these problems invalidate your thesis, it does put some things in perspective. However, I’m still unclear why these trends prove anything even if the trend were very obvious. I see quite a few charts like this (generally with cherry picked dates) meant to prove that either spending or revenue has gotten completely out of balance with the historical trend. But, who is to say the historical trend is correct and proper? The underlying assumption here is that everything was going just fine until recently. I would disagree.

    Regardless of that, I’d like to make a gentleman’s agreement: I’ll be will to roll back to 2003 revenue numbers if you’re willing to roll back to 2003 spending. That would be progress …

  2. Chad Brand on July 20, 2011 at 4:40 AM said:

    I believe FY 2001 spending of 18% of GDP is the right around long-term average, so I’m not sure about cherry picking there, but you are right that revenue levels then should not be the goal. FY 2003 still has a gap of more than 3% of GDP between spending and revenue… not much progress from today. We’d have to meet halfway between those 2003 numbers (at around 18% of GDP on each) to balance the budget. I have no issue with reducing spending more than increasing revenue to balance things out, my main point was that balancing the budget without raising revenue from here is impossible (as overall spending cuts of 40-50% are required).

  3. Chad Brand on July 20, 2011 at 6:20 AM said:

    Oops, apologize for the typo in the first sentence (spending was not 18% in 2001, it was 19%). I looked at the 50-year historical averages… which come to revenue at 18% and spending at 20%. I would actually be okay with that scenario, as we would only need > 2% GDP growth to see debt/GDP decline.

    So, 2003 spending levels of 19% would be fine with me, but with wars and retiring baby boomers, I think it would be hard to have revenue be below the long-term historical average of 18%. That would give us a deficit of $150B, nearly 90% lower than FY2011… seems like a great goal to me.

  4. Given the huge debt US carries shouldn’t it be the goal of any administration to not barely balance the budget but go at surplus?

    Isn’t “balancing” just what it takes to break even for the specified fiscal year?

    If the Congress doesn’t work towards “savings” how could it expect that American people would?!

    Or perhaps it’s the other way around?

  5. Chad Brand on July 25, 2011 at 6:40 AM said:

    The key metric is debt to GDP so if debt stays constant (at a balanced budget) and GDP is rising, the balance sheet is improving. That is why we have essentially been running deficits for over 200 years but only got into a mess the last 10. GDP growth each year was higher than the annual deficit… but we are now nowhere near that scenario.

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