Wednesday, April 27, 2011

Does the United States have a Revenue problem or a Spending Problem?

There is a debate about the causes of the record deficits in the United States. Republicans argue that we have a "spending problem", by which they mean spending is increasing too fast, while the left argues that we mainly have a "revenue problem", by which they mean taxes are too low.

The outcome of this debate will determine whether the most reasonable solution to the structural deficit will be tax increases or slowing the growth of spending. President Obama and liberals such as Paul Krugman like to give the public the impression that the deficit is entirely or to a large extent caused by Bush tax cuts for the wealthy (which is false, since Obama's proposed tax increase on the rich would only collect 0.3% of GDP). If that were the case, the most fair solution to the deficit would be - as the President put it - to raise "a little bit more" revenue from the rich.

It is easier to motivate tax hikes if you convince the public that the deficit was caused by tax cuts, rather than by an unparalleled expansion in spending.

When Republicans such as Paul Ryan say that the deficit is caused by a spending problem, they mean that once the recession is over, a federal tax revenue target of 19% of GDP (the historical average for the U.S) is sufficient to finance federal spending if spending is also kept at historical levels. Throughout, keep in mind that we are talking about Federal revenue and expenditure, the U.S public sector spends about 40% of national income if states and municipalities are included.

Slate columnist David Weigel attacks the Paul Ryan argument. His evidence is that revenue in 1981 was higher than later years of the Reagan presidency, which according to him proves that the Reagan tax cuts reduced revenue. Weigel is wrong. Revenue is highly volatile, because a lot of it depends on corporate profits, capital gains and other variables determined by the business cycle. Weigel is simply cherry-picking the year, 1981 was one of the highest revenue years in post-war history.

Similarly liberals like to pick the peak of the IT-boom at 2000 as the norm, where 20.6% of GDP was collected as revenue, even though it was the highest year in post-war history, and the second highest in American history overall. The highest year was 1944 during World War II, when Federal revenue briefly reached 20.9% of GDP.

In order to give a better picture, I have plotted the average revenue, deficit and spending as a share of GDP for all presidential terms in the post-war period.

First, this exercise shows us that Weigel is mistaken. Tax revenue during both Reagan terms was virtually identical with the Carter years, even though Reagan cut tax rates dramatically.

Second, revenues during the second Clinton term, the highest of the post-war periods, was 19.9%, only a little higher than the 19.0% level Paul Ryan has suggested (which liberals claim is far too little).

Lastly, President Obama has increased spending to levels never witnessed in American post-war history.

Let's move to President Obama's budget, as calculated by the esteemed Congressional Budget Office.

The President likes to give the impression that the deficit debate is about repealing the tax increases for the wealthy. But let us imagine what would happen if revenue during the coming years would be what is was during President Clinton's second term, long before the Bush tax cuts. During those years revenue was 19.9% of GDP.

The overwhelming majority of Presidents Obama's budgeted deficit would remain even if he collected Clinton-era record revenue. By the end of his term, when the recession is projected to be long over, 80% of the deficit caused by President Obama spending plan would remain even if we assume Clinton-era record revenue.

This is not strange, since during the second Clinton term, federal spending as a share of GDP was 18.8%. President Obama has already increased spending to levels unheard on in peacetime. Federal spending with Obama's budget will be 23.4% in 2016, when the recession is projected to be completely over. These numbers show us that President Obama and his defenders cannot use the recession as an excuse for their expansion of government and the immense deficits it is causing.

Clinton-era record revenue would be nowhere near enough to fund Obama-era record spending.

I want to illustrate a final point. Let's ignore the Obama years, and focus on the long run deficit. The figures for spending are from the Long Term Budget Outlook, again calculated by the Congressional Budget Office. These figures take into account the projected increase of Medicare, Medicaid and Social Security spending. This is primary spending, which means that interests on the debt is not included in spending, the numbers would look even worse if we included these.

Let us also be more generous to the left. Instead of assuming revenue for the highest presidential term, let's assume revenue for the record year. As pointed out previously this was the boom year 2000, where revenue was 20.6% thanks to unusually high capital gains and corporate profits.

This picture illustrates what would happen if Federal revenue as a share of GDP increased to the record high of the post-war period and remained there forever, and we continued at the currently projected levels of Federal expenditure.

Because of ever expanding government, the deficit would explode even when assuming record levels of revenue, with the debt growing to several hundred percent of GDP. Jon Stewart was therefore misleading his trusting and economically unsophisticated viewers when he showed them a graph where the deficit appears to vanish if only the Bush-tax cuts were repealed.

The only reasonable conclusion that the United States primarily has a spending problem, not a revenue problem. It is the expansion of the government - some already carried out by Obama, some projected to occur - that is causing the long term structural deficit to grow beyond control, not a reduction of revenue caused by lowering the taxes on the rich.

If liberals want to argue that government spending is too low, and that we should increase it for reasons of social policy and raise taxes to pay for it, they should feel free to do so. But please do not claim that the long term deficit is primarily caused by taxes being too low relative to historical levels, because that is simply not true.


  1. Wow, Great Article! I really like the fact that you look at it from the perspective of just the facts, rather than political ideology and opinion (something I do in my blog.) I must say though, this is of a very high calliber. You would fit right in working for The Wall Street Journal.

  2. This is a truly excellent blog, better even than many of the big name ones. The thought that goes into each article (i prefer article to post because these are too good for such a dismissive label) really shows. Seriously, thank you.

    Quick question. could you clarify how exactly john stewart got the numbers for his graph. In other words, what is different about his numbers and your, or what is he leaving out? How did he even get that result, and why is it deceptive? I suspect the deceptiveness is probably obvious, but i am curious, especially as many people seem to agree with him.

    Again, keep up the great work.

  3. A couple of things that are obvious about Stewart's graph from the video if you look carefully:

    * He stops at 2050, instead of 2080 for which the CBO presents data.

    * In his own graph, if you pause and look at the details you will see than in 2050 the United States will have a debt over the height of World War 2. It just looks small because he compares it with 340% figure of Ryan.

    * Almost certainly, Stewart is assuming Bush tax cuts abolished for the middle class. I would also guess that he uses the infamous Alternative Minimum Tax trick (who knows, since he doesn't disclose his methodology).

    The Alternative Minimum Tax is a high tax for the middle class and others that is formally in the tax code, but never collected, because every year congress in a bipartisan matters abolishes it for the next year but not for the following years.

  4. I tried to comment earlier but it must not have gone through...

    Anyway, this is a really terrific article on an increasingly impressive site. One of my new favorite econ blogs, maybe even the best in terms of quality and honesty.

    Quick question. What data was Jon Stewart using to get the effects that he showed on his show? What was he not including? Just curious what he was using and if and how it was incorrect / misleading.

    Thanks, and keep up the great work!

  5. It's impossible to know, since he doesn't report, but if you look carefully:

    1. He stops at 2050, instead of 2082 för CBO.

    2. Even at 2050, debt is higher than the height of WW2, the highest U.S ever had. It only looks small since it's so compressed.

    3. He *probably* is doing the Alternative Minimum Tax trick. This is a tax that officially exists, but that both parties every year abolish for the middle class. If you don't abolish it, it will grow like crazy since it's not indexed to inflation.

  6. Great, great post Tino!!!!!!!!!!!

  7. One very important thing to note is the fact that tax cuts and expenditures reduce revenue and add to Federal spending/borrowing...

  8. Excellent post, I couldn't ignore those points.

  9. i have never seen such bs in 1 article!! compared to steve ratners charts..a conservative economist recently shown on morning joe..his blow your so called facts out of the water!!! take your kool aide facts & go home!! we are sick of the lies!!

  10. The author first sets up a false premise. He claims that Obama and the Democrats assert that all of the deficit is due solely to the Bush tax cuts. This is false. President Obama and the Democrats have stated that the current deficit was principally created due to the following: 1) the two massive Bush tax cuts; 2) the wars in Iraq and Afghanistan 3) the increases in funding for homeland security programs 4) Medicare Part D, the largest new entitlement since the creation of Medicare and with no funding mechanism; and 5) actions taken to address the worst financial crisis since the Great Depression, which occurred prior to Obama coming to office (both the causes of the crisis and the crisis itself). Saying that Democrats are blaming everything solely on the Bush tax cuts is simply inaccurate.

    Second, he falsely states that the solution is solely a choice between new taxes or cuts in government programs and entitlements. This is not what was proposed by Obama and the Democrats. Obama offered the Republicans a "grand bargain" that had three dollars in program cuts for every dollar in new revenue, which the Republicans rejected. Instead the Republican insisted that the entire deficit be addressed solely through cuts to federal discretionary and non-discretionary (i.e. entitlements).

    Finally, he is lumping the $800B in stimulus money that Obama and the Democrats advocated for and got passed will continue indefinitely. It will not and much of it has already ended. The wars in Iraq and Afghanistan are both winding down, so the Obama administration is anticipating using some of those "savings" to apply to the deficit, but both wars will continue to require a certain level of funding for the foreseeable future, but I am not sure that you can reasonably blame Obama and the Democrats solely for this fact. In fact, Republicans are probably more concerned about cuts to the Defense budget than are Democrats at this point.

    One last comment would be that most economist would say that our current deficit expenditures are not what they are worried most about, but instead that forecast expenditures tied to rising health care costs and other elderly entitlements. Obama and the Democrats attempted to address this problem via their health care reform initiative. Getting all Americans covered was deemed a necessary first step before the country could seriously address the rising cost of health care. The CBO reviewed the health care reform law and found it revenue neutral (given that the CBO had to live with certain assumptions that the Democrats made when passing the legislation and may prove to be inaccurate), so you can't blame the deficit on this new law, especially since the majority of it doesn't go into effect until 2014. Rep. Paul Ryan's proposal to simply make Medicare a voucher program, where rising health care costs would solely be the concern of the individual (and in the case of Medicaid, the state), is more a cop out than a solution in my mind, but maybe you would beg to differ.

  11. I am to submit a report on this niche your post has been very very helpfull click here

  12. Engrossing substance I haven't been finished specified info in a lasting time.
    online cash advance review

  13. Very nice website and articles. I will be realy very pleased to visit your website. Now I am found that we actually want. I check your website everyday and attempt to learn something from a blog. Thank you and looking forward to your new submit.

    software drivers download


Google Analytics Alternative