July 13, 2006
From the desk of Jane Galt:Deficits as far as the eye can see . . .
As an econ blogger, I presumably have a responsibility to comment on the deficit. This about sums up my opinon:
By 2008, Mr Bush’s number-crunchers reckon, the fiscal gap will be down to 1.3%, well below the level needed to fulfil the president’s election promise of halving the deficit in his second term (see chart). The president, who badly needs to rebuild credibility with his conservative base, was ecstatic. Not only was the deficit under control, he claimed, but soaring revenues were clearly the consequence of tax cuts and proof that Bushonomics works. “Some in Washington say we had to choose between cutting taxes and cutting the deficit,” he crowed. “Today’s numbers show that that was a false choice.”Outside the White House, the reaction to the new figures was, rightly, rather less glowing. Many pointed out that a budget deficit of 2.3% of GDP at a time when the economy is booming and the babyboomers about to retire was hardly cause for great celebration. Others grumbled that much of the fiscal “improvement” was fake, arguing that the Bush team regularly overestimates deficits early in the year so that it can flourish better numbers later on.
The White House’s February forecast of a $423 billion deficit was indeed far above other people’s. Both the non-partisan Congressional Budget Office and Wall Street economists expected a gap of about $370 billion. But this week’s budget “surprise” cannot be put down to financial legerdemain. The revisions almost all stem from higher tax revenues, a surge of cash that has shocked everyone.
The White House now expects to get $115 billion more in taxes this year than it did in February. Against the boffins’ expectations, a revenue surge that began in 2005 appears to be continuing. In 2005 tax receipts rose almost 15%, the fastest pace in 25 years. They now look likely to rise by another 11% this year, far above the historical average growth rate of around 7.5%. About half the surge in cash comes from firms; the other half is thanks to higher income-tax payments by individuals, particularly those that are not withheld from pay-cheques, such as tax payments on capital gains and year-end bonuses.
These are impressive figures, but how much credit belongs to Mr Bush’s tax cuts? Fiscal loosening doubtless cushioned the 2001 recession and may have accelerated the subsequent recovery. But the tax cuts cannot be given all, or even much, of the credit for today’s strong revenues. Tax receipts often rise faster than the bean-counters expect during cyclical expansions. Since budget forecasting is more an art than a science, revenue “surprises” are surprisingly frequent.
Most salient point: Bush could close the budget deficit next year, and it wouldn't matter, because we have a whacking great entitlement prolem that is about to, as I once said rather pungently, "become the sucking chest wound of our budget". Not only does Bush deserve no credit for narrowing the budget gap via the magic of dynamic scoring; his political failure on social security reform, and his politically popular but fiscally lunatic prescription drug benefit have made the problems worse.
Of course, if you think this means that I am taking the Democratic line on all this1, you are very much mistaken. The Democrats wanted to spend more money on the prescription drug benefit, and it was their political ads and other vigorous campaigning that brought down social security reform. Neither party is covered in glory here.
About which I thought Greg Mankiw made the most amusing point:
My friend pointed out that forecasting tax revenue entails a lot of inherent uncertainty. A surprise even as large as $100 billion is not all that surprising, and we shouldn't make too much of it. It is absurd, he said, to suggest that this revenue surprise tells us much about current policies. My friend thinks it's just a stroke of luck.We saw a similar phenomenon in the late 1990s, when positive revenue surprises drove the federal budget into surplus. Democrats were then quick to claim credit for Clinton policies. They said, "See, raising taxes did not have all the negative effects that Republicans predicted." Meanwhile, Republicans thought Clinton just got lucky.
Both cases are examples of confirmation bias--the tendency to interpret evidence in favor of one's preconceptions. When there is good news, the party in charge overinterprets the evidence as establishing the rectitude of their policies. The party out of power is too dismissive of the evidence.
Absolutely right, and I think I am slightly entitled to crow, thanks to my frequent opining that Clinton's tax increases didn't help the economy, any more than George Bush's tax cuts did. Nor did either hurt much. The fact is, the Federal government, being largely restrained from radical action on the economic front, has little ability to either help, or hurt, economic growth. For which we may humbly thank God every day.
1 But you didn't really think that, did you?
I think the only deficit that matters is the trade deficit. It is big, growing, and America seems to "sell off the farm in pieces" to outsiders. A strong, and lasting devaluation of the dollar is likely. Which will lead to lowered purchasing power for Americans. What do you think?
"But the tax cuts cannot be given all, or even much, of the credit for today’s strong revenues. Tax receipts often rise faster than the bean-counters expect during cyclical expansions. Since budget forecasting is more an art than a science, revenue 'surprises' are surprisingly frequent."
But if the surprises are generally on the upside, then there must be a flaw in the way economists are making their projections. One serious flaw is the reluctance to adopt dynamic scoring. While some Laffer Curve enthusiasts go too far in arguing that tax cuts often or always pay for themselves, that should not obscure the fact that static scoring overstates the lost revenue due to tax cuts.
The Bush tax cuts have indeed contributed to growth by removing obstacles to productive economic activity and that growth has led to surging revenues (a fact generally lost on the semi-socialists at the Economist).
As Robert Barro has argued:
"The 2003 tax cuts enhanced incentives for work effort, saving, and investment. So I think it is no accident that the U.S. has enjoyed rapid growth rates in gross domestic product, investment, and productivity since early 2003."
what clinton did was get out of the way of the booming economy. In the late 1990s the federal surplus and foreign capital inflow provided the financing or savings for almost half of the capital spending boom.
Absolutely right, and I think I am slightly entitled to crow, thanks to my frequent opining that Clinton's tax increases didn't help the economy, any more than George Bush's tax cuts did. Nor did either hurt much. The fact is, the Federal government, being largely restrained from radical action on the economic front, has little ability to either help, or hurt, economic growth. For which we may humbly thank God every day
I followed your link to your analysis of Clinton's tax increases:
Unlikely. For one thing, as Glen Hubbard has repeatedly pointed out, it is very, very hard to build a credible model in which budget deficits matter to investors, but taxes do not. The basic idea behind the "Deficit reduction causes growth thesis", known to journalists as "Rubinomics", is that by reducing the government's demand for capital, you lower interest rates. Ceteris paribus, I agree with that.
However your Feb 9 piece went to great lengths to argue for tax increases to cover deficits...your argument was that spending is automatically a tax increase either today or tomorrow the only difference is tomorrow that tax increase comes with accrued interest attached. So a deficit balanced today with a tax increase is a smaller increase than one balanced tomorrow with spending.
You followed up with an odd line:
No to repeat myself, but when you find yourself saying the phrases "the effect is much stronger than we anticipated" and "the bond market reacted to the act before it was passed5", that's a sign that you might want to look for some other cause of the remarkable effects you're experiencing.
Certainly you are not saying bond traders don't try to estimate future political policy? I would suspect that the bond market figured Clinton winning the election would be more likely to result in a hawkish deficit policy since a Democratic win would give the gov't a green light for a tax increase. A Bush win would have probably been the reverse because Bush Sr., if he had won re-election, probably would have been more beholden to supply-sidish Republicans who would have wanted him to focus less on the deficit and more on tax cuts.
Anyway, you ignored the more subtle argument around the Clinton tax increases. At the time banks had suffered quite a bit from the busting of a property boom. Regulators had allowed them to count 30-year Treasury bonds as 100% secure assets against their reserve requirements. Since banks did not want to loan out much they were quite heavy on the 'safe' 30 year bonds. However, as we all should know 30-year bonds are only safe in the sense that the gov't is highly unlikely to default on them. 30yr bonds can vary in value quite a bit as interest rates change. If rates go up the value of the bonds go down. At the end of Bush Sr.'s term the economy was in a very shaky position. Banks were unwilling to make major new lending to businesses because they had been burned so badly. The huge position they built up in 'safe' bonds, though, left them very vulnerable. If intererest rates went up, as they would have if the bond market figured the Fed. gov't was going to let the deficit go out of control again, they would have gotten double whacked with huge capital losses...possibly an implosion on a scale larger than the S&L crises.
However the foolish risk that the banks with the help of regulators took ended up paying off for them and the rest of us. Clinton's hawkish stand on the deficit caused rates to drop, this meant instead of collapsing the value of the bonds the banks were holding went up. Now with their profits they found themselves in an environment where Treasury bonds were offering lower rates of return so they started lending more to businesses again rather than the gov't. On top of that, Greenspan accomodated the tax increases with short term rate cuts and we all lived happily ever after.
So I think it would be more accurate to say that Clinton's tax increases did contribute to the growth in the 90's but did so because of a perfect storm combination that cannot be simply repeated at will again. Most of the time controlling the deficit is like healthy eating and exercise, unpleasent in the short term but good in the long term and deficits are like junk food and laziness....fun in the short term bad in the long term.
Have we forgotten the peace dividend? Cold War over?? What was cut from the Armed Forces?
One thing I'm always interested in when people yammer on about the deficit is their mortgage.
CA had a tremendous RE bust in the late 80s-early 90s, IIRC, but I don't remember the entire country tanking.
And Y2K?
http://www.gpoaccess.gov/usbudget/fy07/sheets/hist08z2.xls gives you defense spending in constant dollars. It's a fascinating graph it in Excel. It looks like a perfect sine curve with peaks in 68/69, 88/89 and 06/07. The minimums come in the late 70's and late 90's. Interestingly the deepest valley in the 70's was around $250B, the deepest valley in the 90's was about $289B.
Long story short, there's been no defense savings because of the end of the Cold War. There has been savings from the peak of defense spending in the 80's but today we spend more on defense than we did at the peak of the Reagan era, and are currently matching what we were spending at the peak of the Vietnam War...when the Cold War was hardly Cold.
If you add a trend line to the data we have basically went from spending $300B or so per year in real dollars on defense during the Cold War to about $350B in this post war period. From at least 1968 this trend has a near perfect cyclical ness to it....almost a perfect textbook example for anyone teaching a forecasting class.
"I think the only deficit that matters is the trade deficit. It is big, growing, and America seems to "sell off the farm in pieces" to outsiders. A strong, and lasting devaluation of the dollar is likely. Which will lead to lowered purchasing power for Americans. What do you think?"
Nothing could conceivably matter LESS than the trade deficit.
The only debt that matters is personal debt. The lessons taught by this admin ie; deficits don't matter, have really blinded our greedy graduates. Don't know what the future holds, but it will be cash thin for sure.
democrats want to spend more on drug benefits?!?
The only deficit that doesn't matter is the trade deficit. Or as it's known in some circles, the capital account surplus.
The lessons taught by this admin ie; deficits don't matter, have really blinded our greedy graduates.
And no doubt the previous generation of graduates didn't know about oral sex until the previous administration led by example. Right?
More seriously though, where did you get this logic? From under the rock that flattened it the first time?
Via Lucianne:
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/07/14/cnusa14.xml&menuId=242&sSheet=/money/2006/07/14/ixcity.html
US 'could be going bankrupt'
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