Monday, February 28, 2011

NGA Speech Highlight

Interesting highlight from today's speech to the National Governors Association:

"All told, the budget cuts I’ve proposed will bring annual domestic spending to its lowest share of the economy since Dwight Eisenhower. Let me repeat that. Under my budget, if it were to be adopted, domestic discretionary spending would be lower as a percentage of GDP than it was under the nine previous administrations, including under Ronald Reagan’s." - President Obama

Friday, February 18, 2011

What is Small Government?

What does small government mean? Those calling for massive cuts say we've got big government and they just want us to get back to small government. They say that whoever disagrees with them wants "big government."

Like pretty much all of my fellow Americans, I want govt to stick to its appropriate role. I want a government that does only what we need it to do. But what if that's what we've got now?

Comparing against other modern, industrialized nations would be one way to put it into perspective. In 2009 we had larger than normal expenditures from stimulus and lower than normal GDP from the Great Recession. That year, we had a GDP of roughly $14,258 billion and total Federal spending of $3,518 billion. That's 24.7%. In the same year, the U.K. central government spent around 32.6% of their GDP. Looking back to the more normal levels of a year that doesn't include stimulus spending, in 2007 our Federal spending was 19.38% of our GDP. That same year, the U.K. central government spent 28.44% of their GDP. That's how the general trend goes. Between 1995 and 2010, the our national govt spending undershot their national govt spending by 8.7% on average.

National govt spending as a share of GDP in the US and UK
The U.K. is far from alone among the other industrialized nations in dwarfing our national govt spending.

Expense (% of GDP) in 2004 from
By and large -- though some other countries often run budgets proportionally similar to ours -- we have a relatively small government compared to the other industrialized nations.

Perhaps one could argue that maybe the general trend in the other industrialized nations is to maintain giant governments that dwarf our so-called big government. If that's the case, we should easily be able to find vast, expensive programs that we don't really have any use for in our society ... that few of us would want government to do. Where are those programs?

Shall we cut infrastructure spending and let our already crumbling roads and bridges decay further, making it harder for our businesses to transport products? Shall we dismantle Social Security and allow elderly citizens to starve in the streets? Should we stop investing in the medical research that has helped make our biomedical industry such a large contributor to our GDP? Shall we stop funding education and fail to foster skills needed to compete in the modern global economy? Shall we stop monitoring our food supply so that producers can get away with cutting corners and contamination runs unchecked? Shall we cut billions by stopping payments for police, fire-protection, and border security?

These things are all quite necessary from the government. A modern society doesn't function as well without any of that. When you look at charts showing a much smaller government hundreds of years back in our history, keep in mind that we had an entirely different economy back then. We didn't have the transportation system that we have today. We didn't have a social safety net to make it so an elderly miner could retire rather than just working till he died nor workplace regulations to make it less likely for him to die of black lung. We didn't have such a thriving biomedical industry both making our health better and enriching our nation. We didn't have a workforce capable of designing high-tech products to sell to the rest of the world. We didn't have most of the great things about our modern economy that require government programs to work smoothly and in many cases to function at all. One can't expect the economy of the 21st century to operate with the government spending levels of the 18th or 19th centuries. When we had significantly smaller government, we also drove horse-drawn carts, used outhouses, suffered polio, and couldn't reasonably expect to have a chance of ever retiring. Should we really be basing our idea of appropriate government spending on a time to which we wouldn't want to go back in any other way?

Wednesday, February 9, 2011

Govt Bakers: Cutting the Fat? Or Let Them Eat Cake?

Marie Antoinette
Sen. Toomey (R-PA) in the Wall Street Journal claims, "For too many years, Congress has ignored or exacerbated the looming fiscal crisis created by overspending."

Has it? Has it really? We've got a Congress chock full of GOP members telling us we need to cut, cut, cut because we've been "overspending." So where's all this alleged fat to trim?

The Defense Secretary has suggested we may be able to spare about $78 billion from the defense budget, which is a fair slice of savings. For the defense budget that's not all that far over 10% of their piece. As Gates puts it, "not every defense program is necessary". While I'm no military expert, I hear there's some trial and error in designing new programs. That's a low enough percentage that I could imagine chalking up that much in unnecessary projects.

That's nice, but to zero the deficit immediately by cuts alone -- without undoing those tax cuts -- we'd have to cut about a third of our spending ... not just 10% and not just from defense. Various members of Congress have proposed slashing or even eliminating various specific programs. For instance, Rep. Bachmann proposed cutting what we spend on taking care of our loyal veterans, which left a bad taste with just about everybody else. Turns out that for every program they propose chopping, a bunch of people start pointing out good reasons why we need those programs.  There really just isn't that much we can trim from the budget without mayhem.  There may be some waste, but not a full third of everything.

The GOP keeps telling us that if we just charge the wealthy less at the figurative bakery register, they'll buy more cigars, the cigar makers will buy more bread, the bakery will expand, and there'll be more bread to go around. The bakery took in less money and had to borrow money to keep baking our bread. When the Republicans tried to tell us the bakery should just stop supplying whole-wheat to avoid borrowing, we said, "no, the national diet needs whole-wheat". Now the Republicans say the problem is we bake too much cake.

Monday, February 7, 2011

Reagan, Tax Cuts, and GDP

In honor of the 100th anniversary of President Reagan's birth, lets take a look at the effect of his tax cuts for the top marginal rate. When we looked at the course of the past 80 years as a set, it looks as if there isn't a particularly clear correlation between top marginal tax rates and GDP growth. But what if we weren't looking close enough? After all, the last few decades seemed to have a noticeable symmetry.

Where should we look? For President Reagan, whose tax cuts came into play around 1982, we should see those rates working their magic on the economy by two years later in 1984. The rates would continue any effect after President Reagan left office, so lets keep looking up through 1992.

Tax rates on left scale; GDP growth rates on right scale
Inspiring, don't you think? Apparently that GDP growth going down in about the same slope that top marginal tax rates were going down must have been what they meant by "trickle-down."

Of course, that might not be entirely fair. We should probably look at the President's entire term and see what happened in case we can credit the tax cuts immediately with a big initial boost that gradually faded.

Tax rates on left scale; GDP growth rates on right scale
As seen in the chart of 1980 to 1992, there is indeed a big spike in GDP growth immediately after the tax cuts begin. Yet that conflicts with what we see in the rest of the chart. Why would lowering taxes correspond with expansion in one section of the chart and contraction in another? In this case, we need additional data: the Fed rate. The Fed ramped up interest rates brutally high for the early 80s in order to tame massive inflation. The Fed rate had been slowly ratcheted up over 1978 and 1979. The rate for 1979 started at 10% and went up to almost 14%. For 1980, the rate averaged 13%. For 1981, the rate averaged over 16%. The prime interest rate even ventured into the 20s in 1982. These high rates did tame the inflation, but in doing so they brought on the recession of 1981-1982 because they made it much harder to borrow to invest for growth. Naturally, when the brutal interest rates were eased back down in 1982, there was some pent up thirst for financing just waiting for lower interest rates.

What can we draw from 1980 through 1992 as far as taxes and GDP? If these years are indicative of anything, it is that under relatively normal interest rates lowering the top marginal tax rate appears to come with a corresponding drop in GDP. Whereas during a period of extreme high interest rates, there appears to be no correlation between top marginal tax rates and GDP because of the growth-blocking effect of extremely high interest rates.

For the Gipper, unfortunately, that top marginal tax cut play doesn't seem to have been a win.

Thursday, February 3, 2011

Chained to Real: Tax Rates, Inflation-adjusted GDP Measures, and the Difference

The question:  what impact (if any) do top marginal tax rates have on GDP growth rates?

Our previous chart of top marginal tax rates versus GDP growth rates utilized "chained dollars," a measure with which not everyone is familiar. That data was drawn from the BEA's Current-dollar and "real" GDP table. While the chained dollars therein are a measure of real GDP, they're not the only measure. There's a slightly different set of data at the BEA's NIPA Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product.

To satisfy those who wonders whether the result would be different if we use another measure of inflation-adjusted GDP:

Left scale for top US marginal income tax rates. Right scale for GDP growth in inflation-adjusted "real" dollars. A 10 year moving average for each figure is also included. GDP data from the BEA. Tax rate data from
The results of using this measure of (inflation-adjusted) real GDP are almost the same as using the (inflation-adjusted) chained dollars. From 1951 through 1963 the top tax rate varied between 91 and 92%. During those years, the average rate of inflation adjusted GDP growth (using real dollars) rested at 3.72%, a rather robust growth rate. (GDP growth averaged 3.39% from 1951 through 2007.) By contrast, the GDP growth under the average 37.4% top tax rate from 1986 through 2008 was only 3.2%, 0.52% lower growth than under the much higher 1951 - 1963 tax rate.

Regardless of which inflation-adjusted measure we use, the answer is still the same: Overall, the past 80 years show us a thorough lack of clear correlation between the top marginal tax rate and GDP growth. The data's closest hint of a relationship derives from the slightly more robust average GDP growth back when the top rates were higher, but that closest hint isn't close enough to be sure of an ideal rate. The notion that lowering the top tax rates improves the economy just doesn't hold water. Indeed, these 8 most recent decades show us that increasing the top tax would not necessarily have any impact on the economy, let alone slow it at all.
original chart

Update 02/07/2011:  Replaced original chart with improved version featuring better parity of scales, better visibility of trendlines, and replacement of the poly trend with a linear. The change in scale does suggest an interesting symmetry in the past two or three decades. We'll look at that in more detail later.