U.S. FISCAL POLICY: a 30 YEARS PERSPECTIVE

                                  Data source : the US Congressional Budget Office. 

The U.S. Federal deficit which was once successfully eliminated in the late ‘90s went through a shock with the  Great Financial Crisis of 2008.  By 2011, the gap between revenue and spending reached a record 10% of GDP.

U.S.   FEDERAL GOVERNMENT REVENUES AND  OUTLAYS   as  a %  of  GDP

 

In that timeframe, the level of interest-bearing  U.S. Public Debt (in green below)  almost doubled relative to its 30 years average.

U.S. FEDERAL  DEBT  as  a %  of  GDP   (Gross Public  Debt includes intra-government  debt)

Note that the ECB takes exception with the American way of accounting for the national debt and points out that the Gross Debt is the proper way of reporting public indebtedness -- a line of thought shared by a few prominent US economists including, among others, Carmen Reinhart and Ken Rogoff. By that metric, the % is already close to 100%.

Individual and Corporate Income Taxes, already on a declining trend with the Bush tax-cuts, continued their descent after the Great Recession producing as a result a total revenue base of 15% of GDP: a record low.  Contrary to misleading lobbyist pronouncements, it is noteworthy that Corporate Income Taxes in the US -- already dwarfed by Personal Income Taxes by a 6/1 factor -- are now at record historic lows despite significantly improved business profitability and the backdrop of record unemployment around 10%.

U.S.   FEDERAL GOVERNMENT  TAX  REVENUES ( by major source  as  a %  of  GDP)

The largest aftershock of the Great Recession was a spike in Mandatory Spending which helped cope with the unemployment crisis.  Yet, record-low interest rates helped reduce the cost of debt-servicing.  

U.S.   FEDERAL GOVERNMENT SPENDING    (by major category as a %  of  GDP)

But, with the size of Government Debt at record levels relative to GDP, these low and unsustainable interest rates do mask a large and destabilizing future threat:for every 1.5 % increase in interest rates, the government deficit as a % of GDP is poised to widen by about 1%. Unless proactively addressed by curbing the growth in budget deficits, the cost of servicing the public debt could seriously handicap future economic growth.

  

Total discretionary spending  has now grown by 50% over its low-level of 6.2% of GDP, reached in 1999. Defense spending already galloping ahead with the wars since 2002 has been accompanied by a surge in Domestic spending, indisputably due to the still lingering nefarious effects of the Great Financial Crisis. Over the next 10 years bringing both Defense and Domestic Spending to about 3.5% of GDP each is doable if economic growth and job creation returns to normalcy , yielding $1 to $2 Trillion in cumulative spending cuts.

U.S. FEDERAL GOVERNMENT DISCRETIONARY SPENDING
(by major category as a % of GDP)

Total Mandatory Spending reached a record of 14.8% of GDP in 2009 mostly because of the unemployment benefits and other support programs to American people most affected by the Great Recession. On the other hand Medicare and Medicaid have now started to pose a structural problem with their alarming upward trend. While raising Medicare age limits from 65 to 67 for future beneficiaries, and slowing the increase in cost-of-living adjustments in Social Security are the most likely measures to be adopted, generating $1to $2 Trillion in total spending cuts over the next 10 years will necessitate tackling the intrinsically excessive cost of US HealthCare

U.S. FEDERAL GOVERNMENT  MANDATORY  SPENDING (my major category as a % of GDP)

WHERE DO WE GO FROM HERE ?

Spending cuts, although mandatory, cannot solely be the answer to the US Public debt problem.

·   Immediate and deep cuts, whether Discretionary or Mandatory in nature, amount to austerity measures which will put an untimely damper on the already anemic economic demand.

·   Since 2007, the assumption that the Private Sector could provide for the much needed long-term investments in creating new jobs -- and more taxpayers -- has proven to be largely illusory. 

Furthermore, the Bush tax-cuts have also proven to harbor false expectations as they have neither bolstered consumer spending nor increased capital expenditures in the economy.Instead, with poor domestic demand, both contributed to enlarge the government deficit.

·   These increase the risk that with renewed recessionary pressures in 2012 tax revenues could shrink once more, cancelling out the benefits of spending cuts while widening the deficit.

 

The US Public Debt problem needs as much focus on increasing revenue as on reducing spending:

·  Tax revenues from Estate and Customs in the US are at historical lows: increasing them   should be given no less serious consideration than curtailing Social Security or Medicare  benefits.

·   Revenue from corporate taxes is also at a historical low: instead of increasing them, there could be plenty of room to stimulate employment with a “use it or lose it” tax credit arrangement.

·   As to individual income taxes, we have lots of empirical evidence over the last 30 years that the most robust economic growth -- whether under Reagan or Clinton -- took place despite significantly higher marginal tax rates.  Consequently, starting with a reform of the Tax Code for eliminating all unneeded and unfair tax credits, focusing on revenue improvement is a must.

·  Finally, creative schemes such as a VAT or something similar should not be ruled out either.

 

The US Public Debt resulting from these accumulated deficits unfortunately overshadows the fact that continued hesitation with fiscal rectitude cannot always be compensated with lax monetary policy. Simply put, the Fed is not the answer: it can no longer come to the rescue of political procrastination.  

The danger ahead is clear: it would simply be devastating if the long anticipated growth in new jobs was aborted by a sudden jump in long-term interest rates affecting the cost of US Sovereign Debt.

The European experience of the last 2 years should serve as a “what not to do” in handling the incipient US Sovereign Debt Crisis: nothing is as risky in finance as gambling with lenders’ confidence.