Posted tagged ‘GDP’

If We Can Beat the Mayan Apocalypse Why Not the Fiscal Cliff?

December 21, 2012

If the Mayan apocalypse can be postponed (I am not sure exactly at which time it is supposed to occur so I may be speaking too soon here) then surely the U.S. Congress can agree to actions to avoid the fiscal cliff.  Lawmakers are poised to give us over $500 billion in tax increases and over $100 billion in spending cuts to begin the new year.  The fiscal cliff is a  pretty big lump of coal as a gift to begin 2013.

What is extraordinary about the cliff’s self-inflicted harm is that it appears  almost all sentient beings realize what needs to happen. More importantly, there also appears to be substantial agreement on most of the actions necessary to avoid the economic harm resulting from the fiscal cliff.   Spending clearly has to be cut  just as surely as revenues have to be raised.

deficit trends

With so much apparent agreement on actions needed to avoid the damage, it is hard to understand the calculus of lawmakers as the lack of an agreement begins to  demonstrably affect business and consumer confidence as well as financial  markets.  Congress always comes up with a temporary fix for the alternative minimum tax and can easily do so again.  Almost everyone wants the payroll tax cut to expire (for different reasons – Republicans because they don’t like the temporary nature and believe it has no incentive for work and saving and Democrats because of its impact on the Social Security trust fund).  There is little support for extending unemployment benefits.  It seems like neither party really wants the spending cuts (Republicans opposed to defense cuts and Democrats to non-defense cuts).   There is disagreement over the tax increase for high income individuals included in the Affordable Care Act and Medicare reimbursements for doctors but those are a miniscule portion of the cliff’s effects.   Beyond all the posturing,  the fight in congress is really  about whether to extend tax cut provisions to 98% or 100% of U.S. households.

cliff effects on growth

I know I am simplifying here.  Even with many agreed upon temporary  fixes,  longer-term solutions must be found.  But lawmakers could still salvage strong economic benefits by avoiding the worst of the cliff’s impacts in the short-term while resolving longer-term issues in the first-half of 2013.  Such a “grand bargain”  would both increase business and consumer confidence and set the nation on a more sustainable budgetary and debt path that would quickly overcome any of the short-term negative impacts  resulting from necessary spending cuts and revenue increases.

The Fiscal “Cliff” is No “Bluff”

November 27, 2012

Linguists will take exception to that and note that a cliff is, in fact, a bluff.    The consensus among economists, however,  is that the fiscal cliff is indeed no bluff.    A number of commentators have noted that the fiscal cliff is more like a slope and will not  cause immediate economic calamity.  I was one of those as a guest on NHPR’s “The Exchange“.   But just as there was once too much hyperbole surrounding the fiscal cliff issue, now, as we get closer to the deadlines when the combination of tax hikes  and spending cuts that define the fiscal cliff take effect, there seems to be more of an effort to minimize the likely impacts that will occur if no resolution is found.  That would be a mistake because whether the spending cuts take effect immediately or over the course of a year or more, and whether the tax hikes immediately effect spending and investment decisions is not the issue.  The issue is that the U.S. economy is simply not growing fast enough to withstand the impacts of the full implementation of the provisions of the fiscal cliff.  Skeptics fire away, but below is a succinct chart that shows how the effects of the fiscal cliff relate to real growth in our nation’s economy, assuming the effects of the cliff occur in 2014.  To lump all effects in one year isn’t accurate, but the point is to place the magnitude of the cliff’s impacts into context.  I believe the context in the chart below highlights the importance of a reasonable resolution to the potential problems the cliff could cause.

How Much Federal Government Revenue is Enough?

November 14, 2012

Federal government revenues as a percentage of gross domestic product have averaged about 18% over the past 50 years (the median is also 18%).  Federal government revenue is “pro-cyclical,” that means revenues as a percentage of GDP grow when the economy is stronger, as profitability of businesses increases and as individual wage, salary and investment income is increasing.  This relationship has a couple of important implications: First, it can confound ideological interpretations of the appropriate level of current revenues as a percentage of the economy because higher revenues as a percentage of GDP aren’t associated with slow growth and low percentages aren’t associated with higher rates of economic growth – just the opposite is true (with the exception of the dual recessions of the early 1980s), second it suggests how important economic growth is to revenue growth and thus to potentially reducing the nation’s budget deficit.

I haven’t done the math but others who have indicate that the various deficit reduction proposals all require revenues as a percentage of GDP of over 18%.  The U.S. House passed Ryan budget proposal would produce estimated revenues as a percentage of forecast GDP of approximately 19%, the President’s proposals would produce estimated revenues at 20% of GDP, and the “Simpson-Bowles” model would result in estimated revenues as a percentage of forecast  GDP of 21%.  That doesn’t sound like much of a difference, but in an economy with a GDP of $15.5 trillion each 1% increase equates to $155 billion in revenue.  Going from federal revenues that are 18% of GDP to 21% implies a revenue increase of $465 billion.   I could be ok with that if the bulk of the increase were the result of a roaring economy producing large increases in profitability and income, but that isn’t the foundation of any deficit reduction plan and it is hard to see a scenario where $465 of additional revenue is consistent with a high growth economy (the pro-cyclical nature of revenues aside – that relationship isn’t  infinitely linear).  The national debate over reducing our nation’s budget deficit is framed by two choices or their combinations,  increasing tax rates (or eliminating temporary reductions and reducing tax breaks etc.) or by cutting spending.  Revenues at 18% of GDP seems to have worked reasonably well over the past one-half century with the past decade being the exception.  It may be time to aim for a different ratio for the sake of longer-term fiscal balance, but I wouldn’t do it without first exhausting opportunities for spending reductions that maintain a ratio close to the historical average of 18%.  But whatever the combination of spending reductions and revenue increases that eventually becomes the strategy for addressing the nation’s long-term fiscal imbalances, I hope economic growth is the ultimate goal, because as the chart above shows, achieving that goal will make addressing fiscal imbalances a much more manageable task.


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