Many would argue vociferously against MacArthur’s trust in the people, believing, to paraphrase H.L. Mencken, that human beings are typically passionate believers in the palpably untrue. While humanity's relationship with the truth may be open for debate, the political acrimony of the last 18 months, and a lack of objective reporting, has made it virtually impossible for most Americans to discern the truth about the surge in the nation’s budget deficit. Most readily place the blame on the shoulders of a spendthrift government, and indeed government spending has risen dramatically. However, to gain a true picture of the nature of the budget deficit, one needs to review not only the government’s expenditures, but its revenues as well.
Over the course of the last three fiscal years, which run from October through September, the US budget deficit has exploded from 1.2% to 9.9% of GDP. In absolute terms, it grew from a relatively modest $161.5 billion in fiscal 2007 to a monstrous $1.417 trillion in fiscal 2009 (Chart 1). As the economy slid into its deepest recession in more than 50 years government expenditures skyrocketed. This is to be expected. First, expenditures on social safety net programs increase during recessions. Second, the government typically institutes additional fiscal stimulus programs during recessions in an attempt to fill some of the spending gaps left by contractions in consumer and business spending. Given the fact that the recent recession was the worst economic crisis since the Great Depression, one should not be surprised by the implementation of fiscal stimulus on a scale hitherto unseen.
However, it is important to note that despite advertised price tags of $700 billion and $787 billion for TARP and the American Recovery and Reinvestment Act, respectively, nothing approaching those amounts was spent in fiscal 2009. During the fiscal year, TARP made commitments of $454 billion, of which $364 billion in loans and equity investments were actually paid out. The government received inflows, in returned principal and profit, of $72.8 billion, nearly all of which came from the Treasury’s much maligned investments in the financial sector. The drains on the program have been its investments in AIG, Chrysler, GM and the financing companies of the latter two; the government currently expects to lose money on these investments.
Similarly, relatively modest amounts of the $787 billion stimulus program actually resulted in government outlays in fiscal 2009. First, it is important to note that $288 billion, or more than a third, of the stimulus involves tax benefits. Depending on their construct, tax breaks may result in outlays (rebates) or reduced revenue (credits or lower tax rates). The CBO (Congressional Budget Office) estimates that the direct impact of the stimulus on the fiscal 2009 budget was a $200 billion increase in the deficit of which $112 billion came from increased expenditures and $88 billion from lost revenue. Additionally, government spending on traditional social safety net programs such as unemployment more than doubled in fiscal 2009 to $76 billion, of which about $27 billion is included in the stimulus figures. Finally, an increase in defense spending added $43 billion to the deficit.
Combined, these items accounted for about 91% of the $543 billion increase in US government expenditures in fiscal 2009. So how is it that the deficit ballooned by $962 billion? The answer lies in the 17% decline in the US government’s revenues during the fiscal year. The recession resulted in the highest unemployment rates in nearly three decades and the steepest declines in corporate profitability in more than 50 years (Charts 2 and 3).
As a result, revenue from personal and corporate income taxes plunged over the last two fiscal years. However, revenue from social insurance and retirement taxes rose modestly (Chart 4). The decline in total revenues is far less than the decline in personal and corporate income taxes would suggest due to the overall mix of revenues. Corporate taxes account for only about 6.5% of total government revenue while personal income and social insurance and retirement taxes account for about 43.5% and 42.3%, respectively.
Over the last two fiscal years, US government revenues
have declined 18% while expenditures have grown 29%. Nearly all of the revenue contraction occurred in fiscal 2009, as rising unemployment and declining corporate profits decimated tax revenues. Similarly, most of the increase in spending occurred in fiscal 2009 due to expenditures from TARP, the stimulus bill, and rising payments from existing social safety net programs. In short, the government experienced the largest increase in outlays and the largest reduction in revenue on record, resulting in a gaping hole in its budget. While we believe that the fiscal stimulus could have been more efficiently implemented, these programs were essential in preventing an economic meltdown of far greater proportions. While they were distasteful, they were absolutely necessary.
If a professional football team produces a winless season, it is not simply the fault of the coach, the quarterback, the GM or the owner. To perform that poorly requires incompetence throughout an entire organization. Similarly, corporations, consumers, and the US government all contributed to the US economic crisis, which is the fruit of 25 years of increasing leverage on the part of the financial sector and the US consumer. This was exacerbated by fiscal and monetary policy that largely encouraged greater leverage and less saving and an absence of regulatory oversight. This unholy alliance resulted in an economy driven by asset-based, rather than income-based, consumption that habitually consumed more than it created. The current debacle in the US budget is a direct result of the bursting of bubbles in asset prices and credit (first growth stocks in the late 1990s and then housing during the 2000’s) that were a quarter century in the making.
Given the enormity of the deficit and the likelihood of slower economic growth as consumers rebuild their balance sheets, significant, long-term deficit reduction will not occur through budgetary restraint alone. It must include a combination of expense reduction and revenue expansion; i.e. taxes will have to rise. Failure to address these issues in a timely manner places the country’s vaunted Treasury market at risk of losing its status as the safest credit in the world.