U.S. Budget and Economy

Does Buffett Pay a Lower Tax Rate than his Secretary?

2012-01-22T01:12:00.000-08:00

The January 23rd issue of Time Magazine features Warren Buffett on its cover and contains a story titled "Warren Buffett Is on a Radical Track". Following is an excerpt:

Buffett paid a tax rate of only 11% on adjusted gross income of $62,855,038 in 2010. (After deductions, most of which were for charitable contributions, he paid a still low 17% rate on his $39,814,784 of taxable income; his office staff, meanwhile, paid percentages somewhere in the 30s.)

Buffett discussed this in an op-ed that he wrote titled "Stop Coddling the Super-Rich" that was published in the New York Times on August 14, 2011. He discusses the exact method by which he calculated these tax rates in a letter sent to Republican Representative Tim Huelskamp. In it, he states:

I would guess that if you would take line 60 from your 1040, plus payroll taxes paid by you and on your behalf, as a percentage of line 43 - taxable income - your number would be in the 30s just like all of the people in our office except for me. These people make between $60,000 and $1 million annually and, year after year, end in the 30s.

He gives his exact numbers later in the letter, stating:

To be specific, my adjusted gross income (line 37) was $62,855,038, my taxable income (line 43) was $39,814,784 and my federal income tax (line 60) was $6,923,494. In addition, my payroll taxes were $15,300.

The following tables combines the numbers from these articles:


   Dollars  Tax Item
----------  -------------------------------
62,855,038  Adjusted Gross Income (line 37)
23,040,254  Deductions
----------  -------------------------------
39,814,784  Taxable Income (line 43)

                        % of
               % of  Taxable
   Dollars      AGI   Income  Tax Item
----------  -------  -------  ----------------------------
 6,923,494    11.02    17.39  Federal Income Tax (line 60)
    15,300     0.02     0.04  Payroll Tax
----------  -------  -------  ----------------------------
 6,938,794    11.04    17.43  Total Tax

Few people seemed to question Buffett's figures for his own tax rate. However, a number of articles questioned the tax rates estimated for his staff. For example, an online Forbes op-ed stated the following:

What stands out for me is this - either these folks in his office are making some crazy salaries, or they’re getting awful tax advice, or both. Here’s why I say this: In order to have a tax rate of 41% (which presumably includes the highest state income tax rate for Nebraska taxpayers of 7%), an individual would have to make in excess of $373,651 in taxable income, no matter whether they’re a single taxpayer or married.

At the other end of the spectrum, in order to have an effective overall tax rate of 33%, the individual’s income would have to be in the neighborhood of $209,250 if married, $171,850 if single.

$373,651 was the beginning of the 35% bracket in 2010. Hence, the author appears to be taking 41%, subtracting 7% for Nebraska state income tax, and getting 34 percent. Since this is above the next lower bracket of 33%, a taxpayer would need to have some income in the 35% bracket to reach 34 percent.

Similarly, the beginning of the 28% bracket in 2010 was $209,250 if married (filing a joint return) and $171,850 if single. Hence, the author appears to be taking 33%, subtracting 7% for Nebraska state income tax, and getting 26 percent. Since this is above the next lower bracket of 25%, a taxpayer would need to have some income in the 28% bracket to reach 26 percent.

The problem is that these calculation do not measure the federal tax rate as Buffett describes in his op-ed referenced earlier in the article. That op-ed states the following:

Last year my federal tax bill - the income tax I paid, as well as payroll taxes paid by me and on my behalf - was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income - and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

Hence, Buffett is referring to the federal tax rate which does not include the maximum Nebraska state tax of 7 percent. However, it does include payroll taxes paid by the employee and by the employer on the employee's behalf. The following tables show examples of AGI (adjusted gross income), wages, and taxable income taken from IRS data for 2009:


                              FOR SINGLE TAXPAYERS

                                                           % of Taxable Income
                                                          ----------------------
                      Taxable   Income  Payroll    Total  Income Payroll   Total
      AGI     Wages    Income      Tax      Tax      Tax     Tax     Tax     Tax
---------  --------  --------  -------  -------  -------  ------  ------  ------
   45,000    41,000    26,000    3,481    6,273    9,754    13.4    24.1    37.5
   61,000    55,000    39,000    5,931    8,415   14,346    15.2    21.6    36.8
   86,000    76,000    59,000   10,931   11,628   22,559    18.5    19.7    38.2
  133,000   114,000    97,000   20,869   16,549   37,418    21.5    17.1    38.6
1,720,000   860,000 1,493,000  500,194   38,183  538,377    33.5     2.6    36.1
2,955,000 1,339,000 2,576,000  879,244   52,074  931,318    34.1     2.0    36.2

                   FOR MARRIED TAXPAYERS FILING JOINT RETURNS

                                                           % of Taxable Income
                                                          ----------------------
                      Taxable   Income  Payroll    Total  Income Payroll   Total
      AGI     Wages    Income      Tax      Tax      Tax     Tax     Tax     Tax
---------  --------  --------  -------  -------  -------  ------  ------  ------
   45,000    41,000    26,000    3,063    6,273    9,336    11.8    24.1    35.9
   61,000    55,000    39,000    5,013    8,415   13,428    12.9    21.6    34.4
   86,000    76,000    59,000    8,013   11,628   19,641    13.6    19.7    33.3
  133,000   114,000    97,000   16,613   16,549   33,162    17.1    17.1    34.2
1,720,000   860,000 1,493,000  492,858   38,183  531,041    33.0     2.6    35.6
2,955,000 1,339,000 2,576,000  871,908   52,074  923,982    33.8     2.0    35.9

The values for AGI, wages, and taxable income are the averages for various brackets in the IRS data, rounded to the closest thousand dollars. The value for Income Tax is the tax on taxable income, assuming that all of that income is ordinary and using the 2010 tax tables. The value for Payroll Tax is the payroll tax paid by employee and employer on wages. As can be seen, all of the rates for total tax (income and payroll tax) as a percentage of taxable income is in the thirties for all of the examples. Hence, Buffett's claim that his staff's tax rates "ranged from 33 percent to 41 percent and averaged 36 percent" seems perfectly reasonable.

There are some other articles such as this one from the Cato Institute that claim that Buffett's numbers are flawed. However, that article looks at taxes as a percentage of AGI (adjusted gross income) whereas Buffett is looking at taxes as a percentage of taxable income. Taxable income equals the AGI minus deductions. It seems to me that deductions are a separate issue. The way to fix any perceived problem with inequitable deductions is to modify the deductions, not to tax income from labor and investments at a different rate to make up for this perceived inequity. In any event, Buffett's numbers appear to be perfectly reasonable for the measurement that he clearly defines. To argue that there are better measurements is fine. But the claim that the numbers are flatly wrong is itself flatly wrong.

Fact-checking the Romney campaign

2011-06-27T00:10:00.000-07:00

On June 13th, Mitt Romney policy director Lanhee Chen posted a blog on the Romney web site titled "Taxed and Spent: American Workers Suffering Under Obama". Following is the first paragraph:

President Obama’s policies have failed the American people. And nowhere has this failure been more evident than in this Administration’s handling of our nation’s economy. In the month that President Obama was inaugurated, the unemployment rate was 7.8%, the national debt stood at $10.6 trillion, and the average price for a gallon of gas was $1.83. Today, in the third year of his presidency, unemployment has ballooned to 9.1%, the national debt tops $14 trillion, and Americans are paying double—$3.70 a gallon—for gas.

Technically, the numbers appear to be correct. This page on the Federal Reserve web site shows that the employment rate was 7.8% on January 1st, 2009 and is 9.1% as of May 1st, 2011. However, note that the unemployment rate reached 9.4% in May, just 4 months after Obama was inaugurated and reached the maximum of 10.1% in October, just 9 months after. As I previously discussed at this link, it likely makes far more sense to allow some time lag for economic policies to take effect and/or to measure that effect over full business cycles. According to the National Bureau of Economic Research (NBER), the recession ended in June of 2009. The unemployment rate was 9.5% at that time so it has improved since then. This improvement can be seen in the following graph:

The graph also shows that unemployment was already on a steady rise at the time of the Obama inauguration.

Looking the numbers up at TreasuryDirect, the national debt was about $10.6 trillion on January 20, 2009 and is now about $14.3 trillion. As with the unemployment rate, however, it makes sense to allow a time lag. The policies for fiscal year 2009, which ended on September 30, 2009, were proposed by President Bush and passed by the existing Congress. The prior link shows the national debt on October 1, 2009, the first year of Obama's first fiscal year, to have been $11.9 trillion, a full $1.3 trillion above the number given on Romney's blog. This seems like the earliest point at which Obama's performance should be measured. As with the unemployment numbers, it can even be argued that the first two years, 2009 and 2010, should to be skipped or ignored as they are heavily effect by prior economic policies.

Finally, the graphs at this link and this link suggest that the numbers for the price of gasoline are approximately correct. However, note for the second graph that the price was $4.26 per gallon on 7/7/2008, just a few months before Obama's inauguration and happened to have been near a recent low during the inauguration. In addition, the recent rise is corresponds with the recent conflicts in Libya and other oil-producing states. Hence, it seems difficult to draw any conclusions from the change in gas prices.

All of above shows how important it is to look at as much data as possible when analyzing economic issues and not just look at a few, isolated numbers. This is especially the case when those numbers come from a partisan source and may be cherry-picked or otherwise manipulated.

The Long-Run Budget Outlook (2012 Budget)

2011-06-23T10:23:00.000-07:00

The U.S. Budget for fiscal year 2012 was released on February 14, 2011. As in prior years, it included the Analytical Perspectives which contains a section on the long-run budget outlook. The following graph shows the outlook for federal receipts, outlays, and debt held by the public as projected by this section.

The actual numbers and sources for this and the following graph can be found at this link. As can be seen, receipts are projected to rise and spending is projected to drop over the next 10 years, causing the deficit to narrow to 3.1 percent of GDP by 2020. However, outlays are then projected to begin a steady rise, causing the deficit to reach 12.3 percent of GDP by 2085. This is projected to cause the debt held by the public to rise to 239.9 percent of GDP. This is more than double the prior high of 108.7 percent of GDP reached in 1946, at the end of World War II.

Still, this is a major improvement over the projections from the prior budget. The dashed lines in the above graph show the receipts, outlays, and debt held by the public as projected in the prior budget. As can be seen from the third table at this link, the debt held by the public had been projected to rise to 829.7 percent of GDP, over seven times the prior high reached in 1946. What was the cause of this major improvement from the prior budget? On this topic, the first and third tables at the above link show the projected receipts and outlays from the 2012 and 2011 budgets. Following is a copy of the fifth table which shows the change in the projected receipts and outlays from the 2011 to the 2012 budget:


     CHANGE IN LONG-RUN BUDGET PROJECTIONS FROM THE 2011 TO THE 2012 BUDGET: 1980-2085
                                      (percent of GDP)
                    ------------------------------------------------------------------------
                        1980    1990    2000    2010    2020    2030    2050    2060    2085
                    ------------------------------------------------------------------------
Receipts...........      0.0     0.0     0.0     0.1     0.3     0.0     0.5     0.8     2.5
Outlays............      0.0     0.0     0.0    -1.6    -0.7    -1.5    -8.5   -15.0   -47.5
  Discretionary....      0.0     0.0     0.0    -0.6    -0.5    -0.6    -0.6    -0.6    -0.6
  Mandatory........      0.0     0.0     0.0    -1.0    -0.2    -0.3    -4.4    -7.3   -19.8
    Social Security      0.0     0.0     0.0    -0.1     0.1     0.1     0.2     0.3     0.8
    Medicare.......      0.0     0.0     0.0     0.0    -0.7    -1.0    -4.5    -6.7   -16.7
    Medicaid.......      0.0     0.0     0.0     0.0     0.4     0.4    -0.2    -0.8    -3.3
    Other..........      0.0     0.0     0.0    -1.0     0.1     0.2     0.1     0.0    -0.5
  Net Interest.....      0.0     0.0     0.0     0.1    -0.1    -0.4    -3.5    -7.1   -27.1
Surplus/Deficit (-)      0.0     0.0     0.0     1.7     1.1     1.4     8.9    15.8    50.0
Primary Surplus/Def      0.0     0.0     0.0     1.8     0.9     0.9     5.5     8.8    22.9
Debt Held by Public      0.0     0.0     0.0    -1.4    -0.5    -8.4   -73.8  -153.7  -589.8

As can be seen, there is an improvement of 50% of GDP in the projected deficit in 2085 (from 62% to 12% of GDP). Of this 50% of GDP, nearly all (47.5% of GDP) is from lower projected outlays. Of this 47.5% of GDP, 27.1% is from lower Net Interest, 19.8 is from lower Mandatory Spending, and a mere 0.6% is from lower Discretionary Spending. Finally, of the 19.8% of GDP from lower Mandatory Spending, a majority of 16.7% of GDP is from lower Medicare spending and a much lower 3.3% of GDP is from lower Medicaid spending. The lower Medicare and Medicaid spending is largely due to passage of the Affordable Care Act (ACA). This is described in the following excerpt from pages 50 and 51 of the Analytical Perspectives:

Medicare and Medicaid.— In the long-run projections in this chapter, different assumptions about the growth rate of health care costs are made. In the base case, a continuation of current policy assumes that the provisions of the ACA are fully implemented, limiting health care costs in the long run compared with prior law. The long-run Medicare assumptions are essentially the same as those used in the latest Medicare Trustees’ report (August 2010), which is consistent with how these long-term budget projections have generally been made in the past. The Trustees’ projections imply that average long range annual growth in Medicare spending per enrollee is 0.3 percentage points per year above the growth in GDP per capita. This growth rate is significantly smaller than their previous projections—a reduction they largely attribute to the ACA.

This section goes on to describe the relevant reforms in the ACA:

Along with the rules for Medicare, there are a number of reforms in the ACA that experts believe could produce significant savings relative to the historical trend and that would affect medical costs more broadly. One is an excise tax on the highest-cost insurance plans, which will encourage substitution of plans with lower costs, while raising take-home pay. There is also an array of delivery system reforms, including incentives for accountable care organizations and payment reform demonstrations that have the potential to re-orient the medical system toward providing higher quality care, not just more care, and thus reduce cost growth in the future. Finally, the ACA established an independent payment advisory board that will be empowered to propose changes in Medicare should Medicare costs exceed the growth rate specified in law. The proposed changes in Medicare would take effect automatically, unless overridden by the Congress. Because of these broader reforms, Medicaid spending per beneficiary and private health spending per capita are also projected to slow, though not as much as Medicare.

The following graph shows the growth in outlays that are projected, given the ACA reforms and all other assumptions of the 2012 budget:

As can be seen, Medicare and Medicaid costs do grow somewhat until about 2040 but seem to pretty well stabilize (as a percentage of GDP) from then until 2085. This is a large improvement from the second graph at this link which shows the prior year's projections that Medicare and Medicaid costs would grow rapidly until 2085. This shows the importance of insuring that the reforms of the ACA (or similar reforms) take place and have their projected effect. However, the above graph also shows that, even though non-interest spending is projected to stabilize at just above total projected revenues, Net Interest is projected to keep growing, pushing the deficit ever higher. This is because, as can be seen in the first graph above, the debt on which that interest is paid is projected to keep growing. This shows that non-interest spending needs to be stabilized at a lower level and/or receipts need to rise. Regarding this, page 50 of the Analytical Perspectives states the following:

Without further adjustments to spending and revenue, the deficit will rise relative to the overall economy and the debt-to-GDP ratio will far exceed its previous peak level reached at the end of World War II. Reforms are needed to avoid such a development. The Administration aims to work with the Congress so that the ratio of debt to GDP stabilizes at an acceptable level once the economy has recovered.

Long-term Unemployment of a Year or More

2011-06-07T00:45:00.000-07:00

On June 3rd, an article titled "Nearly 1 in 3 Unemployed Out of Work More Than a Year" was posted on the WSJ (Wall Street Journal) Blogs. Following is the second paragraph:

Even as some people are re-entering the work force, some of the extremely long-term unemployed may be giving up. The number of people unemployed for more than a year dropped a bit last month to 4.006 million from 4.076 million. They now represent 32.6% of the unemployed.

I found this especially interesting as I've never seen data for the number of people unemployed for more than a year. The following graph shows unemployment divided up into the four durations commonly released by the BLS (Bureau of Labor Statistics):

Links to the actual data used to create this graph can be found at this link and on the BLS web site. As can be seen, the longest duration is for workers unemployed for 27 weeks (about a half year) or more. And, although the number of such workers reached record levels in early 2010, the number appears to have dropped recently. In fact, the data shows that the number of workers unemployed for 27 weeks or more reached a record of 6.71 million in May of 2010 and has since dropped to 6.2 million. However, this drop seems somewhat at odds which the following graph which shows the average and median duration of unemployment since 1948:

As before, links to the actual data used to create this graph can be found at this link and on the BLS web site. As can be seen, the median duration of unemployment appears to have dropped since early 2010 but the average duration of unemployment has kept on rising. In fact, the data shows that the average duration of unemployment has reached a record level of 39.7 weeks. How can this measure continue to rise while the others have begun to drop? The most reasonable explanation would be that the number of the very long-term unemployed has continued to rise, pushing the average duration higher.

As I mentioned, I've never seen data for the number of people unemployed for more than a year. The article referenced at the start of this post does not give the source for those numbers. A bit of googling turned up this page on the BLS web site which contains a chart (Chart 2) showing the percent of workers unemployed for a year or more, followed by a link to the numbers through June of 2010. A further search of the BLS web site turned up updated numbers for Series LNU03026300, showing the percent of the unemployed who have been out of work for more than a year. The following graph was obtained on that page by changing the time span to the maximum available:

Percent of the Total Unemployed who have been Unemployed for 52 Weeks or More

As can be seen, the percent of the unemployed who have been out of work for a year or more is more than double its prior high since 1976. In fact, the data shows that it reached a record level of 32.6 percent in May, more than double the prior record of 14.8 percent reached in October of 1983.

The above graphs show that, while unemployment continues to be a problem, very long-term (more than a year) unemployment is an especially serious problem. This would suggest that long-term unemployment may require special attention in the effort to put the unemployed back to work.

Note: At the time of this posting, all of the graphs show data through May of 2011. However, the first two graphs graphs are dynamically retrieved from the Federal Reserve web site and their end dates should continue to increase. The last graph, however, is static and its end date will remain May of 2011.

Effect of the Bush Tax Cuts on Revenues and GDP (updated)

2011-01-16T23:24:00.000-08:00

There have been three major tax cuts under Bush. Briefly, the 2001 tax cut created a new 10% individual tax rate and phased in the lowering of individual tax rates. It also phased in an increase in the child tax credit, marriage penalty relief provisions, an increase of the estate tax exemption, an increase in the IRA contribution limit, and the repeal of limits on itemized deductions and personal exemptions. The 2002 tax cut was chiefly aimed at business, creating 30% expensing for certain capital asset purchases, extending the exception under Subpart F for active financing income, and increasing the carryback of net operating losses to 5 years. Finally, the 2003 tax cut lowered the top individual income tax rate on dividends and capital gains and accelerated most of the phased-in provisions of the 2001 tax cut. For a more complete description of the tax cuts, see page 14 of Revenue Effects of Major Tax Bills.

Enough time has now passed that it's possible to take a look at the effect of these tax cuts on government revenues. The growth of receipts by source, outlays, and GDP over every 8-year period since 1940 is shown in the following graph:

The actual numbers and sources can be found at recgro8y.html. As can be seen in the graph and second table, real (corrected for inflation) individual income tax receipts declined 25.06% from 2001 to 2009. Even real total receipts declined 13.93% over that period. Finally, real GDP grew just 13.36% from 2001 to 2009. This was the lowest real GDP growth over any 8-year span since 13.33% from 1966 to 1976. Hence, although it's been just about eight years since the 2001 tax cut and six years since the 2003 tax cut, the evidence to this point is that the Bush tax cuts decreased revenues over what they would have been, at least over the short term. This was true even in my prior analysis based on data through 2007, before the financial crisis of 2008.

CBO Cost Estimate of the Tax Deal

2010-12-15T00:44:00.000-08:00

On December 10th, the Congressional Budget Office released a one-page table which shows the estimated cost for the so-called "tax deal". More specifically, it shows the estimated change in revenues and direct spending for S.A. 4753, an amendment to H.R. 4853, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The following graph shows the resulting revenues, outlays, and deficits when this change is added to the current baseline:

The graph also shows the revenues, outlays, and deficits for the baseline and the alternative under which EGTRRA and JGTRRA (the 2001 and 2003 Bush tax cuts) are permanently extended and AMT (Alternative Minimum Tax) is indexed for inflation. The actual numbers and sources for this and the following graph can be found at this link.

As can be seen, none of the alternatives have much effect on outlays. Regarding revenues, the tax deal causes a two-year slowdown in their projected recovery and the permanent extension and AMT fix causes a continuing slowdown with revenues remaining between 17 and 18 percent of GDP through 2020. As a result, a reverse relationship occurs with the deficit. The tax deal causes a two-year slowdown in the improvement of the deficit and the permanent extension and AMT fix causes a continuing slowdown with the deficit actually rising from 4.7% of GDP in 2014 to 6.2% of GDP in 2020.

The following graph shows the resulting gross federal debt and debt held by the public for the baseline, tax deal, and permanent extension and AMT fix:

The gross federal debt equals the debt held by the public plus the monies owed to the trust funds, chiefly Social Security. As can be seen, the tax deal causes an increase in both debts but one that does not grow over time. In fact the increase appears to lessen slightly, reaching 3.7% of GDP for both debts in 2020. On the contrary, the permanent extension and AMT fix causes both debts to continue a steady growth through 2020. The debt held by the public and the gross federal debt would be projected to climb to 90.3% and 120.8 percent of GDP by 2020, respectively. The 120.8% of GDP figure would be just short of the 121.7% of GDP peak that it reached at the end of World War II.

The above graphs suggest that a key concern is that the current tax deal not become a permanent extension. Unfortunately, the current situation shows how difficult it is to allow a long-term tax cut to expire, especially in a difficult economic environment. This would suggest that temporary long-term tax cuts are a very bad policy. If projections suggest that a long-term tax cut is not sustainable, the tax cut should be scaled back to a level where it is sustainable and to where no built-in expiration is required.

Will Higher Taxes Reduce the Deficit?

2010-12-02T00:48:00.000-08:00

On November 21st, the Wall Street Journal ran an editorial titled "Higher Taxes Won't Reduce the Deficit ". The authors of the editorial are Stephen Moore and Richard Vedder. Moore is listed as a senior economics writer for The Wall Street Journal editorial page and Vedder is listed as a professor of economics at Ohio University and an adjunct scholar at the American Enterprise Institute. The editorial begins by mentioning that the draft recommendations of the president's commission on deficit reduction and a plan put forward by Alice Rivlin have proposed taxes as a part of reducing the deficit. It continues:

The claim here, echoed by endless purveyors of conventional wisdom in Washington, is that these added revenues—potentially a half-trillion dollars a year—will be used to reduce the $8 trillion to $10 trillion deficits in the coming decade. If history is any guide, however, that won't happen. Instead, Congress will simply spend the money.

In the late 1980s, one of us, Richard Vedder, and Lowell Gallaway of Ohio University co-authored a often-cited research paper for the congressional Joint Economic Committee (known as the $1.58 study) that found that every new dollar of new taxes led to more than one dollar of new spending by Congress. Subsequent revisions of the study over the next decade found similar results.

An initial problem that I have with the editorial is that it does not provide a link to the study or any of its subsequent revisions. I am very leery of any article that does not make it as easy as possible to check its sources. I make a point of giving all of my sources on my website and my blog. At most, such an article might motivate me go out and search for the data myself.

I was able to eventually find what appears to be a 1991 version of the study at this link, subtitled "The $1.59 Study". Note that this is one penny different from "the $1.58 study" cited in the editorial. This appears to have been an honest mistake because the paper contains the following endnote:

8. In 1987, we reported a $1.58 coefficient on the tax variable. Incorporating some data revisions to some variables, we now obtain a coefficient of $1.50 using the 1947-86 period, but the reported $1.59 using the 1947-90 period, suggesting the additional years strengthened the positive tax-spend deficit relationship.

Still, this mistake did have that effect of making it difficult to find the paper since googling "$1.59 Study" found the paper immediately but googling the "$1.58 Study" cited by the editorial did not. In any event, I took a quick look at the paper and noticed a couple of points. Graph 1 shows the estimated spending associated with each $1.00 increase in taxes for the four time spans. The following table summarizes that data:


time span  Estimated Spending per $1.00 Increase in Taxes
---------  ----------------------------------------------
1791-1825  -$0.03
1826-1860  +$0.20
1867-1913  +$0.72
1947-1990  +$1.59

As can be seen, the $1.59 figure is associated with just the last period of 1947 to 1990. The final sentences of the paper's conclusion refer to fact, stating the following:

Historically, there was a time when tax increases meant deficit reduction, but that time passed in the early part of this century. State and local governments still are able to constrain spending increases to levels equal to or less than the taxes raised. Why? We would tentatively suggest that the answer may lie in different institutional constraints, such as balanced budget amendments, spending limitation amendments, line-item vetoes, etc., measures that lower the marginal political benefits of new spending to political decisionmakers. In any case, the Federal fiscal problem is not likely to be solved without significant behavioral change on the part of those decisionmakers, and those changes are not likely given the current system of political rewards and costs.

The following graph shows the growth of spending from 1950 to 1990.

The actual numbers and sources for this graph can be found at this link. The graph and actual numbers show that, as a percentage of GDP, spending was generally increasing for 1947 through 1983, nearly all of the period in question. However, spending as a percentage of GDP dropped steadily from 1991 through 2000. I was unable to find one of the cited revisions to this study which might address this period. However, the editorial itself states the following:

Our research indicates this is a sucker play. After the 1990 and 1993 tax increases, federal spending continued to rise. The 1990 tax increase deal was enacted specifically to avoid automatic spending sequestrations that would have been required under the then-prevailing Gramm-Rudman budget rules.

The statement that "federal spending continued to rise" is highly misleading. As shown in the graph above, federal spending as a percent of GDP (the red line) sank sharply from 1991 through 2000. The first table at the following link shows that spending did rise measured in current dollars. However, any good economist would at least correct those numbers for inflation and likely population growth, if not GDP. The following table shows federal outlays in current and inflation-adjusted (FY 2005) dollars from 1990 through 2009.


       FEDERAL OUTLAYS (dollar amounts in billions)

            Actual Amount             Percent Change
      -------------------------  -------------------------
      Current  FY 2005  Percent  Current  FY 2005  Percent
Year  Dollars  Dollars   of GDP  Dollars  Dollars   of GDP
----  -------  -------  -------  -------  -------  -------
1990    1,253    1,832     21.9      9.6      6.3      3.3
1991    1,324    1,849     22.3      5.7      0.9      1.8
1992    1,382    1,858     22.1      4.3      0.5     -0.9
1993    1,409    1,846     21.4      2.0     -0.7     -3.2
1994    1,462    1,879     21.0      3.7      1.8     -1.9
1995    1,516    1,897     20.6      3.7      0.9     -1.9
1996    1,561    1,907     20.2      2.9      0.5     -1.9
1997    1,601    1,916     19.5      2.6      0.5     -3.5
1998    1,653    1,959     19.1      3.2      2.2     -2.1
1999    1,702    1,990     18.5      3.0      1.6     -3.1
2000    1,789    2,041     18.2      5.1      2.6     -1.6
2001    1,863    2,073     18.2      4.1      1.6      0.0
2002    2,011    2,201     19.1      7.9      6.2      4.9
2003    2,160    2,304     19.7      7.4      4.7      3.1
2004    2,293    2,378     19.6      6.2      3.2     -0.5
2005    2,472    2,472     19.9      7.8      4.0      1.5
2006    2,655    2,564     20.1      7.4      3.7      1.0
2007    2,729    2,565     19.6      2.8      0.1     -2.5
2008    2,983    2,704     20.7      9.3      5.4      5.6
2009    3,518    3,186     24.7     17.9     17.8     19.3

Source: Budget of the United States Government, FY 2011: Historical Table 1.3

As can be seen, outlays in FY 2005 dollars went up very slowly during this period. In fact, they went down from 1992 to 1993, reaching a level below their 1991 level. If they had also been corrected for population growth, they would have likely gone down over a much longer period. In any case, the editorial continues:

The only era in modern times that the budget has been in balance was in the late 1990s, when Republicans were in control of Congress. Taxes were not raised, and the capital gains tax rate was cut in 1997. The growth rate of federal spending was dramatically reduced from 1995-99, and the economy roared.

Of course, a dramatic reduction beginning in 1995 could not be due to a capital gains tax cut in 1997. The most recent tax change before 1995 was the 1993 tax hike. In addition, the above table shows the growth rate of federal spending over this period. As can be seen, the growth rate reached its minimum in 1993 and stayed low until 2000. Spending then began to rise sharply, even as a percentage of GDP, through 2009. Most of this was following the Bush tax cuts of 2001 through 2003. Hence, tax cuts don't appear to restrain growth in spending. This would suggest that growth in spending is largely independent of tax hikes and tax cuts.

For the above reasons, I find the Wall Street Journal editorial to be less than credible. At best, it suggests that we need to make a conscious effort to restrain spending, just as we did during the nineties.

Do Capital Gains Tax Cuts Increase Revenue?

2010-11-25T01:17:00.000-08:00

At the end of my November 8th post, I asked for anyone who knows of an economic study that purports to show that any income tax cut has paid for itself to please post a link to it. On November 18th, I received the following reply:

I'm not an economist of any flavor, but I was wondering what you thought of the article by Stephen J Entin from the Institute for Research on the Economics of Taxation that I've linked below. He appears to argue that increased capital gains tax should decrease net federal revenues.

Any thoughts appreciated.

http://iret.org/pub/CapitalGains-1.pdf

The rest of this post will attempt to answer this reply:

My request at the end of my November 8th post did refer to income tax cuts, not capital gains tax cuts and those are the primary focus of my analysis which I referenced there. The only involved analysis of capital gains tax cuts that I have done are in my prior posts, here, here, and here. Following is my chief conclusion from that relatively short analysis:

The above discussion points to how difficult it is to study the relationship between capital gains tax rates and revenues. Hence, it is not intended to show a simple relationship but rather to show the problems with claims of simple relationships derived from looking at a few changes in the capital gains tax rate. That said, I did notice one interesting relationship in the data. From 1954 to 1982, there appeared to have been something of a positive correlation between the average capital gains tax rate and capital gains revenue. That is, they both tended in increase or decrease at the same time. After 1982, there appeared to be much more volatility in both the average tax rate and revenue and any obvious positive correlation disappeared. This would suggest that a more stable average tax rate might be desirable. This would lessen the need for investors to concern themselves with the timing of their stock transactions and allow them to concern themselves only with the long-term value of the investments themselves. If at any point that it is decided that the tax rate needs to be changed, it would likely be wise to phase in the change slowly.

Following is a graph of the data that this paragraph is referring to:

I did take a quick look through the paper you referenced and do have a few thoughts. First of all, I had some comments on the second paragraph which reads as follows:

However, taxpayers react to higher tax rates by earning and reporting less income. Higher taxes on capital retard capital formation and reduce wages across the board. The particular tax increases that the Congress and the Administration are most likely to adopt would damage the economy and reduce the tax base. In fact, they are likely to result in lower federal revenues, and larger budget deficits.

Except for the word "likely", these statements seems a bit absolute. In any event, this proposed effect is possibly countered by other effects. Consider the following excerpt from an article titled "Policy Points: Experts Agree That Capital Gains Tax Cuts Lose Revenue":

To raise revenue over the long run, capital gains tax cuts would need to have extraordinary huge, positive effects on saving, investment, and economic growth that virtually no respected expert or institution believes they have. In fact, experts are not even sure that the long-term economic effects of these capital gains tax cuts are positive rather then negative.

One reason is that preferential tax rates for capital gains encourage tax sheltering, by creating incentives for taxpayers to take often-convoluted steps to reclassify ordinary income as capital gains. This is economically unproductive and wastes resources. The Urban-Brookings Tax Policy Center’s director Leonard Burman, one of the nation’s leading tax experts, has explained, “shelter investments are invariably lousy, unproductive ventures that would never exist but for tax benefits.” Burman has concluded that, “capital gains tax cuts are as likely to depress the economy as to stimulate it.”

Secondly, I did notice that the paper seems to concede that it is in disagreement with the Treasury and Joint Tax Committee of the Congress. On page 3, it states:

The Office of Tax Analysis at the Treasury and the staff of the Joint Tax Committee of the Congress estimate revenues for the Federal budget. They also estimate changes in revenue associated with proposed changes in tax policy. They base their revenue forecasts on an assumed underlying state of the economy (the baseline economic forecast). The economic baseline specifies the amounts of total output, employment, capital, and the various types of income associated with them (the macro-economic conditions).

The revenue estimates of a proposed tax change are conducted on the assumption that the macro-economic baseline, with its aggregate levels of income and output, labor and capital, is fundamentally unchanged. This is called static revenue estimation. By contrast, estimation that allows for tax changes or other budget changes to affect macro-economic conditions, such as the size of the economy and the level of income, is called dynamic revenue estimation.

This disagreement is also mentioned by the CBPP article which also mentions the non-partisan Congressional Budget Office (CBO) and the Administration’s Office of Management and Budget as estimating that cutting capital gains rates reduces revenues over the long run. The paper does suggest in the excerpt above that this disagreement is because it is using a presumedly better dynamic revenue estimation versus static revenue estimation being used by the other studies. However, the CBO did do at least one study using various supply-side models in 2004 to analyze President Bush's proposals which included extending the tax cuts. As can be seen in the summary of that study at this link, those models estimated a significant cost just as did the conventional model. Now those proposals did include more than a capital gains tax cut. Still, it does show a case where the use of dynamic models by the CBO has had no significant effect on the estimated costs.

Thirdly, the conclusions of the paper seem to be based strictly on a theoretical model, the Cobb Douglas production function described starting on page 36. Although this model was doubtlessly analyzed against real data, the paper does not appear to do any analysis of recent data. Hence, I could only search for critiques of this model. This link states that the "Cobb-Douglas production function was largely abandoned after 1961" and there are some criticisms listed in the
Wikipedia entry for the model. It's not an easy thing to judge these criticisms but neither is it easy to judge the Cobb-Douglas production function itself.

In any event, the paper does seem to agree that there is a significant difference between the effect of income tax cuts and capital gains tax cuts. The following excerpt is from page 22:

The supply of labor is rather inelastic. Many primary workers (the main breadwinners in the households) are employed by others, and have limited ability to vary their hours worked (set by their employers) or the degree to which they participate in the work force (each family needs at least one breadwinner). Their hours worked do not vary a lot as wages rise or fall (so the supply curve in Chart 1 is steeply vertical.) Such workers are assumed to bear most of any taxes imposed on labor, including the income tax and the payroll tax, both the employee and employer shares. Secondary workers in the family, the self-employed, teenagers, and wealthier individuals have somewhat more flexibility in deciding whether or not to work, and how many hours to offer, but even they bear most of the tax on their labor income.

The effect of taxes on capital is quite different. The quantity of capital is far more sensitive to taxes than is the quantity of labor. (Its supply curve is more nearly horizontal.) It is easy and enjoyable to consume instead of save, and quite possible to invest abroad instead of in one’s own country. If the after-tax rate of return on saving and investment in the United States is driven down by an increase in the tax rate, U.S. capital formation may be curtailed, or shifted to other countries. The same phenomenon occurs within the country. When there is a tax increase on capital in any one jurisdiction, the amount of plant, equipment, and buildings in that region shrinks. As the capital becomes scarce, the rate of return on the remaining capital rises, until it is again earning a normal rate of return, after tax.

So this paper does not seem to be in any way suggesting that income tax cuts pay for themselves. Hence, I am still yet to find a single economic study that purports to show evidence that any income tax cut has ever paid for itself and would be interested in any that someone could post a link to. However, I am also interested in any additional studies that make that claim about capital gains tax cuts. Anyhow, I hope these thoughts were helpful to the commenter who asked for them. Feel free to leave any additional comments or questions.

Do Tax Cuts Increase Revenue?

2010-11-08T00:27:00.000-08:00

On November 7th, David Stockman and Mike Pence appeared on This Week with Christiane Amanpour to debate tax cuts. David Stockman was a budget director for President Ronald Reagan and Mike Pence is a Congressman and has been the Chairman of the House Republican Conference for the past two years. A video of the tax cut debate can be found on the This Week website and a transcript can be found at this link. Following is an excerpt from that transcript:

PENCE: Before we get -- look, David Stockman is, you know, he's a really famous guy and a thoughtful guy. I just disagree with him vehemently and I, frankly, have for about 30 years. David believes that every tax increase equals a revenue increase, but that's not true. Anybody who is familiar with the historical data from the IRS knows that raising income tax rates will likely actually reduce federal revenues.

AMANPOUR: Let me ask David...

PENCE: So if we raise taxes, the American people are very likely going to -- the top 1 percent are going to send less money to Washington, D.C., and that will never get us out of this...

(CROSSTALK)

STOCKMAN: I just have to respectfully disagree. You will have some loss of revenue because some activity or transactions won't happen, but if you raise taxes on paper by $100 billion, maybe you'll get $90 billion or $85 billion. But it's just common sense fact that, when you raise the rates, you get more revenue. Normally, it's a bad thing to do. But we are in such dire shape that we have no choice but to accept the negative trade-off of some harm to the economy to start paying our bills. Otherwise, we're dependent on the Chinese, we're dependent on OPEC, we're dependent on a bunch of hedge fund guys to buy our debt, and this game is about over.

Pence states that "raising income tax rates will likely actually reduce federal revenues". This is in reference to the proposal to let all or part of the Bush tax cuts expire at the end of this year. The logical companion to this argument is the old supply-side claim that tax cuts increase revenues above what they would have been otherwise. I have looked at this argument and posted an analysis of it at this link. I could find nothing in the actual numbers to support this claim. In fact, I have asked supply-siders for years to provide the link to one credible economic study that purports to give evidence that supports this claim. As of yet, I have received none.

So far, every economic study that I have found that addresses the issue refutes the claim that tax cuts increase revenue. For example, there is a study titled "Dynamic Scoring: A Back-of-the-Envelope Guide" that was done by N. Gregory Mankiw and Matthew Weinzier. Mankiw was the chairman of President Bush's Council of Economic Advisors from 2003 to 2005. You can find a summary of the study at this link. It gives the following key quote at the top:

"In the long run, about 17 percent of a cut in labor taxes is recouped through higher economic growth. The comparable figure for a cut in capital taxes is about 50 percent."

This pretty much agrees with Stockman's statement that 10 or 15 percent of the revenue expected from a tax increase might be lost due to a decrease in activity or transactions. Both Stockman's statement and the quote above agree with the usual concept that a cut in the tax rate will lose that same percentage of revenue but that some of that loss will be recouped by higher economic growth. However, there are additional effects of tax cuts, negative as well as positive. Following is an excerpt from page 115 of the book "The Coming Generational Storm", co-written by economist Laurence Kotlikoff:

...For tax cuts to raise revenues, pretax labor earnings have to rise by a larger percentage than the tax rate falls.

There are two competing forces at play in determining whether pretax earning rise, stay the same, or fall. On the one hand, workers may say to themselves, "Boy, now that taxes are lower, I can work less and still receive the same after tax pay. I'm going to cut back my workweek." On the other hand, they may say, "Boy, now's a good time to work more and earn more because taxes are lower on every extra dollar I earn". Economists call the first of these reactions the income effect. They call the second reaction, the substitution or incentive effect.

Some of the best labor economists in the country have spent their lifetimes measuring the income and substitution effects. The broad consensus of these experts is that the two effects are roughly offsetting. This means that if wage tax rates are cut by, say 15 percent, tax revenues will fall by 15 percent.

Similarly, there are studies that suggest that certain tax increases can actually promote an increase in economic growth. An example is a study titled "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks" by Christina and David Romer. Christina Romer recently resigned as the chairwoman of President Obama’s Council of Economic Advisers but will become a member of the President's Economic Recovery Advisory Board. The study found that "deficit-driven tax increases" have had a positive effect on economic growth. The following excerpt from page 14 describes these increases:

The figure makes clear that while deficit-driven tax increases have occurred throughout the postwar era, they were most prevalent in the early and mid-1980s. Many of these deficit-driven tax actions were related to Social Security: of the 26 actions in the category, 15 were designed to deal with the long-run solvency of the Social Security system. The Social Security Amendments of 1977 and 1983, in particular, were major tax actions that raised taxes in a number of steps and did not simultaneously increase benefits. The largest deficit-driven tax increases not related to Social Security were those contained in the Tax Equity and Fiscal Responsibility Tax Act of 1982, and the Omnibus Budget Reconciliation Acts of 1987, 1990, and 1993. The first two of these were Reagan-era measures; the third was the Bush tax increase that defied his famous "Read my lips: no new taxes" campaign speech; and the fourth was the Rubinomics-defining tax increase of the early Clinton administration.

The following graph from page 59 shows the estimated impact of a tax increase of 1% of GDP on GDP using long-run and deficit-driven tax changes:

The following excerpt from page 23 refers to this figure:

Panel (b) of Figure 6 shows the results for the two types of exogenous changes. For long-run changes, which make up most of this category, the results are quite similar to those for all exogenous changes. For tax increases to deal with an inherited budget deficit, the results are more interesting. The point estimates imply that output does not fall at all following deficit-driven tax increases. The estimated effect peaks at 1.4 percent after two quarters, and then fluctuates around 1 percent. However, there are too few tax changes of this type for the effects to be estimated very precisely. The maximum t-statistic, for example, is just 1.2. Nonetheless, the estimates are suggestive that tax increases to reduce an inherited deficit may be less costly than other tax increases, and they provide no evidence that they have substantial output costs.

The following excerpt from page 38 summarizes these effects:

In Section III, we found that the responses of real GDP to the two subcategories of exogenous tax changes appear to be quite different. The response to a long-run tax increase is negative, large, and highly statistically significant. In contrast, the response to a deficit-driven tax increase is positive, though not significant.

Finally, the following excerpt from the conclusions on page 41 expands on this positive effect:

Finally, we find suggestive evidence that tax increases to reduce an inherited budget deficit do not have the large output costs associated with other exogenous tax increases. This is consistent with the idea that deficit-driven tax increases may have important expansionary effects through expectations and long-term interest rates, or through confidence.

As I mentioned, I am yet to find a single economic study that purports to show evidence that any income tax cut has ever paid for itself. If anyone who reads this should know of one, please leave a comment with a link to that study. Thanks.

Long-term Unemployment (updated)

2010-07-03T21:24:00.000-07:00

On July 2nd, the Bureau of Labor Statistics released its Employment Situation Summary for June of 2010. Following is the first paragraph:

Total nonfarm payroll employment declined by 125,000 in June, and the unemployment rate edged down to 9.5 percent, the U.S. Bureau of Labor Statistics reported today. The decline in payroll employment reflected a decrease (-225,000) in the number of temporary employees working on Census 2010. Private-sector payroll employment edged up by 83,000.

The drop of 125,000 in nonfarm payroll employment put the number of nonfarm payroll jobs at 130.47 million, just about the same level that existed in December of 1999. Hence, we have gone 10 and a half years with no job growth.

Perhaps more disturbing, however, has been the growth in long-term unemployment. On this topic, the December report stated the following:

In June, the number of long-term unemployed (those jobless for 27 weeks and over) was unchanged at 6.8 million. These individuals made up 45.5 percent of unemployed persons. (See table A-12.)

The following graph shows the average and median duration of unemployment since 1948:

Links to the actual data used to create this graph can be found at this link. As can be seen, the average and median duration of unemployment have risen to what is by far their highest level since 1948 and 1967, respectively. The average has reached 35.2 weeks and the median has reached 25.5 weeks weeks.

The following graph shows unemployment divided up into four durations:

As before, links to the actual data used to create this graph can be found at this link. As can be seen, the number of workers unemployed for 27 weeks and over reached 6.8 million in June. This is over double the prior high of 2.9 million reached in June of 1983. The number of workers unemployed for 15 to 26 weeks was 2.2 million in June, down from the recent high of 3.2 million reached in October of 2009. The number of workers unemployed for 5 to 14 weeks was 3.1 million in June, down from the recent high of 4.3 reached in May of 2009. Finally, the number of worker unemployed for less than 5 weeks was 2.8 million in December, down from the recent high of 3.6 million reached in January of 2009. Hence, all of the durations are starting to trend down except for the longest, those unemployed for 27 weeks and over.

It should be noted that neither of the above graphs include the Great Depression. However, they do show that long-term unemployment has by far reached its highest level since the end of World War II. This would suggest that long-term unemployment may require special attention in the effort to put the unemployed back to work.

Who is econdataus and why should we believe him?

2010-06-08T11:56:00.000-07:00

Yesterday, I received an interesting question from Michael Fremer who has a blog at this link. Following is his question:

I sent my right wing friends some of your analyses and they gulp, but then respond "Who is econdataus and why should we believe him?"

And i can't answer that...

Can you?

My reply (with a few edits for readability) was as follows:

In regards to "who is econdataus", you can tell them that I am nobody they would know. I am a math major and software engineer. As I mention in my profile, I became interested in U.S. budget and economic matters back in 1992, the first time that I remember the debt becoming a major issue in a presidential election. Around that time, I became aware of more and more cases where public political discussion seemed to be based on bad or incomplete data. Hence, my first goal was to build a site with carefully compiled and sourced data in the areas in which I was interested. This gives me (and hopefully others) a ready source to point to when engaged in political discussions online. Giving the data and sources allows others to verify the data and judge the veracity of the sources.

The main analysis that I initially did was just to graph the data and list some fairly straightforward points (such as here). However, I later began to write an occasional analysis on an area in which I was interested (such as here) and at someone's suggestion, I started this blog. I did my best to keep it non-partisan. At this link, for example, I critiqued my own initial analysis stating "the difference in job growth between the two parties does greatly lessen, if not disappear, if one looks at job growth over entire business cycles". In any case, I truly believe that the country needs at least two strong parties to function at its best. And I do not believe that one party is inherently better than the other.

Regarding "why should we believe him?", I would say they should base their belief strictly on the data and their trust in the sources from which that data came. Regarding my analysis of the data, they should believe that only to the extent that it makes sense to them. As I mentioned, I am a math major and software engineer, not a professional economist. I have, to my knowledge, no public reputation, positive or negative. If they desire that, they will have to look elsewhere. The problem, of course, is that many of those reputable experts disagree. Hence, I would suggest that they demand sources for any data with which they are presented and verify it. I can't count the number of times I've come across data that is cherry-picked or just plain wrong. The only way to determine this is to ask for the source and verify the data.

R. Davis

To this, I would just add that they should question any analysis that doesn't totally make sense. In fact, it's probably best to question even those that do! As such, I am more than happy to answer any questions on my analyses or data.

The Risks of U.S. Sovereign Debt

2010-05-19T00:28:00.000-07:00

From February 1st through the 4th, the Buttonwood's notebook blog of the Economist magazine had some interesting posts on the risks of sovereign debt. They were titled The debt trap: ranking the suspects, More debt rankings, The new gold standard, and Adding in the deficit. The first post addresses the effect of a debt trap, where the bond yield is higher than the economy's nominal growth rate. The second post adds in the effect of the debt-to-GDP ratio. Finally, the last post adds in the effect of the primary surplus/deficit. Also called the primary balance, this is equal to revenues minus spending, excluding interest costs. If the primary balance is positive, it's a primary surplus. If negative, it's a primary deficit.

The effect of these four factors (bond yield, GDP growth, debt-to-GDP ratio, and primary balance) are also addressed in a Reuter's column titled Sovereign debt maths show risk of vicious circle. The column mentions all four factors in the following excerpt:

To see how these play out, consider two countries. One has a moderate debt load, 50 percent of GDP, which carries a 4 percent average interest rate. If the budget is in primary balance, the government will still run a deficit of 2 percent of GDP, which is 4 percent (the interest rate) of 50 percent (the debt). As long as nominal GDP grows by 4 percent, the ratio of debt to GDP stays the same.

The validity of this final statement (that the ratio to GDP stays the same) can be seen via the following formula:

(new_debt) / (new_GDP) = (i * D - P) / (r * G) = (1.04 * D - 0.0) / (1.04 * G) = D / G

where i = interest rate
      D = debt (prior)
      P = primary surplus or deficit(-)
      r = rate of GDP growth
      G = GDP (prior)

The value of 1.04 in the above formula is of course the correct factor to calculate a 4 percent increase and is equal to (4/100) + 1. In any case, the column goes on to describe how this same formula applies to the country with the high debt load of 100 percent of GDP. It then continues:

But the equilibrium is fragile. It can be disturbed in three ways: nominal GDP growth can decline, interest rates can go up or the country can start running a primary deficit. The pain is much worse for highly indebted countries like Greece, which has managed all three at once.

Start with growth. Imagine nominal GDP growth drops to zero. If nothing is done, the debt/GDP ratio will rise by 2 percentage points in the moderately indebted country, but by 4 percentage points in the highly indebted one.

This situation can be represented by the following formula:

(new_debt) / (new_GDP) = (i * D - P) / (r * G) = (1.04 * D - 0.0) / (1.0 * G) = 1.04 * (D / G)

For the moderately indebted country, this will equal 1.04 * 50% of GDP which equals 52% of GDP, an increase of 2% of GDP. For the highly indebted country, this will equal 1.04 * 100% of GDP which equals 104% of GDP, an increase of 4 percent of GDP.

The column continues:

Countries can keep that key ratio from increasing, by running compensating primary surpluses. That means moving from balance to a surplus of 2 percent of GDP for the moderately indebted and from zero to 4 percent for the heavily indebted. The higher the debt level, the more the government’s belt will have to be tightened.

To verify this, one can first calculate the formula for the primary surplus in the case where the debt to GDP ratio does not increase as follows:

(D / G) = (i * D - P) / (r * G)  (old debt to GDP ratio equals new debt to GDP ratio)
(D / G) * (r * G) = (i * D - P)  (after multiplying both sides by (r * G))
(r * D) + P = (i * D)            (after simplifying and adding P to both sides)
P = (i * D) - (r * D)            (after subtracting (r * D) from both sides) 
P = (i - r) * D                  (after simplifying)

For the moderately indebted country, the necessary primary surplus will be

P = (1.04 - 1.0) * D = 0.04 * (G/2) = 0.02 * G = 2% of GDP

and for the highly indebted country, the necessary primary surplus will be

P = (1.04 - 1.0) * D = 0.04 * (G) = 0.04 * G = 4% of GDP

Hence, the above formulas show that countries with different levels of debt to GDP can maintain those levels as long as GDP growth keeps pace with the average interest rate and the countries run primary balances of zero. However, they also show that, if one or more of these factors fall out of balance, the country with the higher debt load will see greater negative effects.

The following graph shows the net interest on U.S. Treasury securities as a percentage of outlays, debt, and GDP, along with the nominal growth in GDP:

The actual numbers and sources for this graph can be found at this link. The net interest as a percentage of debt (the blue line) should give the average interest rate being paid on U.S. debt held by the public. As can be seen, the GDP growth rate was generally above the average interest rate from about 1951 to 1981 but was generally below the average interest rate from about 1982 to 2002. From 1951 to 1981, the average interest rate was about 4.2%, nearly half of the average GDP growth rate of about 8.2%. From 1982 to 2002, however, the average interest rate was about 7.3%, over a full percentage point more than the average GDP growth rate of about 6.1%. Hence, it is possible for the average interest rate to surpass the average GDP growth rate for an extended period of time.

The following graph shows the primary and unified surplus or deficit(-) of the U.S. budget:

The actual numbers and sources for this graph can be found at this link. As can be seen, the primary surplus appears to have been, on average, close to balance since 1950, at least until recently. In fact, from 1950 through 2007, the average primary surplus was about 0.14 percent of GDP. However, the graph shows that the primary surplus became a huge deficit in 2009 and is projected to just recover to about a one percent of GDP deficit by 2015. In addition, the tables at this link show that the primary deficit is projected to rise sharply over the coming decades. These numbers come from the most recent U.S. Budget and project that the primary deficit will reach a massive 24.3 percent of GDP by 2085.

Hence, the large primary deficits projected over the long-run would seem the most obvious risk to U.S. sovereign (government) debt. As explained in the above articles, however, investors could start demanding higher interest rates if they believe that these deficits increase the risk of holding government bonds.

On the topic of interest rates, Donald B. Marron, a visiting professor at the Georgetown Public Policy Institute, blogs:

According to the IMF, the average maturity of US debt is only 4.4 years. Portugal, Italy, Ireland, and Spain have maturities that are about 50% greater (from 6.2 to 7.4 years), and the UK is almost three times as long at 12.8 years.

The blog concludes:

The short maturity of US debt is a blessing in the short run, since we can benefit from lower interest rates. But it is also poses two risks in the long-run: greater exposure to interest rate increases (if and when they materialize) and a relentless need to ask capital markets to rollover existing debts. Both good reasons why Treasury should continue to gradually extend the maturity of federal borrowing.

The Long-Run Budget Outlook (2011 Budget)

2010-04-27T23:47:00.000-07:00

As mentioned in my prior post, the U.S. Budget for fiscal year 2011 was released on February 1, 2010. As in prior years, it included the Analytical Perspectives which contains a section on the long-run budget outlook. The following graph shows the outlook for the federal receipts, outlays, and debt held by the public as projected by this section.

The actual numbers and sources for this and the following graph can be found at this link. As can be seen, receipts are projected to rise and spending is projected to drop over the next 10 years, causing the deficit to narrow to 4.2 percent of GDP by 2020. However, outlays are then projected to begin a steady rise, causing the deficit to reach a record 62.3 percent of GDP by 2085. This is projected to cause the debt held by the public to rise to 829.7 percent of GDP. This is over seven times the prior high of 108.7 percent of GDP reached in 1946, at the end of World War II. In addition, it is over double the level projected in the prior budget. The projections for this year and last year are the purple and green lines in the above graph.

Regarding the projected increase in the deficit and debt, Chapter 5 of the Analytical Perspectives says the following:

The key drivers of the long-range deficit are the Government’s major health and retirement programs: Medicare, Medicaid and Social Security.

Further on, it narrows this a bit, stating:

The most important single factor driving the long-run budget outlook is the growth of health care expenditures.

This growth in health care expenditures can be seen in the following graph which shows the projected growth in outlays according to the 2011 budget.

As can be seen, Medicare and Medicaid costs are projected to grow rapidly over the next 75 year. In fact, the first two tables at this link show that the cost of Medicare is projected to be greater than ALL federal receipts in 2085. This is over twice the cost that was projected in the prior budget. Chapter 5 explains the reason for the rapid rise in health care costs, stating:

In the base case, a continuation of the historical trend would see the per beneficiary cost of health care spending for Medicare, Medicaid, and private health care rising 2 percent per year faster than GDP per capita.

It goes on to list three major reforms being considered to slow this growth:

There are three broad reforms in the legislation under consideration in Congress that experts believe will produce significant savings relative to the historical trend: an excise tax on the highest-cost insurance plans will encourage substitution of more efficient plans with lower costs, while raising take-home pay; an independent payment advisory board will be empowered to suggest changes in Medicare and the health care system to improve the quality and value of its services; and an array of other delivery system reforms will gradually reduce costs.

These projections do not include any of these possible saving, however. As chapter 5 explains:

...but the baseline does not include these savings because the final form of the legislation was not resolved in time for the Administration to produce detailed estimates of its long-run effects.

Chapter 5 does go on to explore the projected effects of a number of alternative scenarios. They are summed up in the following table:


Table 5–2. FISCAL GAP UNDER ALTERNATIVE BUDGET SCENARIOS (Percent of GDP)

Baseline....................................................................  8.0
Health:
  Excess cost growth averages 1 percent.....................................  4.5
  Excess cost growth averages 1/2 percent...................................  2.8
Discretionary Outlays:
  Grow with inflation plus population.......................................  6.2
  Defense grows with inflation; nondefense grows with inflation + population  5.9
Revenues:
  Revenues exceed baseline by 2 percent of GDP..............................  6.4
  Revenues fall short of baseline by 2 percent of GDP.......................  9.6
Productivity:
  Productivity grows by 0.5 percent per year faster than the baseline.......  6.6
  Productivity grows by 0.5 percent per year slower than the baseline.......  9.6
Population:
  Fertility:
    2.3 births per woman....................................................  7.1
    1.7 births per woman....................................................  8.8
Immigration:
  1.3 million immigrants per year...........................................  7.5
  0.7 million immigrants per year...........................................  8.4
Mortality:
  Female life expectancy 82.7 years; male life expectancy 79.1 years in 2085  7.2
  Female life expectancy 89.9 years; male life expectancy 87.2 years in 2085  8.8

The accompanying text describes the fiscal gap as follows:

The fiscal gap is one measure of the size of the adjustment needed to preserve fiscal sustainability in the long run. It is defined as the increase in taxes or reduction in non-interest expenditures required to keep the long-run ratio of government debt to GDP at its current level if implemented immediately. The gap is usually measured as a percentage of GDP. The fiscal gap is calculated over a finite time period, and therefore it may understate the adjustment needed to achieve longer-run sustainability.

Table 5-2 shows fiscal gap calculations for the base case calculated over a 75-year horizon and for the various alternative scenarios described above. The fiscal gap in the base case is 8.0 percent of GDP, and it ranges in the alternative scenarios from 2.8 percent of GDP to 9.6 percent of GDP. In all cases, significant fiscal adjustments would be needed to achieve long-run sustainability.

As can be seen, the largest projected savings of 5.2 percent of GDP would come from cutting the average annual growth of health care costs from 2 percent to 0.5 percent above GDP per capita growth. The next largest projected savings would be just 2.1 percent of GDP if defense grows with inflation and nondefense grows with inflation plus population. Both are otherwise assumed to grow with GDP. In any event, both projected savings taken together would add up to 7.3 percent of GDP, still a bit short of the 8.0 percent of GDP baseline fiscal gap.

Budget of the United States Government for Fiscal Year 2011

2010-02-14T23:31:00.001-08:00

On February 1, the U.S. Budget for fiscal year 2011 was released. Regarding the deficit, a Reuters article from that day stated the following:

The budget forecast a $1.56 trillion deficit in 2010, or 10.6 percent of gross domestic product (GDP), up from a 9.9 percent share of GDP in 2009.

But the shortfall was forecast to shrink to 8.3 percent of GDP in 2011. By the time his term ends in January 2013, it would have halved from the level Obama inherited on taking office last year, keeping a key pledge. That supposes Obama gets Congress to agree to spending cuts and that the economy rebounds strongly enough to sharply lift tax revenues.

The following graph shows selected measures of the deficit since 1970:

The actual numbers and sources can be found at this link. As can be seen, the numbers in the Reuters article are for the "unified deficit", shown in purple in the graph. The unified deficit is usually very close to the change in the debt held by the public (labelled "public deficit" in the graph above). As can be seen, however, they differ a fair amount in 2009 and 2010 with the "public deficit" reaching about 12 percent of GDP in those years. The reason for this difference is described on page 59 of the Analytical Perspectives from the 2011 Budget as follows:

In 2009 the deficit was $1,413 billion while these other factors—primarily the net disbursements of credit financing accounts—increased the need to borrow by $329 billion. As a result, the Government borrowed $1,742 billion from the public. The other factors are estimated to increase borrowing by $197 billion in 2010 and reduce borrowing by $66 billion in 2011. In 2012–2020, these other factors are expected to increase borrowing by annual amounts ranging from $59 billion to $145 billion.

In any event, the unified deficit equals federal receipts minus federal outlays. The following graph shows federal receipts and outlays since 1950:

As before, the actual numbers and sources can be found at this link. One thing that is very noticeable in the above graph is that outlays are projected to increase from about 20 percent of GDP from 2003 through 2007 to about 23 percent of GDP from 2012 through 2015. The following table shows the projected change in outlays by function over the eight years from 2007 to 2015. For comparison, it also shows the actual change in outlays by function over the prior eight-year span from 1999 to 2007.


     CHANGE IN OUTLAYS AS PERCENTAGE OF GDP

Superfunction and Function   1999-2007  2007-2015
---------------------------  ---------  ---------
National defense...........     1.0       -0.4
Human resources............     1.2        2.0
  Education, training, etc.     0.1        0.0
  Health...................     0.4        0.3
  Medicare.................     0.6        0.7
  Income security..........     0.0        0.2
  Social security..........     0.0        0.5
  Veterans benefits........     0.1        0.2
Physical resources.........     0.1       -0.3
Net interest...............    -0.8        1.3
Other functions............    -0.1        0.6
  International affairs....     0.0        0.2
  General science..........     0.0        0.0
  Agriculture..............    -0.1        0.0
  Administration of justice     0.0        0.0
  General government.......     0.0        0.0
  Allowances...............     0.0        0.4
Undistributed receipts.....    -0.2        0.1
Total, Federal outlays.....     1.2        3.2

Source: U.S. Budget, FY 2011, Historical Tables,
        tables 3.1 and 10.1

As can be seen, the functions with the largest projected increases in outlays are Net interest, Medicare, Social security, Allowances, and Health with increases of 1.3, 0.7, 0.5, 0.4, and 0.3 percent of GDP, respectively. In fact, these five functions could be said to account for the full 3.2 percent of GDP increase in all federal outlays with the other functions pretty much canceling each other out.

In any case, the projected 1.3 percent of GDP increase in Net interest follows a 0.8 percent of GDP decrease in the prior eight years. Hence, the increase in Net interest is likely due in part to a return to more normal interest rates and in part to an increase in the debt.

Medicare and Health (which consists chiefly of Medicaid) are projected to see a combined increase of about 1.0 percent of GDP from 2007 through 2015. This follows a combined increase of about 1.0 percent of GDP in the prior eight years. Social Security, on the other hand, is projected to increase by about 0.5 percent of GDP from 2007 through 2015. This follows no increase in the prior eight years. Table 5-1 on page 47 of the Analytical Perspectives from the 2011 Budget shows that Medicare and Medicaid are projected to continue growing as a percentage of GDP through 2085. Social Security, however, is projected to stabilize at about 5 percent of GDP after about 2010.

Finally, Allowances is projected to increase 0.4 percent of GDP from 2007 through 2015 when there was no increase in the prior eight years. Table 3.2 in the Historical Tables shows that the great majority of this increase in allowances is for Health Reform, chiefly in 2015.

Hence, the above table shows that the great majority of the increase in outlays that is projected through 2015 falls in two areas. The first area is entitlements, driven chiefly by health care costs but, to a lesser extent, by Social Security. The second area is Net interest. Since interest is pretty much an unavoidable cost, this suggests that the chief focus needs to be on the rise in the cost of health care and other entitlements. One-time increases in outlays, such as the 0.5 percent of GDP projected for Social Security, can likely be addressed by some combination of limiting the increase in outlays and increasing the revenues to pay for those outlays. On the other hand, continuing increases in outlays, such as those projected for health care costs, likely need to be addressed chiefly by limiting those continuing increases. This is especially the case for Medicare which is projected to increase from 3.1 percent of GDP in 2010 to 22 percent of GDP in 2085. Depending on ever-increasing revenues and/or cuts in other outlays to pay for such a large increase does not seem like a viable option.

Long-term Unemployment

2010-01-17T23:47:00.001-08:00

On January 8th, the Bureau of Labor Statistics released its Employment Situation Summary for December of 2009. It stated that nonfarm payroll employment dropped by 85,000 in December. That put the number of nonfarm payroll jobs at 130.91 million, just about the same level that existed in February of 2000. Hence, we have gone nearly a decade with virtually no job growth.

Perhaps more disturbing, however, has been the growth in long-term unemployment. On this topic, the December report stated the following:

Among the unemployed, the number of long-term unemployed (those jobless for 27 weeks and over) continued to trend up, reaching 6.1 million. In December, 4 in 10 unemployed workers were jobless for 27 weeks or longer.

The following graph shows the average and median duration of unemployment since 1948:

Links to the actual data used to create this graph can be found at this link. As can be seen, the average and median duration of unemployment have risen to what is by far their highest level since 1948 and 1967, respectively. The former has reached 29.1 weeks and the later has reached 20.5 weeks weeks.

The following graph shows unemployment divided up into four durations:

As before, links to the actual data used to create this graph can be found at this link. As can be seen, the number of workers unemployed for 27 weeks and over reached 6.1 million in December. This is over double the prior high of 2.9 million reached in June of 1983. The number of workers unemployed for 15 to 26 weeks was 2.8 million in December, down from the recent high of 3.2 million reached in October of 2009. The number of workers unemployed for 5 to 14 weeks was 3.5 million in December, down from the recent high of 4.3 reached in May of 2009. Finally, the number of worker unemployed for less than 5 weeks was 2.9 million in December, down from the recent high of 3.6 million reached in January of 2009. Hence, all of the durations are starting to stabilize or trend down except for the longest, those unemployed for 27 weeks and over.

It should be noted that neither of the above graphs include the Great Depression. However, they do show that long-term unemployment has by far reached its highest level since the end of World War II. This would suggest that long-term unemployment may require special attention in the effort to put the unemployed back to work.

Interest Cost of U.S. Treasury Debt

2010-01-10T16:53:00.000-08:00

Following is an excerpt from a Wall Street Journal article from December 31, 2009:

The Treasury sold more than $2.1 trillion in notes and bonds this year, more than in the previous two years combined, to fund a widening budget shortfall and finance programs to rescue the banking system and support the economy.

Yet, despite the supply onslaught, buyers—from foreign central banks to U.S. households and domestic commercial banks—flocked to the sales. As a result, the government's borrowing costs fell to historic lows in 2009.

Regarding these borrowing costs, the Treasury Department posts the average interest rates on U.S. Treasury Securities at this link. This shows the monthly averages from 2001 through 2009 and was apparently used to create the graph at this link. The table for December 2009 shows that the average interest rates for Treasury Bills (which have a maturity of one year or less) fell to a mere 0.237 percent at the end of 2009, compared to 1.082 percent at the end of 2008. The average interest rates for all interest-bearing debt fell to 3.29 percent at the end of 2009, compared to 3.866 percent at end of 2008. This second pair of numbers is a good amount higher than the first pair since it includes longer-term debt paying at even higher rates.

The following graph gives a longer-term view of the average interest rates on U.S. treasury securities:

The actual numbers used to create this graph can be found at this link. The red line shows the average interest rate paid on the gross federal debt and the blue line shows the average interest rate paid on the debt held by the public (see the note and table at the bottom of this page for the difference between these two debts). As noted at the bottom of this page, the gross interest rates were calculated by dividing the gross interest by the average gross federal debt for each year. Similarly, the net interest rates were calculated by dividing the net interest by the average debt held by the public for each year.

The yellow and green lines are calculated the same as the red and blue line except that that the denominator used is the gross domestic product (GDP). Hence, the yellow line is the gross interest divided by the GDP for each year and the green line is the net interest divided by the GDP for each year.

The graph shows that, since 1962, the average interest rate on the gross debt has been slightly more than it has been on the debt held by the public. This difference reached a maximum of about one percent in the mid-eighties and is projected to be at about that level from 2009 to at least 2014. The two rates generally rose from 1962 to a high of 11 and 10 percent in 1982 and then declined. They are projected to reach a low in 2010 and then start increasing again.

The graph also shows the annual change in the GDP and the Composite Outlay Deflator as the purple and light blue lines, respectively. As can be seen, GDP grew a good bit faster than the average interest rates from 1962 to 1981 but grew somewhat slower from 1982 to 2002. On the other hand, inflation (as measured by the composite outlay deflator) grew at about as fast as the average interest rates from 1962 to 1981 but much slower after that. In fact, the following table shows the averages for all of these measurements from 1962 through 2008:


Measurements from 1962 through 2008              Average
------------------------------------------------ -------
Annual increase in Gross Domestic Product (GDP).  7.251
Average interest rate on gross federal debt.....  6.482
Average interest rate on debt held by the public  6.007
Average increase in composite outlay deflator...  4.230

Hence, it is the case that, since 1962, the the average interest rate on the gross federal debt has been slightly above that for the debt held by the public. Also, both rates have been a bit below the growth in the GDP but well above the rate of inflation.

Finally, the graph shows that by 2014, the interest costs as a percentage of GDP are projected to rise to levels not seen since the late 1990s. However, the levels in the late 1990s were based on interest rates of over 6 percent whereas the levels in 2014 are based on lower rates of 4.5 and 2.5 percent respectively. This would suggest that higher rates of 6 percent or so would bring interest costs as a percentage of GDP to their highest level since at least 1962.

Recent and Projected Federal Outlays and Their Role in Deficits

2009-12-03T22:27:00.000-08:00

The first graph in my prior post shows that total outlays rose from about 18 and a half percent of GDP in 2000 to about 21 percent of GDP in 2008 and, after a large spike in 2009, are projected to continue at about 22 percent of GDP through 2014. As a help in determining the cause of this rise in outlays, following is a more detailed version of the second graph in that post:

In addition, following is a table that shows the change in the nine major components of actual federal outlays from 2000 to 2008 and of projected federal outlays from 2008 to 2014:


                         CHANGE IN FEDERAL OUTLAYS (percentage of GDP)

                                                            Commerce  Undist.
      National                     Income   Social      Net & Housing Offsetng   Other    Total
Years  Defense   Health Medicare Security Security Interest   Credit Receipts  Outlays  Outlays
----- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
00-08    1.300    0.382    0.717    0.419    0.121   -0.519    0.163   -0.168    0.129    2.544
08-14*  -0.825    0.348    0.711   -0.223    0.260    0.725   -0.485    0.064    0.293    0.869
----- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
00-14*   0.474    0.730    1.428    0.196    0.381    0.206   -0.322   -0.104    0.422    3.413

* estimated

The actual numbers used to create this graph and table can be found at this link. As can be seen, total outlays rose about 2.5% of GDP from 2000 to 2008 and are projected to rise another 0.9% of GDP from 2008 to 2014. Following is a short summary of each of the nine components of federal outlays, listed in decreasing order of their size over the entire period from 2000 to 2014:

1) Medicare rose about 0.7% of GDP from 2000 to 2008 and is projected to rise another 0.7% of GDP from 2008 to 2014. Hence, it is projected to rise a total of 1.4% of GDP over the entire 14-year period.

2) Health is projected to rise about half as much as Medicare, a total of about 0.7% of GDP over the entire 14-year period.

3) National Defense spending rose about 1.3% of GDP from 2000 to 2008 but is projected to decrease about 0.8% of GDP from 2008 to 2014. That is the total increase of about 0.5% of GDP.

4) All other outlays rose about 0.13% of GDP from 2000 to 2008 and are projected to rise about 0.29% GDP from 2008 to 2014. That is a total increase of about 0.42% of GDP. The 3-line table at the bottom of this page shows that Veterans Benefits, International Affairs, and Education are the leading contributors at about 0.24, 0.17, and 0.15 percent of GDP, respectively.

5) Social Security rose about 0.12% of GDP and is projected to rise about 0.26% of GDP for a total increase of about 0.38% of GDP.

6) Net Interest dropped about 0.5% of GDP but is projected to rise back about 0.7% of GDP for a total increase of about 0.2% of GDP.

7) Income Security rose about 0.4% of GDP but is projected to drop back about 0.2% of GDP for a total increase of about 0.2% of GDP.

8) Undistributed Offsetting Receipts dropped about 0.17% of GDP but is projected to rise about 0.06% of GDP for for a total decrease of about 0.1% of GDP.

9) Commerce and Housing Credit rose about 0.16% of GDP but is projected to drop about 0.48% of GDP for a total decrease of about 0.32% of GDP.

Both the above graph and table show that Medicare and Health are projected to be the largest contributors to the increase in federal outlays. Together, they are projected to comprise about 63 percent of the total increase from 2000 to 2014. Page 171 of the Analytical Perspectives of the most recent U.S. Budget says the following on this topic:

The health reforms proposed in this budget are the key to achieving long-run fiscal stability. Without significant health reform it will be impossible to rein in Federal spending as required for fiscal stabilization, since in the absence of reform the Government’s major health programs – Medicare and Medicaid – are projected to be the most rapidly growing programs in the budget by a large margin. A successful health reform that slows the growth of per capita health care costs is also the essential ingredient for expanding health insurance coverage without permanently adding to the projected level of long-run spending.

In addition, the above graph and table show that Net Interest is projected to be the largest contributor from just 2008 to 2014. On this, page 174 of the Analytical Perspectives says the following:

Interest rates on Treasury securities fell sharply in late 2008, which brought both short-term and long-term rates to their lowest levels in decades. So far in 2009, short-term Treasury rates have remained near zero, and the ten-year yield remains near 3 percent. Investors have sought the security of Treasury debt during the heightened financial uncertainty of the last several months. In the projection period, interest rates are expected to rise as financial concerns are alleviated and the economy recovers from recession. The 91-day Treasury bill rate is projected to reach 4.0 percent and the 10-year rate 5.2 percent by 2013, at which point unemployment will have reached its long-run value and the annual growth rate of real GDP will have stabilized at 2.6 percent. These forecast rates are historically low, reflecting lower inflation in the forecast than for most of the post World War II period. After adjusting for inflation, the projected real interest rates are close to their historical averages.

Federal Outlays since 1940 and Their Role in Deficits

2009-12-02T22:05:00.000-08:00

There has been a great deal of discussion about the role of spending in the current and past deficits of the federal government. Since the most commonly referenced deficit, the unified deficit, is equal to federal revenues minus federal outlays, deficits are affected by all items that affect revenues and outlays. These items include tax rates, economic activity, and spending. Regarding spending, I have posted a number of graphs and tables that look at spending from 1940 to 2014 at the following links:

Outlays in Billions of Current Dollars
Outlays as a Percentage of GDP

The following graph shows total federal outlays and receipts since 1940:

The actual numbers used to create this graph can be found at the second link. As can be seen, total receipts have mostly been in the 17% to 19% of GDP range in the 54 years since 1954. They have only dipped below 17% of GDP in five years, reaching a low of 16.1% of GDP in 1959 and they have risen above 19% in just nine years, reaching a high of 20.9% of GDP in 2000. However, they are projected to dip below the prior low in 2009, reaching a new low of 15.1% of GDP.

Outlays have been less stable. They were likewise in the 17% to 19% of GDP range for all but two years from 1954 through 1966. However, they then began to rise steadily, reaching a high of 23.5% of GDP in 1983. From there, they began a long decline, finally getting back in the 17% to 19% of GDP range in 1999 through 2001. However, they have now risen back to nearly 21% of GDP in 2008. Hence, one could argue that a major contributor to deficits was the steady increase in spending from 1966 to 1983 and from 2000 to 2008 with no corresponding increases in receipts. However, these deficits were also exasperated by the sharp drop in receipts from 1981 to 1983 and from 2000 to 2004 and were relieved by the growth in receipts from 1992 to 2000 and from 2004 to 2007.

The second link above shows outlays as a percentage of GDP. This is a useful measure of the stability (or lack thereof) of the growth in receipts and outlays. Because wages tend to grow at the same rate as the GDP, receipts tend to remain at the same percentage of GDP, given that tax rates and economic activity stay at the same relative level. If outlays can likewise be kept at the same percentage of GDP, then the budget can be kept at the same level of balance.

The following graph shows nine major components of federal outlays:

The actual numbers for this graph can be found at the second link. In any event, following is a short summary of each of the nine components:

1) National Defense spending has been generally decreasing, going from 13.1% of GDP in 1954 to 4.3% of GDP in 2008. There were increases from 1979 to 1986 and from 1999 to 2008 but the overall trend has been down.

2) Social Security rose from 0.9% of GDP in 1954 to almost 5% of GDP in 1983 but it has since dropped back slightly to 4.3% of GDP.

3) Medicare has risen fairly steadily since its inception in 1967, reaching 2.7% of GDP in 2008.

4) Health (of which Medicaid grants comprised 71% in 2006) rose from under 0.1% of GDP in 1954 to nearly 1% of GDP in 1979 but stabilized at that level through 1990. From there, it began to rise, reaching nearly 2% of GDP in 2008.

5) Income Security consists of General and Federal Retirement and Disability, Unemployment Compensation, and Housing, Food and Nutrition, and Other Income Assistance. It was between 1 and 2 percent of GDP from 1949 through 1970, rose to 3.2% of GDP by 1975, and has been between 2.5 and 3.6 percent of GDP since then.

6) Net interest was between 1 and 2 percent of GDP from 1944 through 1980, rose to about 3% of GDP from 1985 through 1997, and has now dropped back to the 1 to 2 percent level.

7) Commerce and Housing Credit has been relatively small (less than 0.7% of GDP) since 1948 except for when it rose to over 1% of GDP in 1990 and 1991. This was due to an increase in Deposit Insurance spending to pay for the Savings and Loans bailout. In addition, it is projected to soar to 5.3% of GDP in 2009 as a result of the recent financial bailout.

8) Undistributed Offsetting Receipts consist chiefly of the payments federal agencies make to retirement trust funds for their employees and are counted as negative outlays. They have gone from about -1% of GDP in 1952 to -0.6% of GDP now.

9) All other outlays rose from 3.3% of GDP in 1954 to 5.9% of GDP in 1978 but dropped to a low of 2.9% of GDP by 1997. Since then, they have risen back to 3.2% of GDP. The third and fourth graphs at this link show a further breakdown of this other outlays category.

Do Balanced Budgets Cause Depressions? (Part 2)

2009-10-14T00:20:00.000-07:00

My prior post suggested that the initial events that lead to financial crises are more likely wars, not the periods of paying down the resultant debt. The following graph shows the federal debt held by the public during major wars since 1790:

The actual numbers and sources can be found at this link. The graph shows the federal debt as a percentage of GDP, as opposed to my prior post which deals with the current dollar amounts. The debt as a percentage of GDP gives a better measure of our ability to service the debt since the government receipts used to pay the interest have remained around 18 percent of GDP for the past 50-plus years (see the first graph at this link).

In any event, the graph shows that there was a tremendous growth in the debt during the Civil War, World War I, and World War II. The growth in debt was much more rapid than any paydown in debt after the war. The growth in debt during the Mexican-American War and the War of 1812 was much more modest but the paydown in debt immediately following those wars was even less. Hence, the graph does agree with the conclusions of my prior post. Looking at the debt as a percentage of GDP does make the paydown in debt appear much more substantial but it still, for the most part, appears to be just a paydown of the tremendous debt run up during war years.

The relationship between the debt and war years reminded me of a similar relationship that I had noticed years ago. The following graph shows the CPI (Consumer Price Index) and M2 Money Supply since about 1800:

The actual numbers and sources for this graph can be found at this link. As can be seen, inflation has tended to increase during major wars though it did not during the smaller Mexican-War War. In addition, the growth in the M2 money supply has tended to increase during major wars since at least World War I. In fact, there appears to have been a positive correlation between the growth in the M2 money supply and inflation since World War I though this relationship seems to have broken down somewhat since about 2000. I had a discussion about this with Rodger M. Mitchell (who I mentioned in my prior post) at this link. He felt that the use of ten-year spans to "smooth" the data had in fact "ruined" it. But, as I explain in my comment of October 11th, even the graphs using five or one-year spans (shown here) show a correlation.

I also mentioned in my comment of October 7th that Thayer's claim that the six financial collapses that he lists "have been the only major depressions in U.S. history" is questionable. As I pointed out, I have seen 1907 mentioned as a possible depression in several places, including this article. Another article mentions that the U.S suffered a serious economic downturn at the start of the 1920s. The list of recessions on wikipedia lists the Depression of 1920-21 and the Panic of 1907. It also lists the first five of Thayer's six collapses (1819, 1837, 1857, 1873, 1893) as Panics. The sixth collapse in 1929 is, of course, listed as the Great Depression.

The Panic of 1907 and Depression of 1920-21 are significant in another way. Treasury data shows that the Panic of 1907 was preceded by rising debt, with the debt increasing from 1898 to 1913. The huge debt run up during World War I did decrease from 1919 to 1930 but, as this article mentions, that was through the recovery. Hence, the Panic of 1907 contradicts the notion that all depressions are preceded by decreases in debt and the Depression of 1920-21 contradicts the notion that deficit spending is an absolute necessity for recovery.

In any event, the above graphs again suggest that the initial events that lead to many financial crises are wars, not periods of paying down the resultant debt. For that reason, it would seem that our higher priority should be to find ways to prevent wars and their resulting cost in lives and treasure.

Do Balanced Budgets Cause Depressions?

2009-10-04T01:32:00.000-07:00

According to this link, Frederick C. Thayer, a professor of Public Administration at George Washington University, wrote an article titled "Do Balanced Budgets Cause Depressions?" for The Washington Spectator on January 1, 1996. Following is an excerpt:

Even though the sequence that begins with budget-balancing and ends with depression has been common in American history, the question of a linkage has been ignored. The following paragraphs include all the basic data:

1817-21: In a period of five consecutive years, the national debt was reduced by 29 percent, to $90 million. The first acknowledged major depression began in 1819.

1823-36: In a period of 14 consecutive years, the national debt was reduced by 99.7 percent, to $38,000, a virtual wipeout. This didn’t help either. A major depression began in 1837.

1852-57: In a period of six consecutive years, the national debt was reduced by 59 percent, to $28.7 million. A major depression began in 1857.

1867-73: In a period of seven consecutive years, the national debt was reduced by 27 percent, to $2.2 billion. A major depression began in 1873.

1880-93: In a period of 14 consecutive years, the national debt was reduced by 57 percent, to $1 billion. A major depression began in 1893.

1920-30: In a period of 11 years the national debt was reduced by 36 percent, to $16.2 billion. The sixth real depression -- the Great Depression -- began in 1929.

As opposed to many less important downward “business cycles” or recessions, these six collapses have been the only major depressions in U.S. history. The batting average is perfect -- six sustained periods of reducing the national debt followed by six major crashes.

Since 1791, these debt reduction crusades have colored 57 of the 93 years in which debt was reduced. The debt was increased in each of the 112 years, an indication that federal deficit spending has been anything but unusual. We have almost chronic deficits since the 1930s, and there has been no new depression since then -- the longest crash-free period in our history.

Other articles by Thayer from about the same time and containing the same numbers can be found here and here. According to this link, Thayer passed away in 2006 at the age of 82.

More recently, these same basic numbers have been posted by Rodger Malcolm Mitchell, author of the book "Free Money: Plan for Prosperity". Following is an excerpt from his website:

1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1998-2001: U. S. Federal Debt reduced 9%. Recession began 2001
2004-2008: Deficit Growth reduced 40%. Recession began 2008.

The first six sets of numbers are the same as Thayer's except that the second lists a debt reduction of 99% instead of 99.7%. In addition, he adds a 9% reduction in federal debt from 1998 to 2001 followed by the recession of 2001. It should be noted that this 9% reduction appears to be a reduction in the federal debt held by the public. Mitchell's figures link to this page which contains graphs showing Federal Debt Held by the Public (FYGFDPUN) and Federal Government Debt: Total Public Debt (GFDEBTN). According to the data for the series found here and here, the Debt Held by the Public went down by 11.3% but the Total Public Debt went up by 5.1% from 9/30/1998 to 9/30/2001. The difference is due to the fact that the Debt Held by the Public does not include the federal debt owed to Social Security and other federal trust funds. There are likely arguments in favor of using either of these two measures of debt. In any event, it's important to note the one that is being used.

Mitchell also adds a 40% reduction in deficit growth from 2004 to 2008. It is very interesting that he chooses to switch from "federal debt reduction" to "deficit growth" reduction. In fact, sticking with "federal debt reduction" would have resulted in data that would have run very much counter to his other data which shows depressions and/or recessions being preceded by reductions in debt. According to the figures for Federal Debt Held by the Public, the debt increased from $4303 billion on 09/30/2004 to $5814 billion on 09/30/2008, an increase of 35 percent in just 4 years!

In any event, following is a critique of Thayer's original numbers:

In order to evaluate Thayer's claim, one needs to look at all of the major changes in the debt during this period. The following table attempts to do that:


     FEDERAL DEBT (in millions of dollars) AND PERCENT CHANGE

   High Debt     Low Debt
---------------------------- Prior Low    High  Prior Low
Year     Debt  Year     Debt   to High   to Low    to Low Events
---------------------------------------------------------------------------------
1804    86.43  1812    45.21             -47.69           War of 1812 (1812-15)
1816   127.33  1821    89.99    181.65   -29.33     99.04 Panic of 1819
1822    93.55  1836     0.04      3.96   -99.96    -99.96 Panic of 1837
1843    32.74  1846    15.55  87184.08   -52.51  41352.78 Mex-Amer War (1846-48)
1851    68.30  1857    28.70    339.25   -57.98     84.56 Panic of 1857
               1861    90.58                       215.61 Civil War (1961-65)
1866  2773.24  1873  2234.48   2961.61   -19.43   2366.84 Panic of 1873
1879  2349.57  1893  1545.99      5.15   -34.20    -30.81 Panic of 1893
               1915  3058.14                        97.81 World War I (1914-18)
1919 27390.97  1930 16185.31    795.68   -40.91    429.25 Great Depression

Source: Treasury Department: 1791 to 1849, 1850 - 1899, 1900 - 1949

The first period that Thayer cites is the five years from 1816 to 1821, when the debt was reduced by 29 percent. What Thayer fails to mention, however, is that in the four years from 1812 to 1816 (which includes the War of 1812), the debt was increased by 182 percent. Hence, the debt in 1821 was still nearly double it's level when the War of 1812 began.

The second period that Thayer cites is the 14 years from 1822 to 1836, when the debt was reduced by over 99 percent, to $38,000. This is the one period that Thayer cites when a recently acquired debt was not simply being partially paid down. In fact, the debt was paid down to its lowest level on record.

The third period that Thayer cites is the six years from 1851 to 1857, when the debt was reduced by 58 percent. Once again, Thayer makes no mention of the fact that the debt had just increased 339 percent in the prior five years, driven largely by the Mexican-American War. Even after the 58% decrease, the debt was still 85 percent above where it had been just 11 years earlier.

The fourth period that Thayer cites is the seven years from 1866 to 1873, when the debt was reduced by 27 percent (19 percent by the Treasury numbers in the above table). Thayer makes no mention that this immediately followed the Civil War during which the debt increased by nearly 3000 percent! Even after the 19 percent decrease, the debt was still nearly 25 times its size at the beginning of the war.

The fifth period that Thayer cites is the 14 years from 1879 to 1893, during which the debt was reduced by 57 percent (34 percent by the Treasury numbers in the above table). In fact, this represented a further paying down of the tremendous debt run up during the Civil War. Even after this 34 percent decrease, the debt was still about 17 times its size at the beginning of the Civil War.

The final period that Thayer cites is the 11 years from 1919 to 1930, during which the debt was reduced by 36 percent (41 percent by the Treasury numbers in the above table). This followed another war which Thayer saw no need to mention, World War I. In the four years from 1915 to 1919, the debt had increased by 796 percent. Even after the 41 percent decrease, the debt was still over 5 times its size at the beginning of World War I.

Hence, four of the six periods of surpluses that Thayer mentions followed wars during which the debt rose far more than it was paid down during those periods. Another of the periods (1879 to 1893) was just a further paying down of the tremendous debt run up during the Civil War. Hence, only one of the periods represented a seemingly voluntary paydown of debt not recently acquired through war.

The above timeline suggests that the initial events that lead to financial crises are wars, not periods of paying down the resultant debt.

The Long-Run Budget Outlook

2009-08-19T00:05:00.001-07:00

As stated here, the OMB (Office of Management and Budget) released the final volumes of the President's FY 2010 Budget on May 11th, 2009. These included the Analytical Perspectives which contains a section on the long-run budget outlook. On June 25th, the CBO (Congressional Budget Office) released the Long-Term Budget Outlook. The following graph shows the outlook for the federal debt held by the public as projected by both documents.

The actual numbers and sources for this and the following graph are at http://www.econdataus.com/pro2010.html. As can be seen, the CBO document provides two projections, one for the "extended baseline scenario" and one for the "alternative fiscal scenario". The former appears to be very close to 2010 Budget projections. Regarding these projections, the 2010 Budget states the following on page 190 of the Analytical Perspectives:

The long-run budget projections in this section extend the particular policies proposed in the 2010 Budget, but do not reflect the long-term impacts from slowing health care cost growth. Although the Budget offers major initiatives in many areas that are needed to put the economy on a sounder long-run footing, the Administration recognizes that not all of the needed policy initiatives have been formulated. In particular, the Administration’s plans for health reform are still under development in consultation with Congress. The budget projections in this chapter reflect the fact that simply extending current laws and policies would leave the budget in an unsustainable position.

Similarly, following is a description of the two sets of CBO projections from page 1 of the CBO document:

The “extended-baseline scenario” adheres most closely to current law, following CBO’s 10-year baseline budget projections for the next decade and then extending the baseline concept beyond that 10-year window.1 The scenario’s assumption of current law implies that many policy adjustments that lawmakers have routinely made in the past will not occur.

The “alternative fiscal scenario” represents one interpretation of what it would mean to continue today’s underlying fiscal policy. This scenario deviates from CBO’s baseline even during the next 10 years because it incorporates some policy changes that are widely expected to occur and that policymakers have regularly made in the past. Different analysts might perceive the underlying intention of current policy differently, however, and other interpretations are possible.

Hence, both the 2010 Budget and the CBO extended baseline projections are based on current law. The CBO alternative fiscal projections, on the other hand, are based on policies that are not written into current law but are "widely expected to occur and that policymakers have regularly made in the past". These assumptions are summarized in Table 1-1 in the CBO report. On the spending side, the main difference is that the alternative fiscal scenario assumes that physician payments from Medicare will be higher than under current law and that spending other than Social Security, Medicare, Medicaid, interest, and stimulus-related spending will remain at its projected 2009 share of GDP. On the revenue side, the main difference is that the alternative fiscal scenario assumes that the Bush tax cuts will be extended and that the AMT (Alternate Minimum Tax) parameters will continue to be adjusted for inflation as they have in the past.

The following table shows the estimated levels of spending and revenues (and the resulting deficits) in the year 2080 for all three sets of projections:


 BUDGET PROJECTIONS FOR THE YEAR 2080 (percent of GDP)

                    2010    Extended  Alternate Extended
                   Budget   Baseline   Fiscal    - Alt
----------------  --------  --------  --------  --------
Primary Spending    27.0      31.7      34.4       2.7
Interest            11.2      11.9      30.3      18.4
----------------  --------  --------  --------  --------
Total Spending      38.2      43.7      64.7      21.0
Revenues            22.6      25.9      21.9      -4.0
----------------  --------  --------  --------  --------
Deficit            -15.5     -17.8     -42.8     -25.0

As can be seen from the last column, the difference in revenues between the two CBO scenarios is somewhat larger than the difference in non-interest spending. Hence, the extension of the Bush tax cuts and AMT fix is projected to have a significant effect on the deficit and debt. However, the table also shows that, once the debt starts growing rapidly, interest costs likewise start growing rapidly and become the predominant problem. This is similarly shown in the following graph which shows the projected growth in outlays according to the 2010 budget.

As can be seen, net interest costs start rising rapidly starting in about 2020, in response to the rapidly rising debt. The non-interest outlay that appears to grow the fastest is Medicare.

It is important to note that these are projections based on current law, not predictions of what will actually happen. It is likely that something will change well before the debt reached such historically high levels. On this topic, page 192 of the Analytical Perspectives states the following:

These rising deficits would drive publicly held Federal debt as a ratio to GDP to levels well above the previous peak level reached at the end of World War II and beyond. Before the debt reaches the levels shown in the table, there would likely be a financial crisis that would force budgetary changes, although the timing of such a crisis and its resolution are impossible to predict. Timely reforms, especially those that lowered the trend of health care costs, could go far to avoid such a crisis.

California's Budget Crisis

2009-05-28T01:03:00.000-07:00

As reported by numerous news sources, California now faces a $21.3 billion gap between revenues and spending. Many have attributed this gap chiefly to increases in spending. For example, a February 18th article from the Reason Foundation is titled "What Caused the Budget Mess? California's Spending Has Nearly Tripled Since 1990". According to the article, state spending (including the General Fund, special funds, and bond funds) has nearly tripled from $51.4 billion in FY 1990-91 to $144.5 billion in FY 2008-09. The numbers in the first table at this link agree with the 1990-91 figure but show $136.2 billion in 2008-09. The small difference is likely because this latter figure is an estimate which continues to change. Still, this represents an increase of 165 percent.

The problem with this comparison is that the figures are not corrected for inflation or the growth in California's population. In fact, the article states the following in a later paragraph:

If California had simply limited its spending increases to the 4.38 percent average increase in the state's consumer price index and population growth each year since FY 1990-91, the California would be sitting on a $15 billion surplus right now.

Hence, the article seems to admit that this a more valid way to compare the figures. Another commonly used method to compare revenue and spending figures is to take their values as a percentage of the economy and compare those. This is reasonable in that revenues tend to generally grow in line with the economy from which they are drawn. The following graph shows California budget expenditures as a percentage of the California gross domestic product.

The actual numbers and sources for this and the following graph can be found at the aforementioned link. The numbers do show that expenditures (excluding federal funds) rose from a low of 6.33% of state GDP in 1994 to a high of 7.97% of state GDP in 2002. In retrospect, it would have been wise to restrain this increase. Still, the graph shows that there has not been the runaway increase in spending that many have described. In addition, there may be a reasonable explanation for the slight increase in spending. Following is a paragraph from a May 8th editorial in the Los Angeles Times that addresses this issue:

While spending has increased over time, the growth in spending reflects demands imposed by a population that is growing, aging and becoming more diverse. In the last year alone, California has added more than 408,000 new residents, nearly equal to the population of Sacramento. And, critically important from a budgetary standpoint, the fastest-growing segment of the population is the elderly, increasing demands on health and age-dependent services. About 60% of the nursing home days in California, for example, are paid for by Medi-Cal, the publicly supported health program for low-income Californians.

The problem of increased entitlement spending as the population ages is likewise a national problem. Another shared problem is shown in the following graph:

The graph shows that the interest costs on general obligation and lease-revenue bonds are projected to hit a new 30-year high. Hence, the cost of servicing its debt is a growing concern for California just as it arguably is for the nation as a whole.

Major Foreign Holders of Treasury Securities (update)

2009-03-16T01:02:00.000-07:00

According to a number of news stories, Chinese Premier Wen Jinbao expressed concerns about China's holdings of U.S. government debt on March 13th. Following is the opening paragraph in a March 14th article in the Washington Post:

Exerting its new influence as the U.S. government's largest creditor, China yesterday demanded that the Obama administration "guarantee the safety" of its $1 trillion in American bonds as Washington goes further into debt to combat the economic crisis.

Further on, the article states:

China surpassed Japan last year as the largest foreign holder of Treasury bonds. Any indication that it intends to cease those purchases -- or, worse, stage a sell-off -- could drive up the cost of borrowing for the U.S. government, as well as send mortgage rates higher for millions of Americans.

To my knowledge, the chief source for the amounts of Treasuries held by foreign countries is the Treasury Department. Each month, it posts updated estimates of the foreign holdings of U.S Treasuries by country at this link. It also posts estimates going back to March 2000 at this link. The following graph shows the totals for all countries by the type of treasury security and the totals for the four countries (or groups of countries) with the largest holdings at the end of 2008.

The blue line shows the grand total of all treasury securities held by all foreign countries, private and public. As can be seen, it has been increasing steadily since early 2002 and accelerated sharply at the end of 2008. The yellow line shows those securities held by "official institutions", defined on page 7 of the Report on U.S. Portfolio Holdings of Foreign Securities at End-Year 2004 as follows:

Official institutions consist primarily of national government and multinational institutions involved in the formulation of international monetary policy, but also include national government-sponsored investment funds and other national government institutions. Data on such institutions are collected separately because the motivations behind holdings of official institutions may differ from those of other investors.

The dark blue line just below the yellow line shows the totals for bonds and notes which are that portion of the total securities that are long-term debt securities, with an original
maturity of over one year. As can be seen, this long-term debt has not been increasing over the past half-year. Hence, the increase over this period appears to have been totally in short-term debt. More details on short-term and long-term debt securities can be found on page 7 of the Report on U.S. Portfolio Holdings of Foreign Securities at End-Year 2007.

The other four lines show the holdings of the four categories of countries with the largest holdings. These can be seen in more detail in the following graph which shows the holdings of the eight countries with the largest holdings:

The actual numbers and sources for both of the above graphs can be found at this link. As can be seen, the holdings of Mainland China has risen steadily since early 2002, increasing nearly ten-fold from $76.5 billion in February of 2002 to $727.4 billion at the end of 2008. As mentioned in the article, China did surpass Japan as the largest foreign holder of Treasuries in September of 2008. In fact, Japan's holdings reached a maximum of $699.4 billion in August of 2005 and have fallen to $626 billion now. Also, I noticed a few other interesting things in the data. The United Kingdom's holdings soared from $50 billion in June of 2007 to $271.2 billion in May of 2008 and then dropped back to $55 billion in June of 2008. In fact, there appears to be a large continuing discontinuity between each annual survey for the United Kingdom causing a large saw-tooth effect in the graph. If anyone knows the reason for this, please leave a comment.

In any case, there are a number of other countries whose holdings have increased rapidly for some portion of the past eight years. The holding of Oil Exporters have more than quadrupled from $43.9 billion in January of 2004 to $186.2 billion now. The holdings of Brazil went up by more than a factor of ten from $14 billion in January of 2005 to $158 billion in June of 2008 but have sunk back somewhat to $127 billion now. The most recent rapid increase has been in the holdings of Russia which has gone up by more than a factor of fifteen from $7.4 billion in March of 2007 to $116.4 billion now. I would guess that most of this investment from Oil Exporters, Brazil, and Russia came from income from resources, chiefly oil. With oil having fallen from a high of $147 per barrel last July to the mid-forties now, it would have seemed likely that future investment in Treasuries by these nations would have fallen. However, only Brazil's investment had begun to decrease by the end of 2008. In addition, it would seem possible that China's future investment might slow due to it's own stimulus plans or for other reasons. The Washington Post article says the following on that topic:

Wen, however, stopped far short of saying China would cease purchasing Treasurys. Although analysts say China may already be moving to curb some purchases of U.S. debt, any move to sell off its current holdings would severely deflate their value on world markets -- hurting the Chinese as well as the Americans. Years of red-hot growth have allowed China to build up the world's largest reserves -- some $2 trillion. But analysts say almost half are held in U.S.-government-backed debt.

One final item of note is that the Washington Post article mentions Chinese holdings of "$1 trillion in American bonds". However, the Treasury figures show that China held just $727 billion in treasuries at the end of 2008. It seems likely that the $1 trillion figure includes holdings in Fannie Mae and Freddie Mac bonds. A September 18th New York Times article stated the following regarding China:

Its bond holdings of government-sponsored enterprises, estimated by credit rating agencies at $340 billion, rose in value by billions of dollars in a single day when the Bush administration made explicit the government guarantee of Fannie Mae and Freddie Mac bonds, causing their interest rate spreads compared with Treasury bonds to narrow by 5 to 35 basis points within hours.

The exact amount of China’s gain cannot be calculated without knowing the maturity and composition of its holdings of these bonds, which Chinese officials have not released, according to specialists in fixed-income securities.

Fiscal Year 2010 Budget Overview Document

2009-03-02T01:08:00.001-08:00

An overview of the fiscal year 2010 U.S. Budget was released on Thursday, February 26th. A link to the overview can be found on this page, along with the following description:

A New Era of Responsibility: Renewing America’s Promise, provides a description of the Obama Administration’s fiscal policies and major budgetary initiatives. This document is an overview of the full Fiscal Year 2010 Budget expected to be released this spring.

The overview contains 9 summary tables which give actual budget numbers for 2008 and projected numbers for 2009 through 2019. These numbers can be combined with historical budget numbers from the prior budget to look at historical and projected budget data from 1940 through 2019. The following graph shows selected measures of the deficit since 1970:

The most commonly discussed measure of the deficit is the unified deficit, shown in purple. The graph shows the actual values of the unified deficit through 2008 and projected values from 2009 forward. In addition, the dotted purple line shows the projected values of the unified deficit from last year's budget. The actual numbers and sources can be found at this link.

As can be seen, the extraordinary financial crisis has caused the outlook for the unified deficit to change radically. The prior budget projected that it would become a surplus in 2012 while the current budget projects that it will skyrocket to $1.75 trillion this year and decrease to $581 billion by 2012.

In any event, the graph also shows the change in the debt held by the public (the blue line), referred to as the public deficit. This is usually very close to the unified deficit as the government must generally make up for the difference between receipts and outlays by borrowing from the public. However, the graph and table show that the debt held by the public is projected to increase by $2.56 trillion in 2009, well over the projected unified deficit of $1.75 trillion. Table S-9 in the overview shows that this difference is chiefly due to Direct loan accounts ($482 billion), Troubled Asset Relief Program (TARP) equity purchase accounts ($202 billion), and Financing accounts for potential additional financial stabilization efforts ($432 billion).

Finally, the graph shows the change in the gross federal debt (the red line), referred to as the gross deficit. This is equal to the public deficit plus those monies borrowed from Social Security and the other trust funds. As can be seen, the gross deficit is projected to reach $2.72 trillion in 2009, descend to just under a trillion dollars per year by 2012, and maintain that general level until 2019.

Regardless of the significance of the deficit, the federal debt is arguably more critical. Afterall, it is the debt, not the deficit, that we are paying interest on every year. The following graph shows selected measures of the U.S. debt since 1940:

The actual numbers and sources for this graph can be found at this link. As can be seen, the gross federal debt is projected to jump from 70.2% of GDP to 89.2% of GDP in 2009 and reach 98.3% of GDP by 2011. As the graph shows, that is not far from the historic peak that we reached in World War II. Unlike the end of that war, however, there is no sharp drop in the debt to GDP ratio when the current economy improves. That is because the budget is projected to stay well in deficit through 2019 with unified deficits around 3 percent of GDP and gross deficits around 5 percent of GDP. That's very unlike the end of World War II when the drop in war expenditures allowed the budget to achieve approximate balance for the next decade or more.

On the positive side, the overview contends that these numbers are more realistic than some prior budgets. On page 36, it states:

This Budget, therefore, provides a projected cost for the wars in Iraq and Afghanistan; does not assume that all of the 2001 and 2003 tax legislation magically disappears at the end of 2010; does not allow the alternative minimum tax to take over the tax code, which almost every observer agrees is unrealistic; recognizes the statistical likelihood of natural disasters instead of assuming that there will be no disasters over the next decade; includes a contingent reserve as a placeholder in case further legislative action becomes necessary to stabilize the financial system; and provides a 10-year rather than a 5-year look into our fiscal situation.

Of course, projections are likely to become less and less accurate the further into the future they extend. Look at the radical change in projections that the current financial crisis caused in just one year. Still, it seems responsible to at least attempt to plan for the future, especially the relatively near future of ten years. Even more important, it seems critical to provide the public with numbers that are as realistic as possible. The more accurate a picture that the electorate has of our current situation, the more likely they are to support those actions which will best address it.

Job Growth Under Bush and Prior Presidents

2009-02-17T01:00:00.001-08:00

On February 6th, the Bureau of Labor Statistics (BLS) released its Employment Situation report for January of 2008. Following is the opening paragraph:

Nonfarm payroll employment fell sharply in January (-598,000) and the unemployment rate rose from 7.2 to 7.6 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Payroll employment has declined by 3.6 million since the start of the recession in December 2007; about one-half of this decline occurred in the past 3 months. In January, job losses were large and widespread across nearly all major industry sectors.

The following graph shows the labor force, household survey employment, nonfarm employment, and unemployment rate since 1998:

The actual numbers and sources for this and the following graph can be found at this link. As can be seen, employment has decreased and the unemployment rate has increased sharply since December 2007, especially in the past few months. Also noticeable is the fact that the labor force has dropped off for the past three months. However, much of the drop in the last month was due to adjustments to population estimates for the Household Survey. The BLS Employment Situation report states:

The adjustment decreased the estimated size of the civilian noninstitutional population in December by 483,000, the civilian labor force by 449,000, and employment by 407,000; the new population estimates had a negligible impact on unemployment rates and other percentage estimates.

In any event, the following graph shows the items shown in the prior graph, plus population and private employment, since 1950:

As can be seen, the current unemployment rate of 7.6 percent is the worst since the 1980-82 recession but is still well below the level of 10.4 percent reached in January of 1983. However, it also shows that the growth in employment, especially private employment, has been especially poor over the past eight years. In fact, private employment has increased just 407 thousand over that period. That works out to an average of just 4.24 thousand jobs per month. More on this can be found in an article that I've just updated titled Job Growth Under Bush and Prior Presidents.