The Budget Deficit in Context

I’m preparing a few slides for a class discussion about the US federal budget. In so doing, I produced the following picture of federal revenues and spending, excluding the Social Security trust fund. Even I, someone extremely familiar with the details of the US’s budget problems, was slightly astonished by this picture.

Note: The projection for the rest of the decade is from the CBO. This CBO forecast assumes that Bush’s tax cuts are made permanent, that AMT is mostly fixed, that spending in Iraq and Afghanistan tapers off gradually over the next decade, and that non-defense non-homeland security (NDNHS) discretionary spending is sharply curtailed. Unlike the referenced CBO document, however, I do not assume that Bush’s social security privatization scheme is enacted into law.

Two things stand out to me about this graph.

Even with the Bush administration’s probably unrealistic goals for cutting NDNHS discretionary spending, their budget plans will result in on-budget deficits of $400-$500 bn (roughly 3% of GDP) for the next several years. And of course, this forecast assumes steady real GDP growth of roughly 3% per year. Much more likely, of course, is that there will be a recession sometime in the next five years, which will cause the deficit to be much, much larger.

But the truly remarkable thing about the graph is just how far federal revenues have fallen over the past fifty years. It appears that successive tax cuts, especially those by Reagan and Bush, have driven down federal revenues in a permanent way. Equally important, it is clear that those tax cuts have NOT driven down federal spending; the only substantial decline in federal spending happened during the 1990s, following a major tax increase in 1993. Yet more evidence that the “starve the beast” theory has the empirical validity of the Ptolomaic solar system.

Revenues have trended strongly down over the past fifty years, while spending has remained roughly constant (with the exception of the Clinton-era downsizing of the federal government). That, in a nutshell, is the reason for the US’s present and future deep structural budget deficit.

Kash