Spending and Revenue

This Labor Day weekend is the eye in the storm of the Republican and Democratic conventions.  As we listen to all the rhetoric and half-truths (at best) coming out of both conventions, it might be best to take a long term view of government spending.  The two biggest components of federal spending are defense and what is called human resource spending, which includes federal Education and Training Programs, Medicare, Medicaid, Social Security, various social safety net programs and veterans’s benefits (functions 500 – 700 described here ).  Data is from the Office of Management and Budget (Source), Table 3.1, Outlays by Function and Super-function.

The 70 year average (1940 – 2011) of total government spending is 20.6% of GDP.  The 30 year average from 1981 to 2011 is 21.2%.  During the Obama administration, spending has increased to 24.1% of GDP.  Each 1% of GDP is about $150 billion at current levels of GDP. (Click to enlarge in separate tab)

Defense spending has doubled in the past decade.

This spending figure includes only active defense spending.  Outlays for Veterans benefits, education and job training for vets are included under the Human Resources superfunction.  Housing benefits for veterans are included under another superfunction, Physical Resources.  The total outlay is estimated at over a trillion dollars and that figure has been acknowledged by Senator John McCain, a long time supporter of strong defense spending.

As a percent of GDP, however, active defense spending has remained below 5%. Putting this increase in spending in historical perspective puts the lie to the contention by some liberals that our budget problems are mostly due to defense spending.

Human Resource spending includes Social Security payments, which comes out of current taxes and a trust fund surplus of $2.7 trillion (Source).  Since most Social Security payments come out of a tax that has been dedicated to those payments, I have deducted them from total Human Resource spending to get a more accurate picture of the trend in spending on the social safety net. 

When financial conservatives on both sides of the aisle warn of this upward trend, this is what they are talking about.

What too many Republicans won’t acknowledge is that we have had and continue to have a severe revenue problem.

Since I listen to and read a lot of “conservative” media each day, I repeatedly hear the mantra that Reagan lowered tax rates and revenues increased.  This is the justification for pushing for continued tax cuts. Reagan and a Democratic Congress lowered tax rates.  The president signs bills that are passed by the Congress.  This is not a one man show.  Total revenues, including Social Security and Medicare taxes, did increase because Social Security taxes were increased 12% during the Reagan years (Source).  When we look at tax revenues without Social Security taxes, revenues as a percent of GDP fell, just as anyone would expect when tax rates are reduced.  Since WW2, tax rates have been gradually reduced, and, as expected, tax revenues as a percentage of the economy have fallen.  There is no magic formula here.  Lower tax rates = lower revenue.

In this ongoing battle of ideologies, there are three real issues.  Should we spend more than 5% of GDP on active defense spending?  Should we spend more than 10% of GDP on social safety programs (excluding Social Security)?  Can we expect to ever live within our means if we collect only 10% of GDP in income and excise taxes?  We can not do all three.

Tax Limbo

Back in the ancient days before the Internet, before Disco, even before the Beatles, Chubby Checker popularized a song called “Limbo Rock”. The dance craze involved bending backwards and shimmying under a limbo stick, a bar, that could be raised or lowered. An Olympic pole vaulter tries to get over the bar. A limbo dancer tries to get under the bar.

Below is a 30 year graph of Federal revenues as a percentage of GDP.

The Heritage Foundation has a 70 year chart of Federal revenues, showing the 18% historical average – the bar – of revenues to GDP and projected 2010 revenues of less than 15%.  The AP released a story today that Federal revenues for the 2011 tax year are also projected to be below 15%. 

We don’t like bending over backwards, so we party on under a different bar, one that we keep raising.  That bar is the national debt.

Those to the left of center will repeat their mantra that the government needs to spend more when times are tough.  “Raise the bar,” they chant. Those on the right will continue to press for more spending cuts (but not defense spending, their sacred cow). “Stoop lower,” they encourage.  A reasonably sane person would say we need both cuts and higher taxes if we are to avoid the long term problems of ballooning government deficits and long term debt.

Revenue Sources

Continuing my study of the shell game that our elected representatives are playing, today we’ll look at the revenue sources of the federal government minus Social Security taxes. (Click image to enlarge)

During the Nixon era in the late sixties and early seventies, excise and other taxes decreased.  As inflation ran rampant during the seventies, taxes on individuals made an increasing contribution to the federal pot.  As a share of the pot, corporate taxes decreased so that in the last three decades, individual taxes and Social Security and Medicare taxes on individuals made up about 3/4 of federal revenue.

As I have noted before, this country practically invites imports.  We have the lowest import duties of any developed country yet we scratch our heads and wonder why our trade balance is so far in the red, why we have a deficit, and where have the jobs gone?

Some will say that government needs to get leaner but most large organizations, both private and public, do not run lean.  Any of us who have worked for a large corporation can attest to that fact.  We can continue to campaign for leaner government but the fact is that the federal government is not raising enough money.  Like a giant Ponzi scheme, our elected representatives have been collecting Social Security taxes and treating the excess taxes as “income”.

In this coming decade, the boomers will start asking for their Social Security pensions.  The largest influx of retirees won’t occur for another 10 years and the demand for Social Security pensions will overwhelm the receipts collected sometime in the middle of the 2020s.

Just as Bernie Madoff swindled most of his investors by not investing the money entrusted to him,  politicians will be in the uncomfortable position of admitting that they spent rather than invested the Social Security excess taxes and there aren’t enough new taxpayers to get the money from.

It’s going to be a bloody battle then – not as bloody as a battle scene in the movie “Braveheart” but you get the idea.  Retired people get the majority of their income from Social Security.  Inevitably, politicians will have to find some way to tell boomers that their pension payments are going to be reduced.  The coming furor will make a Tea Party rally look rather sedate.