Growth May Not Be Enough

2011 March 13 by Frank Monaldo.

This year the budget deficit will be $1.6 trillion. Total spending will be $3.8 trillion. For every dollar we spend as a country we will have to borrow 42 cents. This level of debit accumulation does no seem prudent or sustainable.

A budget deficit is the consequence of the difference between the amount of spending and the revenues generated. A plot of revenues and spending over time, shown below may be revealing. The red curve represents spending, and the blue curve represents revenues. Since 1980, the spending has been generally higher than revenues. Fortunately, at the end of the 1990’s there was a surplus. During the period of the surplus, spending increases moderated, but not much. The increase in revenues caused by increased growth bringing in increasing revenue largely accounte fro the surplus.

The recession in the early 2000s reduced revenues, and spending did not abate, so we had widening budge gap. However economic growth kicked in an we approached a balanced budget. For all intents and purposes we were in near balance. It is hard to believe that the budget deficit was only $160 billion in 2007, less than the budget deficit accumulated this month alone.

A combination of high gas prices and an over-leveraged mortgage market caused a large decrease in GDP with a loss of revenue. The government decided to increase spending to stimulate economic growth, but growth has been anemic, with only very modest increase in federal revenues. Spending rolls on and the deficit balloons.

If we had revenues equivalent to what we had in 2007, this years deficit would be $1.2 trillion. If we maintain the same revenues as 2007, and same rate of increase in spending from the previous few years, the current budget deficit would be $500 billion, very large, but a third of the current deficit. Therefore, spending increases more than revenues shortfalls have been the primary cause of the current deficit.

It is clear from the graph, that spending has risen too quickly and revenues have not. It would seem that the wisest course at this point to reduce the rate of spending increase. However, even if we had no increase in spending for the next few years, we would require very high levels of economic growth to narrow deficit to more historic levels.

We have a $14 trillion GDP and the federal government brings in revenues equivalent to 20% of GDP per year. We gain an increase in revenues of about $30 billion per year for every 1% increase in GDP growth. If we can grow by 4% a year over 10 years that would represent a $1.4 billion revenue increase. Remember, the long-term growth rate of the US has been about 3.5% and it may be hard to achieve such a rate as more people move to retirement.

In other words, a very high ten year growth rate of 4% per year would balance the budget only if we froze spending at current levels for a decade. However, given that Social Security and Medicare costs will inexorably grow just because of the entrance of new retirees into those systems, and the increase debt payment will have to be paid, all other government programs from the military, to education aid, to food stamps would have to undergo dramatic decreases to maintain a freeze.

No one expects government spending to be constant over ten years, given only modest increases we will still need extraordinary rates of growth to bring total debt levels to even a more reasonable fraction of GDP. It used to be we could endure deficits, because growth would rescue us from ourselves. We are rapidly approaching spending levels , where no reasonable rates of growth can bends the two lines in the curve back together.

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