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Redstate...
The Growth Deficit and Spending Fairy Tales
It’s Our Income That Matters, Not The Government’s
Posted by Dan McLaughlin
Thursday, May 24th
Note: The article makes reference to a number of graphics and charts. To see them, click the Redstate link below.
The United States faces a number of economic and fiscal challenges in
the short and long terms. But the single biggest is the Growth Deficit:
the problem of government spending and government debt growing faster
than the private sector. That deficit needs to be reversed; we are on
an unsustainable path unless we start producing a Growth Surplus. And
Republicans and conservatives need to put more effort into emphasizing
the importance of the Growth Deficit to the public.
The Obama Administration seems to recognize that this is a political
vulnerability, as it has lately been spinning the notion that the last
few years have not actually grown federal spending. Below the fold,
I’ve collected a number of charts that illustrate why this is nonsense.
But first, a word on how we should be measuring our solvency.
I. Operating Deficits and Credit Card Balances
We’re all familiar with the budget deficit, the measurement of how much
more the federal government’s annual operations spend than the
government takes in. I refer to this as the “operating deficit.” The
operating deficit has really only one important role: it tells us how
much of the government’s spending will lead to the issuance of new
debt. While large operating deficits can be a symptom, they are not the
real problem. Let me illustrate with a simplified example. Let’s say
you have a credit card with a fairly low teaser rate, 2 or 3%. You are
running a balance on that card instead of paying your bills on time,
which means you’re paying a modest interest rate and the balance is
accumulating. In terms of your credit card spending, you have an
operating deficit – you’ve spent more than you paid back. But in this
example, the amount you’re spending on the card isn’t that big compared
to your income and savings. That balance may not be a great idea:
eventually, you’ll have to pay it off, that could be a pain to do if
you let it pile up too much, and if it goes on too long the interest
rate will go up. But you don’t have a serious problem because you have
the money to pay for what you’re spending, even if you aren’t paying
your bills on time.
Now picture the opposite situation: you’re spending way more every
month than you earn, but you’re still paying your bills each month by
raiding your savings account. You don’t have a credit card balance, and
thus don’t have an operating deficit – but you do have a serious
problem, because you are spending more than you’re making, you’re using
up your savings instead of adding to them, and sooner or later your
savings will run out and you won’t be able to keep this up. You’ll be
broke.
The credit card balance in these examples is the operating budget
deficit – it tells you whether or not you’re paying your bills on time.
But it doesn’t tell you whether you’re spending more than you (the
American taxpayer) can afford.
To know whether we are spending more than we can afford, we have to
compare government spending to the nation’s income (ie, the money being
made by the taxpayers), not to how much of that income is being used in
a given month or year to pay the bills when they come due. Sure, a big
balance is often a sign that you’re spending too much – but you can’t
cure that problem, long term, by raiding your life savings to pay this
month’s bill. You can only fix it by bringing your spending in line
with how much money you make in the first place. In the real world,
that means we have to ask, not whether the government is taxing us
enough to pay its bills, but whether the government is running up bills
we can’t afford to pay with the money we make. The government can’t fix
the problem of spending more than we can afford by taxing us to stay
current on its bills; if it does, we’re just raiding the private
sector’s savings and income to pay for today’s spending, depleting the
money that’s left over to pay tomorrow’s bills. Over-reliance on
operating deficits to measure fiscal health ignores this dimension by
assuming that a government that is eating the private sector’s seed
corn to pay today’s bills on time is healthier than one that is living
well within a society’s means but doing so partly by issuing debt.
II. The Growth Deficit
What I’ve explained above is the overall parameters. The proper
measurement, in my view, is to compare the total spending by the
federal government to total private sector income, which can –
depending how you look at these things – be measured by private-sector
GDP or by Gross Domestic Income. Phil Kerpen, for example, makes the
case for using private-sector GDP.
Economist and investment manager Rob Arnott adds another way of looking
at the question, arguing that besides private sector GDP we can look at
what he calls “structural GDP” – GDP minus the operating deficit. The
theory for that is that including operating deficits in GDP growth
figures lets the government massage the numbers:
Let’s sup-pose the gov-ern-ment wants to daz-zle us with 5% growth next
quar-ter (equiv-a-lent to 20% annu-al-ized growth!). If they bor-row an
addi-tional 5% of GDP in new addi-tional debt and spend it
imme-di-ately, this mag-nif-i-cent GDP growth is achieved! We would all
see it as phony growth, sab-o-tag-ing our national bal-ance sheet –
right? Maybe not. We are already bor-row-ing and spend-ing 2% to 3%
each quar-ter, equiv-a-lent to 10% to 12% of GDP, and yet few observers
have decried this as arti-fi-cial GDP growth because we’re not
accus-tomed to look-ing at the under-ly-ing GDP before deficit spending!
From this per-spec-tive, real GDP seems unreal, at best. GDP that stems
from new debt – mainly deficit spending – is phony: it is debt-financed
con-sump-tion, not pros-per-ity. Isn’t GDP, after exclud-ing net new
debt oblig-a-tions, a more rel-e-vant mea-sure? Deficit spend-ing is
sup-posed to trig-ger growth in the remain-der of the econ-omy, net of
deficit-financed spend-ing, which we can call our “Struc-tural GDP.” If
Struc-tural GDP fails to grow as a con-se-quence of our deficits, then
deficit spend-ing has failed in its sole and sin-gu-lar purpose.
I’ll return to Arnott’s charts later, but one of the things that’s
frustrating in evaluating this issue is that consistently collected
private GDP figures over time are not that easy to come by. The BEA has
them in one dataset from 1963-97 and a different method of collecting
the data from 1997-2010, although the numbers appear to be reported in
“current dollars.” (General note: I’m happy to hear from people who
have better ways to skin this particular cat in terms of measurements).
The fact that we’re not reporting a regular, widely-used and easily
available private sector growth measurement is itself a symptom of the
failure to popularize thinking in these terms.
Another methodological problem is that federal operating deficits tend
not to get reported honestly. USA Today had a big cover story this
morning on this, noting the various items (like new liabilities for
entitlements) that get exempted from officially reported deficits. USA
Today’s chart illustrates the impact:
A proper picture of our fiscal health would look at three variables –
private sector GDP compared to spending and debt. (It would also look
at state and local government spending and debt. In fact, a good deal
of the explosive growth of federal spending the past several decades,
in particular in the Medicaid, education and transportation areas,
involves the state governments effectively borrowing money on the
federal government’s low credit rating to cover their own operating
deficits). That’s the balance that really matters: keeping our public
spending in line with the source of income that ultimately pays for it.
But it would then also track the relationship of those variables over
time to see if we are headed in a positive direction (the private
sector growing faster than our public obligations) or a negative one,
as we are now.
That’s the problem of the Growth Deficit. We’re already spending too
much of what we earn, and that in and of itself puts a crimp in the
base from which we grow the private sector. But the bigger problem is
that the relationship between public spending and private-sector growth
has been getting worse, and is projected to get a lot worse. We have to
look, over the multi-year view, at whether government spending –
including things like entitlement spending and interest on debt that
grow on auto-pilot – is growing faster than the private sector economy.
The picture isn’t pretty. Here is Arnott’s chart, in small format and
clickable blow-out format, showing the trend since 1944 (in
inflation-adjusted per capita terms) in – among other things –
structural and private sector GDP (the yellowish and greenish lines,
respectively), and federal outlays (the brown dotted line). Even
adjusting for the fact that Arnott uses a different visual scale to
measure federal receipts and outlays than to measure GDP figures, the
trend of convergence between the federal outlays line and the private
sector GDP line is alarming.
The debt trend is not encouraging either. I don’t have comparable
numbers to do a proper chart of the ratio of debt to private sector
GDP, and I continue to apply Crank’s First Law of Government Financial
Forecasts (i.e., they are always, always wrong), but basically every
measure available shows a sharp increase over the past few years, and
as Phil Klein illustrates, even the White House’s own numbers show only
a slight projected decrease in the rate of debt growth from 2012:
III. Spending Fairy Tales
Enter the Obama White House and its allies, which are touting an
‘analysis’ by Rex Nutting of Marketwatch supposedly showing that
spending has actually grown slower under Obama than under past
presidents. James Pethokoukis explains here and here some of the
reasons why this is nonsense (make sure to read both), and presents
these two graphs to illustrate the real story. First, the properly
illustrated rates of spending growth:
Second, the properly illustrated share of GDP – and again, this is
comparing to GDP as a whole (including both tax-financed and
debt-financed government spending, rather than just compared to the
private sector).
And note, these are for years before the new Obamacare spending
entitlement and Medicaid expansion go into full effect, plus before the
waves of retiring Baby Boomers start exploding the rates of spending by
Social Security and Medicare. As this NY Times graphic illustrates,
entitlements have been driving the real per capita growth of government
for years.
But there’s more! This enormous and excellent graphic by Political Math
(again, I’m indebted to the work that went into these graphics, make
sure to click the links and follow for a full explanation) shows
exactly how many other bits of hacktastic dishonesty had to go into
that Rex Nutting analysis.
So much of our public debate over spending and debt involves numbers
with, as PJ O’Rourke once put it, vapor trails of zeroes after them,
and it is dreary work indeed trying to make sense of them all. But our
analytical framework should remain constant: the voters need to
understand exactly how large a share of private sector income is being
spent by government or borrowed against by government, and whether we
are growing the private sector faster or slower than the public sector.
Until we start framing the issue in those terms, we are not even asking
the right questions.
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