The federal budget outlook is still dismal, but—believe it or not—there has been substantial progress. Federal spending in the past three years has increased by a total of only 1.5%, while federal revenues have increased by a total of 22.7%, despite a 2-year payroll tax holiday and no increase in tax rates!
The chart above shows the 12-month running total of federal spending and revenues. Note that since the end of 2009, spending has been almost flat, while revenues have increased steadily. Congressional gridlock gets the credit for slowing spending growth, while the economy's ongoing recovery—regardless of how unimpressive it has been—gets the credit for boosting tax revenues. It is unfortunate that President Obama has placed so much importance on increasing tax rates for the rich in order to address the still-yawning budget gap, when tax revenues have been rising quite impressively without any assistance from higher rates. Economic recovery has once again proven to be the best source of tax revenues for the federal government. The public has not gotten this message.
This next chart shows spending and revenues as a % of GDP. Note that simply stopping the growth of nominal spending is enough to bring about a fairly impressive decline in the burden of government (i.e., spending as a % of GDP). No actual cuts are needed to effectively shrink the size of government.
This chart puts the current situation in a long-term historical perspective. Note that spending as a % of GDP is still substantially higher than its post-war average, whereas revenues are only slightly below their post-war average. In order to achieve a balanced budget, this strongly suggests that the heavy lifting of policy should be focused on restraining the growth of spending while promoting economic growth. Higher tax rates are not needed. Unless, of course, President Obama's intention is to permanently increase the size of government, and increasingly it looks like it is.
We are very fortunate as a nation that the federal deficit has declined significantly in the past three years, from a high of 10.5% of GDP in late 2009 (a level that was clearly unsustainable) to less than 7% today. 7% is still very high, but it is not unsustainably high and it is on a downward trajectory.
As this next chart shows, gains in federal revenues have accreted throughout the year. Every month in 2012 showed higher revenues than the same month in prior years.