Charting the Unsustainable Budget

by: Kurt Brouwer

This is a very nice chart packed full of useful information on the history of tax revenues and spending. When you look at it, you can see clearly the truth that is often masked — we are screwed. That is, unless we see the light and make significant changes.

Click to enlarge

Click to enlarge

Source: Keith Hennessey

In case you were wondering, the sources for this chart are the President’s budget itself, as well as historical data on spending and revenues.

The chart packs a great deal of information in one place. Here is how its creator, Keith Hennessey, described it in this post [emphasis added]:

…The dotted red line shows us that, over the past 50 years, federal government spending averaged just over one-fifth of the economy (20.2% of GDP). The dotted blue shows us that, over the past 50 years, federal revenues averaged just over 18% of GDP. The small yellow double arrow between the dotted red and blue lines shows the average deficit over the same period: 2.1% of GDP.The vertical white line at 2011 separates the past from the projected future of the President’s policies.

…Three things should jump out at you from the future portion of this graph:

  • The red and blue lines diverge enormously, and the gap grows over time.

  • The blue line is flat while the red line slopes upward.

  • Both the red and blue lines shift upward significantly.

So, when you hear rhetoric about draconian budget cuts or slashing or whatever, just look at the red line. Spending is going up over time, not down. The gap between revenues (blue line) and spending (red line) grows over time because spending goes up while revenues top out.

Why, you may ask, do revenues top out. For some reason, they do. Here’s why.

Taxpayers adapt to higher rates

How does this work? Well, it should be no surprise to readers of this blog, that when you raise tax rates, investors and taxpayers change their behavior accordingly. For example, when capital gains tax rates go up, investors slow down realization of gains. So, despite a higher capital gains tax rate, the actual revenue received from capital gains taxes may not go up much. Conversely, when capital gains tax rates go down, investors speed up realization of gains, thus increasing tax revenues. Is there a correlation? Yes there is.

It’s important to remember that investors have some control of when and if they will realize a gain on a sale of stocks, mutual funds, real estate or a business. And, this is not just an issue for the ‘rich.’ In recent years, many households reporting capital gains have been under $100,000 in annual income.

The next chart corroborates the data in the chart above. In fact, it indicates that the projection about tax revenues as a percentage of GDP may be generous.

This chart appeared in the Wall Street Journal a few years ago. It shows steady tax revenues as a percentage of GDP despite the significant changes that have occurred in the highest marginal tax rates. In other words, even when income tax rates were much higher than they are now, tax revenues were not higher when measured against the economy.

Click to enlarge

Source: Wall Street Journal

As you can see, over the long haul, Federal revenues stubbornly cling to the level of 18-20% of GDP. Currently, they are at a lower level due to economic weakness and the impact of the financial panic on capital gains and incomes.

Math is hard for politicians

However, Federal spending seems to be limited only by the imagination of our political leaders. Currently, it is around 25% of GDP. Taken together, those two factors translate into the fact that we can face enormous deficits as far as the eye can see.

Those politicians who think we can raise taxes to cover spending have not done the math. With a current budget deficit of $1.6 trillion or so and individual income tax revenues of $935 billion, can we really expect that we could cover the deficit with higher taxes.

Consider this: All Federal income tax revenues from individuals have been running a bit over $900 billion a year for 2009 and 2010 (see data here). Even if you throw in corporate taxes, that’s only estimated to be $156 billion this year. Even if we go back to the revenues from 2008, the grand total for income taxes and corporate taxes for 2008 was only $1.45 trillion.

Is there any form of math that suggests the Feds could nearly double the take from income taxes and corporate taxes? I don’t think so.