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With the fiscal cliff looming, it's good to put our current state of Government receipts and expenditures in perspective relative to gross domestic product.

There is no doubt that over the last four years, the Federal Government has been spending more than ever and running huge deficits to pay for it.

But how does this compare historically, or at least back since 1947?

I created a chart showing both State and Federal receipts and expenditures, including both combined to get an appreciation of aggregate Government contribution to our economy.

(click images to enlarge)

Starting with the bottom two lines, blue is State and Local receipts, and green is the expenditures of State and Local Governments. Spending reached 15% of GDP in the third quarter of 2009, and is now 14% of GDP as of the 2nd quarter of 2012. States are running a slight deficit of a little less than 1% of GDP overall. We might be in for more State taxes, like higher property taxes next year, to fill that gap.

The middle orange and red lines are Federal receipts and expenditures, red being expenditures and orange being receipts. Tax receipts from the Federal Government as a percent of GDP have been trending between 15% and 20% or so since 1947, while expenditures had been in-line with receipts up until Nixon took the dollar off the gold standard in August of 1971. Spending had outstripped receipts in most of the years ahead.

The only time Federal receipts were above Federal expenditures was in the late 1990s, when we had nearly 65% of our population employed in a job paying payroll taxes and income taxes. Today, 58.8% of our population is employed in a job paying payroll taxes and income taxes.

See this chart of employment to population ratio for reference:

The chart above is a good reference, as it shows the down legs in employment to population led to down legs in Federal receipts.

In this last recession, we took Federal spending from about 20.6% of GDP in 2007 to 25.5% of GDP until mid 2011. As of the second quarter of 2012, Federal expenditures are 24.2% of GDP.

The problem with this is, we forgot to raise taxes to compensate for the increased spending.

I think it is doubtful that we'll get the jobs we lost in the last recession back. I think we are to stay about where we are today within the range of employment to population, with a risk of further downside.

Without more employees as a percent of our population, there will be great pressure to raise taxes and cut spending to reign in the Federal deficits, which is what the fiscal cliff is all about: Raising taxes and cutting spending.

Federal and State expenditures combined reached 40.4% of GDP in the first quarter of 2010, the highest since 1947. Federal and State expenditures are 38.2% as of the second quarter of 2012.

We can't have our cake and eat it too, as the saying goes. While it was for the short-term gain of stopping the job losses and defaults from occurring, all the stimulus and deficits increased our debts even more, risking the long-term fiscal soundness of our nation's credit.

The chart below is an eyeful of data from economies around the world, showing their own budget and trade balances, as well as their latest 10-year bond interest rates:

Both the U.S. and Britain have twin deficits over 10% of GDP, yet both countries are afforded low 10-year bond rates for their sovereign debt as of today.

In the event the U.S. fails to reign in its deficits (and Britain, too), there will almost certainly come a time when the markets will lose confidence in our capacity to tax and pay down our debts, leading to higher interest rates. As a result, we could face the same fate as Greece, Spain and Italy, which have to pay 26.2%, 6.61% and 5.93%, respectively, for 10-year bond issues. All are near, if not fully, insolvent.

Higher interest rates take funds away from spending on the real economy and transfer them to the bankers and owners of the bonds. So confidence is key and having low borrowing rates is a bargain.

What are the consequences of reducing the Federal deficit? One theory is that it will impact corporate profits to the downside. James Montier of GMO conducted a study showing that negative Government net savings contributes positively to corporate profits.

Here is a chart from his study:

The red is net Government saving. As of the first quarter of 2012, net Government savings is -$1,061 billion, which is 6.9% of GDP.

In conclusion, reducing the Federal deficit in and of itself should provide a headwind for corporate profits, which may prove disappointing for U.S. stocks.

Not reducing the Federal deficit, which should continue to benefit corporate profits, would create increased risk for the value of long term bonds and our nation's credit rating.

Source: An Objective Perspective On Government Receipts And Expenditures