Many Americans believe that the deficit and debt problem faced by the US is simply one of too much spending and not one of insufficient revenue collection. For this reason, many Americans believe that the Obama administration's oft-repeated claim that "a balanced approach" is necessary to bring the US back on the path to fiscal sustainability is simply a ruse designed to provide cover for tax increases.
The skeptical disposition of many Americans is not limited to the arguments put forth by the Obama administration. Many prominent independent and conservative voices - the bi-partisan Simpson Bowels Commission, the so-called Gang of Six and former Bush administration Comptroller General David Walker are just some prominent examples - are also stressing that there is an absolute necessity for a two-pronged approach that both restrains spending and raises additional revenue.
In this two-part article, I will directly address the understandable skepticism expressed by many Americans that a two-pronged or "balanced" approach is required. Fortunately, the facts really do speak for themselves and, in the end, leave little room for doubt. Please refer to the table below:
Fact 1: Outlays Are High, But Cutting Spending Alone Cannot Balance Or Avert A Fiscal Crisis
Total federal outlays as a percent of GDP are currently running at a rate of approximately 24.3%. This compares to a historical average of 21.2% between 1980 and 2007, with a high of 23.5 (1983) and a low of 18.2 (2000, 2001). As another point of reference, average outlays as a percent of GDP during the Reagan and Bush administrations were 20.8% with a high of 23.5% (1983) and a low of 21.2% (1989).
Thus, it can be objectively asserted that the current outlays as a percent of GDP are running at a rate of approximately 3.5% of GDP higher than the historical average between 1980 and 2007. Furthermore, the current rate of outlays is 2.1 percentage points higher than it was during the 12 years of the Reagan and Bush administrations.
Some might argue that this current "excess" level of spending of 3.5% of GDP is justified for countercyclical reasons in the context of an economy that has been immersed in a serious crisis. Others might disagree.
However, what is incontrovertible is this: With the budget deficit projected to be 8.5% of GDP in 2012, spending cuts totaling 3.5% of GDP (that would reduce outlays as a percent of GDP to the average level between 1980 and 2007) would not suffice to balance the US budget or even bring the deficit down to a sustainable level. The clear implication of these facts is that any serious attempt to bring the US budget deficit down to a sustainable level must necessarily raise substantial new revenues at the same time.
Fact 2: Government Receipts Are At The Lowest Levels Since 1950, But Raising Revenues Alone Cannot Balance the Budget
Total federal receipts are currently running at a rate of approximately 15.8% of GDP. This compares to a historical average of 18.0% between 1980 and 2007, with a low of 15.1% (2009, 2010), and a high of 20.6% (2000). The average for the Reagan and Bush administrations was 18.2% with a high of 19.6% (1981) and a low of 17.3% (1984).
The most important thing to note here is that between 2008 and 2012, receipts as a percent of GDP collapsed to the lowest levels since the days of the Truman administration in 1950 (the figure in that year had collapsed to 14.4% compared to an average of 16.9% during the entire two-term Truman administration). It is also interesting to note that the average level for the Eisenhower administration - a group hardly known as tax and spend liberals - was 18.1%.
Thus, it is an objective fact that the current levels of receipts as a percent of GDP, at 15.8%, are extremely low by any modern standard. Specifically, government revenues are currently being collected at a rate that is 2.5% of GDP lower than the historical average between 1980 and 2007.
Perhaps an even more dramatic illustration of how low the current government "take" of GDP has become is that total receipts as a percent of GDP are 2.3 percentage points lower than they were on average during the Eisenhower administration. Furthermore, receipts as a percent of GDP are also currently 2.3 percentage points lower than they were during the entire 12-year Reagan and Bush era.
Some would argue that the recent precipitous decline of revenue receipts as a percent of GDP was a necessary component of a countercyclical strategy to stimulate the economy in the context of a severe economic crisis. Others might argue otherwise.
What is indisputable is this: With the U.S. budget deficit forecast to be 8.5% of GDP in 2012, revenue increases that would bring tax receipts back to their historical average of 18.3% between 1980 and 2007 would only close the fiscal gap by 2.5 percentage points of GDP. Such revenue increases would clearly not be sufficient to balance the US budget nor even bring the deficit down to a sustainable level.
The data is clear. There can be absolutely no doubt that the fiscal problem in the US is both spending and a revenue problem. The following graphic clearly illustrates the point:
Expenditures have skyrocketed to never-seen-before levels while revenues have plummeted to levels that are virtually unprecedented in the post-war era. Americans cannot reasonably presume to receive the level of services that they have come to expect and demand of modern government when their tax contributions as a share of their incomes are lower than they were during the Truman and/or Eisenhower administrations, before the advent of the modern state in the United States.
It is shocking to note that expenditures as a percent of GDP are currently higher than at any time in American history since World War II. US fiscal deficits are currently also higher than at any time since World War II. But did you know that during the four years of the Obama administration, revenue receipts as a percent of GDP have collapsed to a level that is lower than those of the average of any US president since Herbert Hoover?
The US clearly has both a problem of excessive spending and insufficient revenue collection. I invite readers to read Part 2 of this essay to understand additional reasons why a two-pronged approach to deficit reduction is an absolute necessity for US fiscal sustainability. In Part 2, I will also explain how a careful analysis of the US fiscal situation - regardless of the prospects for a Grand Bargain -- leads to caution regarding US equities generally, represented in index ETFs such as (NYSEARCA:SPY), (NYSEARCA:DIA) and (NASDAQ:QQQ) and major stocks such as Apple (NASDAQ:AAPL), Oracle (NYSE:ORCL) and Amazon (NASDAQ:AMZN).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.