The question I asked myself was: Which factors
have determined the size of the US deficit (or, more rarely, surplus) over
time? I'm not talking about specific items of expenditure, but more in general.
What is it really that makes the US spend more than it takes in? And; what can
be done about it?
Some blame the deficit on lack of growth - the
phrase "grow away the deficit" is very popular among liberals. That
was the whole idea behind the stimulus package after all: Sure, it will create
a deficit right now, but it will create growth, growth will produce more tax
revenue and hence the deficit will fall back again.
Another favourite claim among liberals is that
the deficit is really the Republicans' fault - surely we balanced the
budget under Clinton, did we not?
Others blame unemployment, or war. Wanna know
which excuses actually hold empirically? Keep reading (I'll start by discussing
my conclusions; I describe my methodology later in this post):
Conclusions
- "Growing away the
deficit" - an absurd lie. Out of the many findings
my research gave me, this one is the most surprising: Growth does not actually
reduce the deficit. Here is how it works: Higher growth this
year will, as one
would expect, reduce the deficit this year - but it will actually raise the
deficit the next year. I was shocked
myself to find this, and double-checked the data at least a dozen times before
accepting that it was correct. Here's why this happens: If you have high growth
one year, then revenue will go up that one year and the deficit will fall. But;
once politicians realize that growth for the year has been higher (and the
deficit lower) than expected, they will increase spending the following year
(the budget for one year is usually set late the year before). Sure as long as
growth keeps going up, they figure they'll be fine. But then, that's never the
case. The net effect (over two years) of high growth is actually negative. 1 %
growth will decrease the deficit by roughly $15 billion this year, but increase
it by slightly more the following year. Hence, to grow away the deficit is an
absurd lie.
- Taxing away the
deficit - another liberal daydream. What about raising
taxes? Surely that would reduce the deficit? The answer is yes. Don't get too
excited though - a 1 % increase in tax revenue (as a % of GDP) will only reduce
the deficit by approx. $32 billion dollars. Given that the deficit is over
$1100 billion dollars, the US would have to more than triple its tax revenue
(again, as a % GDP share) before the budget (hypothetically!) would be
balanced. More precisely, federal tax revenue would have to reach 50.65 % of
GDP (compared to 15.4 % in 2011). This would make the US the second highest
taxed country in the world (only the small island nation of Kiribati currently
has a higher revenue/GDP ratio at 70 % - why can't liberals just move there?).
So why do tax hikes not work as well as one might think? You see,
theoretically, a 1 % increase in the revenue/GDP ratio should reduce the
deficit by something like $130 billion dollars*. There are two problems: One is
that when you raise taxes, you will generally reduce economic activity. There
will be fewer companies and workers that you can tax (this is why in extreme
cases, a tax hike can actually reduce revenue). However, the major problem
again comes down to the politicians: Tax hikes are unpopular. If you want to
increase taxes, you'll most likely have to increase spending as well to make
the voters accept it. Also, even if that was not the case, politicians just
generally have a hard time keeping their hands off any extra revenue - whether
it comes from growth or tax hikes.
- No, inflation won't
solve this either. It is well-known that inflation is good for the
borrowers and bad for savers. And since the US as of today most definitely is a
borrower, inflation really should help. While there's no denying there are
upsides and downsides with inflation, if you're hoping that inflation may solve
the US deficit crisis all I can say is don't hold your breath. Inflation does
reduce the deficit, but only by about $8 billion for each extra %. Which means
that in order to balance the budget, Americans would have to accept an
inflation rate around 130 % - again this is very hypothetical assuming each
extra % of inflation reduces the deficit by the same amount as the last one. In
reality, an inflation rate of 130 % would of course destroy the entire US
economy.
- Elections don't have
consequences. Yes, that pretty much
sums it up: Democrats and Republicans are equally good at deficit spending. There's
no statistically significant difference, which confirms what you must have
suspected after the first two conclusions: The political system is broken.
There is a culture in Washington, DC that is permeating the Democrat and the
Republican party. This culture - a culture best known for its shortsightedness,
lack of care for future generations and disregard for the common man - is the
real problem. This is more serious than you might suspect: Because we're
dealing with a "cultural" problem, the problem won't go away until
the culture has changed. Culture rarely changes overnight - changing the
culture in Washington, DC may take decades. Meanwhile, the US is quickly
running out of time...
- Deficits are
addictive. If you're a regular
Rightspeak reader, you may recall that I've previously argued that
governments form habits just like individuals do, and that deficit spending is
one of those things that easily becomes a habit. Now, empirical evidence
appears to prove me right: A $1 billion increase in the deficit this year, will
lead to a $585 million increase in the deficit next year. In short: There is a
lag. This means that a deficit isn't very easy to just shake off from one year
to another. That's not good news, but it's also no big surprise. Moving on...
- Wars cause deficits. If the previous
conclusion was a no-brainer, then this one should be even more so: Wars
increase deficits. You may be surprised to find out though that they only
increase deficits by about $74 billion (per year). A lot of money, yes - but
again the liberal talking point "the budget would be balanced if not for
the wars" appears to be wrong. There may have been a time when $74 billion
really made the difference between surplus and deficit, but that time is not today.
We should also note that sometimes, the alternative to war may have caused a
higher deficit: If the US had sat back after 911 and not done anything, that
would have allowed for even more terrorist attacks on US soil. I admit I don't
have any empirical data to back this up, but I think in the long run allowing terrorists to
hit skyscrapers with airplanes can have an adverse effect on the fiscal
well-being of a country.
- Reducing unemployment
only goes so far. Here's some good news: If we could only reduce unemployment
back to normal levels (about 5 %), the deficit would be approx. $150 billion
lower than it currently is ($50 billion for each %). The bad news of course is
that there's still almost $1 trillion deficit left. And the really bad news of
course is that the current jobs policies pursued by the Obama administration
won't create any jobs in the private sector. While the public sector is an
important part of society, jobs in that sector don't really do much to reduce
the deficit - the government has to pay the salaries, so those jobs actually
represent an expenditure. I trust that most CT readers already know this - I'm
just explaining it in case there are any politicians reading this. They are the
only ones who don't seem to get it.
What is the
solution?
What I've written so far has been very
depressing. Trust me when I tell you that conducting this research was even
more depressing for me than reading the results were for you. I truly want the
US to succeed. I am one of few Europeans who openly support the US superpower
and who wants the 21st century to be an American century. I'm not gloating at
your misfortune.
When I began working on my research
project, I had a pretty good idea about what I would find. I knew it would be
mostly bad news - though I could never have imagined how bad.
The bottom line is: The US cannot grow,
tax nor inflate its way out of its current deficit. As you've probably guessed,
this leaves only one option: Cutting spending.
This is something that we need everyone to
understand: The only thing we should be discussing right now are which budgets
to cut and by how much. The sooner we understand that austerity is the only way
to go, the faster we will get out of this mess. As long as politicians and
pundits are fooling themselves into thinking we may somehow solve this with a
bit of growth and maybe a tax hike, the problems will only get worse.
The other suggested "solutions" to the
deficit remind me a lot of fad diets promising to help you lose weight
effortlessly - it's only once you realize that there is in fact no easy way,
and that you have to make major changes to your lifestyle that you can begin to
shed pounds. And the same thing goes with the deficit: As long as we believe in
solutions promising balanced budgets without effort, nothing will ever get done
and we'll only get fatter until the inevitable heart attack happens. We can
still do something. The US is not yet doomed, but we can only be saved if every
conservatives leads by example and accepts spending cuts, even if it will hurt
them personally (for example a conservative with a mortgage should support
eliminating the mortgage deduction). You are going to have to cut about 40 % of
your budget - there is no way this can be done if everyone insists the budget
cuts be designed in a way so that everyone gets hurt except themselves. I am
frankly quite pessimistic; I don't know whether Americans will accept these
hard truths before its too late. But it's not too late now, so it's still
possible.
Basically, the only good news I can bring you is
that there is still time.
Methodology
For those of you interested in the technical
details of my research, here's a summary of my methodology: I constructed a
model with the surplus/deficit as the Y-variable, and the following
X-variables: Growth, Growth last year, Surplus last year, War, Inflation,
unemployment, tax revenue. War is a dummy variable taking the value 1 if there
was a war, and 0 otherwise. I also tested for (more) lags of each variable, but
they came back insignificant. I also tested whether which party possessed the
white house/congress/both had any impact on the deficit, but as I state above
these variables were insignificant. The model's adjusted r-square is 92 %. I
didn't find any heteroscedasticity nor serial correlation (for p=2). Unit roots
were identified in inflation, GDP and surplus data, but the Engle-Granger tests
that I made showed no cointegration. My research covers the years 1946-2011, ie
the entire post-war period. *I have adjusted the data for inflation using 2005
as my base year.
2 comments:
Thanks for sharing your research. A very interesting piece of work. Good luck in your Master's too.
You're right, John, the system is broken.
And what do you do when something is broken?
You fix it.
How do you fix it?
In the immortal words of Ross Perot, you fix it by "cleaning out the barn", by cleaning out the political bribery - a.k.a. "campaign contributions" - that infects & corrupts the entire political process.
We need 100% public financing of all political campaigns, combined with large & equal amounts of free tv & radio airtime for all candidates.
But this critical reform will never occur unless the voters make it priority number one.
It almost happened 20 years ago with the insurgent presidential campaign of Ross Perot.
So why not try again, except this time with a candidate who's a bit more predictable and reliable than Ross Perot turned out to be.
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