What Deficit? What Cliff?

By John Weeks.

Representative Ryan contemplates the Fiscal Cliff. (Apologies to Caspar David Friedrich, "Wanderer above the sea of fog" 1818, Wikipedia free image.)

Republicans and Democrats alike tell us, it is time to "get real" about government finances, to prevent falling off the "fiscal cliff" sometime soon after Christmas. They shudder at the size of the fiscal deficit, a whopping 7 percent of national income (aka gross national product, GDP). They show signs of hysteria when contemplating the federal debt, over $16 trillion.

If households have to live within their means shouldn't those freeloading politicians make the government do the same? The president himself tells us an Austerity-Lite version of this. The disagreement is over what and how much to cut (the independent senator from Vermont, Bernie Sanders being a notable exception to this fiscal madness).

As a first step to "getting real", label all that deficit and debt debate as unmitigated nonsense. No cuts are necessary (as in zero). The deficit has been in continuous decline since the middle of 2009, which is three years by my count. The deficit declined simultaneously with the much maligned Obama fiscal stimulus, as timidly inadequate as it was. You read that correctly. The infamous spending "surge" in the first year of the Obama presidency did not increase in the deficit, quite the contrary. If you don't believe it, look at Chart 1. At the beginning of 2006 the federal budget balance was minus 207 billion, at the end of 2007 minus 277 billion, and minus 662 billion as the Bush presidency staggered towards its timely termination at the end of 2008. About the day Mr Obama took the oath of office the deficit approached one trillion. This was the largest peacetime increase in the debt-GDP ratio in US history, which could be listed as one Mr Bush's outstanding achievements along with two illegal and eventually lost wars.

When the funds and tax cuts of the American Recovery and Reinvestment Act began, the deficit total had reached 1.3 trillion at current prices, and 1.2 trillion measured in the prices of early 2006. Once the stimulus package kicked in, the deficit began its decline, as a percentage of GDP (from 9.4 to slightly less than seven), in constant prices (from 1,215 to 960 billion), and even in current prices (from 1.3 to 1.08 trillion). The deficit is getting smaller without expenditure reduction. Even continuation of the current

pathetic rate of economic growth would bring the deficit down to less than three percent of GDP by the end of the Obama government.

Chart 1: We fell off the cliff in 2008

Federal government budget balance (FGBB), current and constant dollars, and percentage of GDP, by quarter, 2006Q1 - 2012Q3

Surely, this chart cannot be right. Deficits do not go away on their own, do they? And how can spending more and cutting taxes lower the deficit? Deficits do go away on their own, spending can lower deficits, and this is neither rocket science nor voodoo. It is the result of very simple relationships that operate in a market economy. I have written and spoken about these before on the Real News, but many remain unconvinced. With hopes of greater success, I offer Chart 2.

This shows changes in government revenue and expenditure from one three month period ("quarter") to the same three month period a year later. This subtraction converts quarterly changes into annual changes. These numbers are shown as percentages of national income (GDP), and compared to the growth rate of GDP for the same quarter.

A look at the lines makes the basic relationships obvious. When the economy grows slowly or contracts, government revenue contracts. People and businesses have less income, so they are charged less tax. We also see a negative relationship between the growth of the economy and the share of government expenditure in GDP, though it is weaker. About the middle of 2010, after most of the stimulus funds were disbursed, the increases in spending decline to zero and turn negative. In part this is because unemployment declined, reducing benefit payments.

Chart 2: Climbing up the fiscal slope

Changes in Government Revenue, Expenditure (% of GDP) and the GDP Growth Rate, 2007Q1 through 2012Q3

I include Chart 3, what is called a "scatter diagram", to make the point more obvious. As before, this chart shows changes in federal tax revenue from one quarter to the same quarter the next year, this time the current dollar value rather than share of GDP (vertical axis). The horizontal axis measures the current dollar change in GDP between quarters. For example in the last quarter of 2009 the change in GDP was relatively tiny, a mere $6 billion (4/100ths of GDP for the year). In the same quarter tax revenue declined by $189 billion. The next quarter, beginning of 2010, GDP rose by $384 billion and tax revenue increased by 139 billion.

For the 23 quarters (five and one-half years) the link between changes in taxes and changes in national income was very close, as summarized by the dashed line in Chart 3. Therein lie lessons: 1. deficits decline because tax revenue increases, not because expenditures are cut;
2. tax revenue increases when the economy grows; and
3. when the private sector is in recession, we get growth through more public spending.

It really is that simple, as the charts show. Too bad that all the Republicans and 95 percent of the Democrats haven't got a clue. This brings to mind a quotation from the Bible, “Hear now this, O foolish people, and without understanding; which have eyes, and see not ” (Jeremiah 5:16, usually misquoted as "none so blind as those that will not see").

A second Biblical quotation is even more appropriate, "many false prophets have gone out into the world" (John 4:1). We find the contemporary False Prophets concentrated in and along Wall Street and the City of London, where they preach that spending and tax policy should not be left to the democratic process, but must conform to the demands of financial speculators.

Chart 3: Grow and the deficit goes away (not vice-versa)

Absolute changes in federal government revenue and GDP (dollars bns), 2007.1 - 2012.3 (quarter to same quarter a year later)

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