ARE WE REALLY ALL KEYNESIANS NOW?
Typically, our analysis of the Fed’s Z.1 flow of funds report has focused on household finances. But the Z.1 is a big data set, and also contains some interesting stuff on government finance, particularly table F.106.
First, a chart that everyone should be familiar with: government receipts less government expenditures, otherwise known as the deficit.
No surprises here, the government is spending more than it brings in. But this is mostly due to Keynesian-style spending meant to stimulate the economy, right? Let’s look at the breakout of spending:
One of the more salient features of this graph has been highlighted by the red arrow: 1972, when transfer payments became the most significant government outlay. The portion of government spending that could be referred to as stimulative is consumption expenditures, but this is becoming a smaller portion of total government spending. For instance, when flow of funds data was first collected in 1952, consumption expenditures made up 71% of total expenditures while transfer payments made up 20%. By the end of 2009, consumption made up only 28% of the total while transfer payments made up 61%. The primary function of government now seems to be transferring wealth from one group to another through programs like Social Security, Medicaid, Medicare, unemployment benefits, the new health care system, etc. It’s hard to consider this kind of spending stimulative, and I doubt this is what Keynes had in mind. The interesting line to watch going forward will be the green one: interest payments. While they are currently low, this is due to low interest rates, not low absolute debt levels (as just about everyone should be aware). It’s easy to imagine scenarios in which the green line quickly becomes a more significant portion of government expenditures.
For now, however, transfer payments are king of the hill. They are now so large that they have caught up with total government receipts. Let’s look at this idea in the following two charts.
Put a different way, effectively all government receipts (personal income taxes, corporate taxes, various withholdings) are going right back out the door to fund Social Security/healthcare/unemployment/etc. All other government expenditures need to be financed.
Perhaps we’ve naively made the upper bound of that last chart 100%. It’s likely that we’ll need to reformat that axis in future, unless the long-term trend of rising transfer payments can reverse itself. The more likely outcome will be the search for higher receipts, in the form of higher personal income and corporate taxes.
I am no Keynesian. Let the Keynesians take the blame for governments that default on or inflate away their debts.
Can the USA default on their “debt”? Where is the inflation?
It has become clear to me in my adult life that all politicians are Keynesians. There really is no difference between Republicans and Democrats when it comes to spending. Where is the inflation? Don’t our debts have to be paid down first?
You’re correct about politicians. But what debt does the US owe? We have not one penny of foreign denominated debt.
Good point, extend and pretend then inflate and wait for debts to get paid off. I was more referring to the delevarging that needs to occur between consumers and private and public sectors.
Put a different way, effectively all government receipts (personal income taxes, corporate taxes, various withholdings) are going right back out the door to fund Social Security/healthcare/unemployment/etc. All other government expenditures need to be financed.
That’s a slanted way to describe it. Expenditures exceed receipts; it doesn’t matter exactly what those expenditures are.
The deficits are the result of spending being greater than income, regardless of whether that spending ends up buying guns, butter, or whatever. We have a deficit during good times or bad because politicians are generally unwilling to match taxation with spending.
The American consumer lives in much the same way. They use leverage as a substitute for a lack of current income. Life imitates government, and government imitates life.
If we want to fix this, we’ll need to both reduce our spending and increase taxes. It’s the latter part of that equation that is the most politically troublesome.
Increasing taxes isn’t the only way to increase tax receipts. Implementing pro-growth and pro-investment policies will also increase receipts and/or mitigate the need for tax increases. I also disagree that it doesn’t matter where the government spends its money. While virtually no goverment spending has a multiplier greater than or equal to 1 (recent research suggests aggregate government spending has a multiplier of 0.4 to 0.7), some types of spending are more accretive (or likely just less dilutive) to economic activity than others. Funding unfunded liabilities like SS or Medicare have a multiplier approaching zero. Building roads or financing education will have some payback greater than zero.
Inflation would be in the form of higher interest rates on US Treasuries, but the peculiarity of the past 10-15 years has been that China is locked into buying our debt to maintain a currency peg. Because the Chinese one-party cannot afford a disruption to economic growth when ~6% annual growth is necessary just to supply enough jobs to accomodate the millions moving from the countryside to urban areas, they have committed themselves to their current export-dependent economic model. To keep the party going, they have to buy US debt, that keeps a lid on our long-term interest rates, and we can all party like it’s 2005-07 with low long-term interest rates.
So everytime we are threatened by recession, fiscal and monetary authorities can fire up the helicopters without a lick of real concern from long-term Treasury markets. Thus, the Greenspan/Bernanke/fiscal put works. Presto, we have an economy dependent on rising asset-values (which is actually logical if you believe authorities always have the power to reflate, case in point March 2009-now). How long can this keep going? Who knows, but we should watch disruptions in China very carefully…
Implementing pro-growth and pro-investment policies will also increase receipts and/or mitigate the need for tax increases.
The Bush 43 tax cuts were a failure — they increased the deficits by reducing tax revenues. GDP growth did not offset the reduction in tax rates.
There comes a point when reducing tax rates leads to lower tax receipts. This mantra of always cutting our way to prosperity doesn’t make any sense at all.
Even if you accept the concept of the Laffer curve, it does not follow that the optimal tax rate for generating taxable receipts is zero. Tax rates were considerably higher when Reagan enacted his cuts than they were when Bush 43 enacted his, and we should be willing to accept the notion that tax cuts could be appropriate when the rates were high while simultaneously accepting that they were a mistake when the rates were already low enough. This shouldn’t be a matter of ideology, but one of finance.
I also disagree that it doesn’t matter where the government spends its money.
From the standpoint of this article, it doesn’t. The money multiplier is a valid concern, but that isn’t the issue being addressed in this article.
The federal budget deficit is the net of receipts minus expenditures, and it doesn’t particularly matter what those expenditures are. Buying more guns in place of butter won’t fix the deficit; the actual spending has to be cut and/or the receipts increased.
The problem with the Bush era was runaway spending and a general apathy toward domestic economics. Of course, Dems at the time complained, for instance, that Medicare D wasn’t large enough, so…
I think this focus on single year cash flows is beside the point. Because our government is on a path where deficits will grow faster than the economy, we will be accumulating debt at an higher rate than our national income can support it. Eventually this becomes a self-reinforcing Ponzi cycle.
The “multiplier” is important because government will invest according to political and social ends rather than for greatest economic return, which is a waste of otherwise valuable resources. On a net basis we are worse off after 1st, 2nd, and 3rd round effects are considered.
In the short term government spending is an input in the accounting identity. In the long term, it is a leveraged investment. Central planners are notoriously poor investment managers.