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# Budget Trends

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Steve ("the skeptical optimist") Conover writes

The two trend lines, receipts and outlays, confirm what I thought I had seen two months ago. Federal tax receipts are growing much faster than federal spending outlays: 15.2% versus 8.5%, respectively.

As a result, he sees a balanced budget by 2008.

I am not sure how he is drawing his trend lines, but I would not extrapolate from performance in a post-recession period. My guess is that the ratio of tax receipts to GDP was depressed during the recession of 2001-2002, and what we've seen in the most recent two years is bounceback from that.

Furthermore, I am more skeptical than optimistic about any trend in which spending and tax receipts are growing faster than GDP. I want to see GDP grow faster than government.

CATEGORIES: Fiscal Policy

Steve Conover writes:

Hi Arnold,

First of all, thanks for noticing my post. You wondered about how I calculated the trends; there are no secrets, so here's the method.

Most important step is to convert monthly receipts and monthly outlays into a time series of (rolling) 12-month totals. For example, R-12 receipts for October 2005 would be the sum of monthly receipts from Nov '04 thru Oct '05. That removes most, if not all, of the seasonality, and usually yields a smooth line, each point of which is an annual total. (I've been using this method in private sector forecasting for quite a while, and it works well.)

After that, it's just math. Two points determine a line, and one of those points is Oct '05; the other is up to you. I tried it two different ways: the point from 6 months prior, and the point from 12 months prior. Here were the results:

Annualized growth using 6-month trend line:
Receipts = 14.4%; Outlays = 6.9%.
Result: budget balances in 2007.

Annualized growth using 12-month trend line:
Receipts = 15.2% growth; Outlays = 8.5% growth.
Result: budget balances in 2008.

Let me know if you want the equations. (And, by the way, thanks for recommending Kurzweil's book, The Singularity is Near; it's a page-turner.)

spencer writes:

Rather then your methodology you might try reading the documents. The reason the receipts are rising is a one time boost from the end of special one time cuts in corporate taxes last year.

Timothy Tien writes:

I was just curious if the GDP is nominal or chain weighted (Real), as it would materially vary the spread between GDP growth and receipt growth.

writes:

Spencer is right. Furthermore, this is reinforced by looking at Conover's own post. There was no increase at all in tax receipts until Jan. 2004. This is a rather short time trend to be making anything much out of for any projections into the future.

writes:

The increase in tax revenues relative to GDP recently is largely driven by 1) The asset price bubble 2) The tax increase that the expiration of the depreciation incentives constituted. Nneither of these is sustainable so I don't think we should expect the trend of higher tax reveneues relative to GDP to continue.

On the other hand, because of Bush's drug benefit bill and similar items, spending is likely to continue to increase relative to GDP.

Christopher Clay writes:

Question. Why wouldn't the tax depreciation incentive have a more lasting effect? Wouldn't bonus depreciation lower your depreciation expense in following years? How does the asset price bubble effect tax reciepts (other then local property tax or am I missing something)? Is there any data out there on the effect of the asset bubble on taxes?

Or have I totally missed something? If that's the case don't waste your time with me.

spencer writes:

The way tax depreciation works is that it changes the share of depreciation expenses you can count in a given year against that years revenues in calculating profits.

If you have a \$100 piece of equipment that you depreciate over 10 years you count \$10 each year as an expense in calculating profits. So the tax change allows you to deduct \$20 this year it reduces your profits and your tax obligation. the next year it has a double impact. One, the ammount of depreciation goes back to even less then \$10 -- the total depreciation can only be \$100 so if you take \$20 in one year you have to take less then \$10 in other years.

Second, the special provision leads to firms shifting investments they would have made next year back to this year. Consequently, investment in the next year or less then they would have been. So this has a doulbe impact on the ammount you have in depreciation to count as an expense.

Christopher writes:

Thanks for the answer. However, I think I understand how depreciation works. However, I was more curious as to whether or not it would have a more long term effect on revenue. As you say they are taking less depreciation (i.e. expense) for the remaining years and years being multiple. If the effect of depreciation stays for following years, why would it not be sustainable?

I do see the point about motivating people/business to buy their assets sooner rather then later. An asset is something that has future economic value though so theoretically one would hope that the assets would have a positive future economic benefit (how that relates to taxes is what I wouldn't know). Thanks for your answer I find this stuff so interesting although I feel way out of my league.

writes:

The ratio of revenues to GDP has been remarkably consistent since roughly the end of WWII. Between 17-19%.

Since we dropped below 17% for a couple of years, I'd expect to see it rise for a few more years.

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