Arnold Kling  

Fiscal Reality

Riding Tigers by James ... Income Distribution Reality...

Some numbers from the proposed Budget for 2009 for the Federal government. I try to divide non-security spending crudely into necessary spending (courts, justice, Treasury, the mysterious "other" mandatory spending) and "worthy causes" (things that are really discretionary).

Update: Figures in parentheses are from FY 2000, when we ran a $200 billion surplus. I am estimating as best I can from these tables

Defense: $515 billion ($294)
Homeland Security: $38 billion ($0; was in Domestic Necessary)
Domestic Necessary: $713 billion
Domestic Worthy Causes*: $305 billion ($217)
Social Security: $644 billion ($409)
Medicare: $408 billion ($197)
Medicaid and SCHIP: $224 billion ($136)
Interest: $260 billion ($223)
Total: $3107 ($1789)

(*Domestic worthy causes = Agriculture, Commerce, Education, Energy, Health and Human Services, Housing and Urban Development, Interior, Labor, Transportation, NSF)

Personal income taxes: $1259 billion ($1004.5)
Corporate income taxes: $339 billion ($207.3)
Social Insurance receipts: $949 billion ($652.9)
Other taxes: $153 billion ($161)
Deficit: $400 billion (surplus $236 billion)

Message to Republicans: if you cut spending on "worthy causes" to zero, you still would not balance the budget. You will have to raise personal income taxes.

Message to Democrats: if you increased personal income tax receipts by 25 percent (a ginormous tax increase), you still would not balance the budget. You will have to cut back on "worthy causes."

Message to the AARP: if Social Security and Medicare continue to be "untouchable," then y'all had better buy guns, because in twenty years there won't be any money left to pay for national defense, much less for any "worthy causes."

Update: Today's Lead Editorial in the Washington Post is about Obama, Clinton, and McCain ignoring fiscal reality. One note that I would make is that tax increases (cuts) tend to add (subtract) less revenue than is typically projected, because of the way people adapt to them. I also suspect that spending programs often cost more than is projected, because projections seem to err in that direction.

Also, in response to a comment, I added estimates for these categories for FY 2000. That was a fantastic year for personal tax receipts (also for "other" taxes), thanks to the Internet Bubble. But note how much lower Medicare and Social Security were relative to Social Insurance receipts. The unfunded prescription drug benefit is probably the big reason for the adverse move since 2000, although the rise in health care spending and the gradual increase in the ratio of beneficiaries to workers will be the main factors going forward.

Comments and Sharing

CATEGORIES: Social Security

COMMENTS (24 to date)
Ed Hanson writes:

I know this is a fast first estimate, but the very premise is wrong.

First, it assumes that the budget should be balanced from the current situation in one fiscal year. Besides being impossible by the simplified political goals of each party, such a massive fiscal change in one year is economically irresponsible.

Second, it is a completely static analysis. Raising average tax rates 25% will not increase tax revenues by 25% but by some amount less, and will reduce rate of increase of GDP in future years.

Third, it ignores the the impact of total debt. The goal here should be to decrease total dept as a percentage of GDP. This is accomplished better by taking less in income via taxation, especially those taxes that have the greatest impact on investment in growth.

brian writes:


On your first point, while it may of course take several years, hat table has to balance out sometime. Of course, you have to take into account unexpected expenditures: Bush promised to have it balanced by something like 2004 with a large surplus by 2006 or 2007, but we all know how that turned out. Of course, on the other hand a large part of that was expected in the form of tax cuts.

On your second point, neither Arnold nor anybody else said "increase tax rates by 25%." He said "tax receipts by 25%."

On your third, could you explain how cutting taxes on investment would decrease national debt? Seems to me it would have the opposite effect--increasing the demand for savings, pushing up interest rates, and increasing debt. And that's not even considering the effects of a (presumably) larger deficit on debt.

I could see how cutting taxes on savings (accompanied by equal cuts in unproductive government spending) would help, but cutting taxes on investment seems like a step in the opposite direction if the goal is to shrink the national debt.

Lastly, I like how Arnold used the word "ginormous." I use it all the time but occasionally feel self conscious about it if I'm in an "intellectual" crowd.

Anthony writes:

I'd like to see a comparison to the numbers a few years ago, when we were running a budget surplus. What was different then? Were tax receipts 25% higher? Surely spending on "worthy causes" wasn't $0.

Or was the relatively low spending on the Iraq war (if you want to call it that at that point) the big difference?

Matt writes:

Optimum portfolio theory is counterparty.

The government should optimize its products such that we all buy in proportion to income; and we should balance our shares in government according to the variance of government products. Only then do we approach the proper "return to scale" distribution of government wealth.

Of course, quantum limits, we can only have one share of government in the long run (one man, one vote). The quantum restriction on efficient market leads to a problem, once again. The economy operates closer to balance when we occasional resort to oligarchy rule to balance. Once again, we need a secondary market of greedy oligarchs to occasionally have a fit of corruption, then we want them to go away. Until we formalized the process of raiding government wealth, we will always be "biased".

Standardizing on earmarks is no good. Earmarks, when they are institutional, will be cyclic because we do not need earmark greed all the time.

Harry writes:

As a pure mathematical exercise, this raises a legitimate and a very fundamental question. How are policy makers going to make the numbers work?

My question is, what is the value received for these expenditures? Of course, that is rhetorical because nobody can answer it, but you see my point. I don't mind spending large sums of money to receive excellent value, but will not spend even a small amount to receive very little value.

Matt writes:

By the way,m the TAF auction which Ben executed was the classic Quantum adjustment. He organized an N+1 rank market for a short period. When volatility has been released, Ben goes back to an N rank architecture, quickly.

Bill Gates used to be very good at this. He would sometime position Microsoft as a subcontractor of IBM, and he would sometimes position Microsoft as an independent. He was closer to efficiency the faster he could make the transition, and he could never be both at once. This is rapid switching between quantum restrictions cause real growth, and is the fundamental basis for growth theory, there is no other at the moment.

Anthony writes:

Wow, I took a stab at comparing this to 1999. Tax revenues, pretty much across the board, were about 55% higher in 1999 than 2009 proposed, in non-inflation-adjusted dollars.

2009 on left, 1999 on right:

ind inc tax 791 (45%) 1259 (47%)

corp inc tax 198 (11%) 339 (13%)

ssi 596 (34%) 949 (35%)

other 158 ( 9%) 153 ( 6%)

total 1743 2700

def/hmelnd 553 (18%) 272 (16%)

dom nec/wc 1018 (33%) 514 (30%)

ssi 644 (21%) 393 (23%)

mdcare/caid 632 (20%) 312 (18%)

interest 260 ( 8%) 242 (14%)

total 3107 1733

So yeah, tax revenues are probably going to have to go way up. Of course, this doesn't mean tax rates have to go up, at least not by 55%. An improving economy will help a lot. And inflation will help a lot too, due to the inflation tax.

Josh writes:

Anthony, you reversed the tax revenue data. 2009 is 55% higher than 1999. That works out to about 4.4% growth per year, which has probably exceeded GDP growth slightly(?). The spending has increased at a 5.7% rate. Broken down:

ind inc tax +4.8%
corp inc tax +5.5%
ssi +4.8%
other -0.3%

def/hmelnd +7.3%
dom nec/wc +7.0%
ssi +5.0%
mdcare/caid +7.3%
interest +0.7%

So it seems as if tax revenue increased at about the "right" rate (assuming it should match GDP growth), but the growth in spending on defense, medicare and random stuff was about double what it should've been.

Josh writes:

Sorry, I see that those numbers in my last post ignore inflation. The revenue rates are probably a bit lower than GDP growth taking inflation into account and the spending rates are probably a bit high (but not 2x).

Matt writes:

One thing I should clear up about the TAF auction. As was pointed out in the paper referenced by Arnold, the TAF auction made no fundamental change in the aggtegate balance sheet of the Fed.

There is a general form of this result. The yield curve, being a close approximation to a completely orthogonal Fourier analysis of the economy, the individual period interest rates are independently normal random variables. Since the TAF auction was an auction of single period bonds, there will no net change in the yield curve, hence no net change in the balance sheet.

Snark writes:

Arnold correctly assumes that the message to taxpayers goes without saying.

Lary writes:

The future trajectory of spending increases is far more disturbing than the current imbalances. Rather than worry about getting these numbers in balance, we need to figure out how to grow the economy so that at tolerable taxation rates we can pay for the coming health care/social security tsunami.

If we do have to increase taxpayer burdens, I strongly prefer progressive consumption taxes to higher income taxes. That encourages saving and doesn't discourage work.

Trevor writes:

I for one am ready to dismantle Social Security completely - if Ponzi schemes are illegal for private citizens why do we allow Congress to run the biggest one ever conceived?

8 writes:

According to Arnold's numbers, SS and Medicare are already in deficit. I assume that is Medicare, but I believe SS begins drawing down the surplus in 2009, meaning Congress will have to find new sources of revenue just to maintain existing spending.

shayne writes:

What sorts of things fall within the "Domestic Necessary" category?
(My first econ professor instilled in me an enormous suspicion of anything deemed "needed" or "necessary". I've never lost that suspicion.)

shayne writes:

Follow up ...

The U.S. government is proposing a new revenue source - see

Remember when folks used to say, "Well, at least they can't tax us for air"?

Brandon Berg writes:

There's no need to raise tax rates. First, there's nothing mandatory about "mandatory spending," and I would argue that much of it could be cut. Second, we're at war. Military spending should come down a bit when the war ends.

Finally, we can close the budget gap over a period of several years just by holding spending growth to below the rate of GDP growth, which is exactly what happened during the Clinton administration. Granted, strong revenue growth played a role here, but real per-capita spending barely budged during this time, so the budget gap would at least have shrunk even without the strong revenue growth.

I expect leftists to talk about the necessity of tax hikes, but as libertarians our job is to call BS and point out that the government is spending far more than is necessary or prudent.

Snark writes:

I'm also curious about Domestic Necessary, as it doesn't show up on the official list of OMB budget items. Apparently, it now trumps SS as the largest share of federal spending.

Does anyone know specifically what DN includes?

Anthony writes:

Thanks Josh. I figured something had to be wrong, but I was already late for work so I hit submit anyway! Now I'm late for going home from work, so I'll wait until later to look at the corrected numbers.

brian writes:

Lary: I strongly prefer progressive consumption taxes to higher income taxes. That encourages saving and doesn't discourage work.

I agree that progressive consumption taxes are better than income taxes, but your second sentence is only half right. Consumption taxes certainly encourage saving, compared to income taxes, but they DO discourage work.

To see why, consider the fact that you work for real wages, not nominal ones. So under an income tax, your consumption in dollar terms per hour worked is given by your after-tax wage divided by the price level C=[(1-t)w]/p......where t is the income tax rate, w is your nominal wage, and p is the price level. Under a consumption tax, the same figure is your real wage [w/p] times one minus the tax rate: C=[w/p](1-t). These terms are mathematically identical.

Intuitively, remember that you won't work for cash, you work for the consumption that cash provides. If your nominal income doubles (because of, say, the removal of a 50% tax rate), but at the same time all goods double in price (because of, say, the shift to a consumption tax), your incentive to work remains unchanged..

The point is that income and consumption taxes discourage work equally.

Anthony writes:

"I agree that progressive consumption taxes are better than income taxes..."

"The point is that income and consumption taxes discourage work equally."

A sales tax imposed on the consumer should be equivalent to a gross receipts tax imposed on the vendor. A sales tax exemption for business purchases should be equivalent to a deduction for business purchases. So a properly formed income tax should be equivalent to a consumption tax, right?

"Consumption taxes certainly encourage saving, compared to income taxes..."

Not if the income tax exempts investment income. A consumption tax defers taxes until you spend the money, like a traditional IRA. But when you do eventually spend the money you'll be (on average) spending more than you earned, and therefore paying a higher sales tax, due to your return on investment. An income tax which exempts investment income makes you pay the full tax up-front, but then compounds tax free until you spend the money. So an income tax which exempts investment income is equivalent, in the long run, to a consumption tax, in the same way a Roth IRA is equivalent, in the long run, to a traditional IRA (both assuming the tax rate stays constant).

If you read the actual Fair Tax bill (H.R. 25) it becomes quite obvious (at least to me) that it's really just a roundabout and hidden form of income tax. It's a well designed and simplified income tax, as the special interest groups have not yet gotten to it, but you can see that it's going to wind up with many of the same difficulties with regard to recordkeeping, accounting, etc. There's a cash basis and accrual basis (section 503). There's depreciation (section 705). There are hobby loss exceptions (section 701). There's barter income (section 103(f)).

Under the Fair Tax, when you buy a car that you use in your business you'll still have to keep track of your business mileage vs. your personal mileage, so that you can apply for a rebate on the sales tax based on the percentage used for business purposes. Ditto for the gas you buy to put into the car, the repairs you make to the car, the insurance, etc. Will commuting be considered business usage? The regulations (and likely, the courts) will have to specify. When you buy a house and use part of it for a home office you'll get a rebate for the sales tax you paid on that fraction of the home over the next 30 years. People will lie about their home offices in order to get a bigger sales tax rebate just as much as they currently lie about their home offices in order to pay a smaller income tax. Courts and regulators will have to draw lines in the sand as to what constitutes a home office, for instance the current IRS rule that the area must be used regularly and exclusively.

We're better off intelligently simplifying (and hopefully, eventually, lowering) the income tax than we are starting over from scratch with a "consumption tax".

Lord writes:

AARP would like to see healthcare reformed. The Republicans on the other hand see nothing wrong with it.

retired military writes:

One thing that isnt mentioned but will probably impact Social security tremendously in the next 10 years.

Illegal (Currently) immigrants.

Once they are eligible for Social security under any plan by McCain, Clinton , or Obama (and I think we are screwed under all 3 on this issue) Social security will rapidly tank faster than what it is.

Of course that wont matter to the dems as they will have millions of new voters.

Kurt Brouwer writes:

I enjoyed the post and the comments, which were substantive. Congratulations to all.

I want to add three points to the discussion:

1. Is balancing the budget the best course of action for government? Why?

2. If tax revenues grew by roughly 33%, but spending grew faster (since 2000), then shouldn't we look to the rate of spending growth as the problem?

3. When we consider government spending, shouldn't we distinguish between ordinary expenses and those that are actually long-term investments? In other words, how can we assess the government's financial condition without a true balance sheet that includes assets owned by government?

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