In his latest Breakfast With Dave letter, David Rosenberg does some back-of-the-napkin maths to show why a mere re-acceleration of the economy won’t be enough to save us from a deficit calamity:
I get asked all the time why anyone should get nervous over the fiscal backdrop
since so much of the deficit is due to faltering government revenues. Well, here is
the answer. If revenues had not declined as a share of GDP, as it usually does in a
recession as lower employment, wages and sales drag down tax receipts, then the
deficit would be $1.1 trillion today, not $1.5 trillion. Hopefully that makes you feel
better, but it shouldn’t because what this means is that even if the economy
comes back to the point where revenues re-accelerate, we would still be left with a
deficit of 7-8% of GDP. We need a budget gap of half that size at most to prevent
the U.S. public debt-to-GDP ratio from maintaining its upward trajectory.
The fiscal challenge is one of dramatic overspending by the federal government
— not just spending, which is normal to combat a recession, but the degree and
the lack of effectiveness since cash-for-clunkers, Social Security bump-ups,
bailouts and housing goodies provide a short-term sugar-high but do not have
very powerful multiplier impacts and do little to encourage investment and
productivity growth. So, when we do the maths a little differently and assume
that the government had held its spending-to-GDP ratio constant during this
recession, then the deficit would be $650 billion today (due to the recession
effect on the revenue base and the effects from whatever tax relief has come
our way over the last two years).
Federal government spending now represents over 24% of GDP. Let’s put that
into some context. Scouring eight decades of data, outside of World War II,
government spending has never been so high in relation to the size of the
economy. During the roll-out of the LBJ ‘Great Society’ experiment, this share
approached but never exceeded 20%. During the peak of military spending
during the Vietnam and Korean wars, this ratio rarely touched the 20% mark. In
fact, go back to the Great Depression and the seven years of massive New Deal
stimulus and incursion by FDR, and the spending to GDP ratio peaked at just
over 10% — less than half of where it is today. (Ditto for the deficit-to-GDP ratio,
which never exceeded 6% as a share of GDP back in the 1930s; FDR was a
downright conservative next to what we have on our hands today)!
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