INSIGHTS: IF DEFICITS ARE THIS HUGE NOW, WHAT HAPPENS WHEN THE RECESSION HITS?
GUEST COLUMNIST: Ryan McMaken, a senior editor at the MISES Institute. Reprinted with permission.
The Treasury Department released new budget deficit numbers this week, and with two months still to go in the fiscal year, 2019’s budget deficit is the highest its been since the US was still being flooded with fiscal stimulus dollars back in 2012.
As of July 2019, the year-to-date budget deficit was 866 billion dollars. The last time it was this high was the 2012 fiscal year when the deficit reached nearly 1.1 trillion dollars.
At the height of the recession-stimulus-panic, the deficit had reached 1.4 trillion in 2009. (The 2019 deficit is year-to-date):
What is especially notable about the current deficit is that it has occurred during a time of economic expansion, when, presumably, deficits should be much smaller.
For example, after the 1990-91 recession, deficits generally got smaller, until growing again in the wake of the Dot-com bust. Deficits then shrank during the short expansion from 2002 to 2007. During the first part of the post Great Recession expansion, deficits shrank again. But since late 2015, deficits have only gotten larger, and are quickly heading toward some of the largest non-recession deficits we’ve ever seen.
The situation is a result of both growing federal spending and falling tax revenues. As of the second quarter of 2019, year-over-year growth was nearly at a nine-year high. Federal spending rose 7.5 percent, year over year, during the second quarter of this year. The last time growth rose as much was during the first quarter of 2010 when spending increased 13.8 percent, year over year.
Meanwhile, federal revenue growth has fallen, with only one quarter out of the last eight showing year-over-year growth.
Historically, a widening gap between tax revenue and government spending tends to indicate a recession or a period immediately following a recession. We saw this pattern during the 1990-91 recession, the Dot-com recession, and the Great Recession.
The Trump administration has attempted to brag that it has increased revenues through tax hikes (i.e., tariff increases), and as
Bloomberg reports, “tariffs imposed by the Trump administration helped almost double customs duties to $57 billion in the period.”
But tariff hikes also cut intro entrepreneurial activity and overall production, reducing earnings and hobbling economic growth. Not surprisingly, tax revenues have not kept up.
Of course, if tax revenues actually limited government spending, there wouldn’t be much to complain about. Lower revenues really would mean fewer resources flowing into government coffers — and that can be a good thing.
But, in a world where government borrowing allows spending to balloon even in times of falling revenue, we’re setting the stage for future problems. The more the total national debt rises, the more debt service will become a serious issue if interest rates increase even moderately. Given the prospects for higher interest rates in the future, the Congressional Budget Office estimates interest payments on the debt will increase substantially in the future:
It is troubling that after a decade of an economic expansion, the US government is still spending money as it does during and immediately following a recession. Thus, if deficits are this large right now when times are good, how big will they become when the US enters recession territory? Back in 2009, the recession and its aftermath (i.e., massive amoounts of stimulus) drove deficits beyond the trillion dollar mark four years in a row. With 2019’s deficit total now pushing toward 900 billion, we should perhaps expect deficits to top two trillion when the next recession hits. And probably for several years.
The piper will then need to be paid when interest rates increase and substantial cuts must be made to social security, medicare, and to military budgets in order to service the debt and avoid default.
This reckoning can be put off, however, so long as the dollar remains the world’s reserve currency, and the central bank can continue to monetize the debt. As long as the dollar reigns supreme, the central bank can keep this up without causing high levels of price inflation. But when the day comes that the dollar can no longer count on being stockpiled worldwide, things will look very different.
The central bank won’t be able to simply buy up debt at will anymore, interest rates will rise, and Congress will have to make choices about how many government amenities will be cut in order to pay the interest bill. Americans who live off federal programs will feel the pinch. State governments will have to scale back as federal grants dry up. The US will have to scale back its overstretched foreign policy. Not all of this is a problem, of course. But lower-income households and the elderly will suffer the most. Everything may seem fine now, but by running headlong into massive deficits even during a boom, the feds are setting up the economy for failure in the future.
But that’s in the future, and few lawmakers in Washington are worried about much of anything beyond the next election cycle.
ON THE ECONOMY: MO MONEY MO PROBLEMS
John Dunham, Managing Partner, John Dunham & Associates
I don’t know what they want from me. It’s like the more money we come across, the more problems we see. These words form the hook in the 1997 rap song, Mo Money Mo Problems performed by The Notorious B.I.G and written by Christopher Wallace, Sean Combs, Steven Jordan, Mason Betha, Bernard Edwards and Nile Rodgers. Amazing how the real names of rappers sound so much like Rogers & Hammerstein.
If some of the candidates for the Democratic Presidential nomination have their way, it’s likely many Americans with mo money will see mo taxes. It’s not just that nearly every candidate wants to raise income tax rates, but also many wish to impose a new tax on assets, a so-called wealth tax.
There are a ton of political reasons to oppose a wealth tax. Not only does it amount to double – and sometimes triple – taxation, but it also rewards gluttony rather than thrift and envy over good will. On the other hand, the political reasons for taxing wealth are also myriad. A tax on wealth can, at least initially, impact very few people, it can raise a lot of new money for the government, and it can encourage consumption, something that politicians tend to equate with economic activity.
It is not my place to discuss the political arguments for or against the wealth tax, but rather to look at the economics surrounding a federal tax on assets.
First, it is important to distinguish a wealth tax from an income tax. Wealth, or better stated, assets, are simply accumulated savings. They are the value of work that was accomplished in the past but not yet spent. One can argue if the grand children of John D. Rockefeller should own his unspent work, of if Jeff Bezos deserves his unpaid work to be worth millions of dollars per minute, but that is a totally different point. The issue is that assets are unspent work from a prior period.
There is a value to time, and the time spent waiting to spend assets is represented in the interest, or dividends, that those assets can generate. This is done by lending those assets to another party that needs them to start a business, or buy a house or a car. The assets are repaid over time, and the value of that time is the interest earned on them. This interest is currently taxed either as income or as capital gains. But the value of the asset remains.
As an example, if I have $1,000 that I earned from completing a project for a client, and I do not spend that today, the value of the work that I accomplished (or the $1,000) becomes an asset in my bank account. The bank uses that $1,000 to provide a loan to the pizza shop downstairs, and the owner pays it back over time. While my $1,000 is sitting there, it generates interest – say $100 – this is my taxable income, which I can spend or keep in the bank as another asset.
So, a tax on the money generated by an asset already exists and this is called an income tax.
A wealth tax, on the other hand, would confiscate a portion of the asset and transfer that to the government. In the example above, my $1,000 would still generate the $100 in interest, which of course would be taxed, but at the end of the year, the government would confiscate (under a 5 percent wealth tax), $50, making my asset worth just $950. If my money were to continue to sit in the bank, over time it would be gone, as the next year, the government would confiscate $47.50, and so on and so on.
The same is true of all assets, be they Van Gough paintings, retirement savings, houses, cars or factories. Over time, the value of everybody’s property would fall.
What does this mean for the economy?
There are myriad examples of how the confiscation of property – particularly the property of productive entrepreneurs – has led to economic chaos. One only has to visit Cuba to see how an entire economy can be destroyed by such a policy. It’s easy to understand when the economic machinery is examined.
All economics works on the principle of supply and demand. In this case, the supply of assets and the demand for assets. Supply of assets is enhanced by savings, and demand by investment. Economies grow when both supply and demand increase, as long as prices stay the same. In effect, the returns to consumers and producers grow.
If the government confiscates assets, it would be effectively reducing supply. When this happens, prices rise. This is why one candidate, NYC’s mayor, is reducing the supply of licenses for “for-hire vehicles”. He wants to raise the price and force people to use them less.
In the case of a reduction in savings, the price of capital, or interest rates, will increase, and as interest rates rise, investment will fall. Lower investment means less demand for houses, cars, machinery, and fewer jobs for those who make them. This will reduce savings even further, and so forth and so on. The reduction in savings and investment will, over time, reduce what economists call consumer and producer surplus, in effect, the returns from economic activity.
In the end, a wealth tax will directly grant some sort of relief to those who envy the wealthy, be they the 1 percent, the 10 percent or the 20 percent (remember wealth is relative), but over time, the envious will also see their wealth fall whether it is directly or indirectly taxed.
The effects of an ill-advised wealth tax on the US economy could be much larger than even the opponents of the proposal think. I think that The Notorious B.I.G got it right. I don’t know what they want from me. It’s like the more money we come across, the more problems we see.