The Budget Deficit is Falling!

The Budget Deficit is falling, not rising, although it remains at historically very high levels. In August, the federal government spilled $90.23 billion worth of red ink — $13.03 billion, or 12.6%, less than it spilled in August 2009.

The data, while extremely seasonal, is not seasonally adjusted, so looking at the month-to-month change is worse than irrelevant, it is highly misleading. However, what is worth looking at to get a longer-term perspective, is the fiscal year-to-date deficit relative to the same period a year ago. Through the first eleven months of fiscal 2010 (ends 9/30) the government has spent $1.260 trillion more than it has taken in from taxes. That is down $110.92 billion, or 8.1%, from the red ink in the first eleven months of fiscal 2009.

September is traditionally a month where the budget deficit is small, or actually in surplus, so the current figures are close to where the final figures for the year end up.

For the month, the year-over-year improvement came all on the tax collection side as a healthier economy provides more taxes to the government. Total revenues rose 12.7% to $164.0 billion, while total spending rose just 2.2% to $254.5 billion. For the year-to-date numbers, the improvement came from both sides. Total revenues are up to $1.917 trillion — an increase of 1.6%. Total spending fell 2.5% to $3.176 trillion.

Clearly, however, the government cannot go on indefinitely spending $1.66 for every dollar of taxes it collects. Still, that is an improvement over the $1.73 spent per dollar collected last year.

In the short term, though, that gap is desperately needed by the economy. The collapse of the housing bubble erased about $8 trillion of wealth from households and destroyed their balance sheets. As a result, consumers have been cutting back and paying down non-mortgage debt at an unprecedented pace.

Since there is a glut of housing on the market (the months of supply of existing houses was at an all-time record high of 12.5 months in July) there is no need to build any more new houses. Oh, a few houses are still being put up around the country (an empty house in Dayton, Ohio is not a very good substitute for a new house in North Dakota, especially if there are no jobs in Dayton but there are in North Dakota), but the pace of new construction is down almost 80% from the peak of the bubble.

Think of It This Way…

Without the federal budget being in deficit, total demand would be FAR lower, and with it unemployment would be much higher. For you conservatives out there, just think how bad the economy would be if taxes were raised by $1.260 trillion…for not even a full year. That far exceeds the $700 billion that taxes would “rise” over 10 years if the Bush tax cuts for income over $250,000 per couple are allowed to expire, as the current law calls for.

For those of you who think that government is not entirely the work of the devil and has a place in a civilized society, if the budget were to be balanced just by cutting spending, we would have had to cut ALL of the spending so far this year at Health and Human Services (that includes all of Medicare), ALL programs at the Department of Labor (not just extended unemployment benefits), ALL of the spending at Housing and Urban Development, ALL of the Department of Agriculture (not just food stamps), ALL spending at the Department of Transportation (hey, who needs highways, anyway), along with eliminating NASA, the EPA, as well as the Departments of State and Justice (that includes the FBI as well as all of the federal prosecutors.

Together, those programs make up most of what we think of as the government, outside of the Pentagon. Anyone who suggests that we can eliminate the budget deficit by only cutting non-defense spending is either an idiot who does not know what he is talking about. Or a liar. Whatever the case, they are best ignored and have no more reason to be on the Sunday morning talk shows than the bag lady babbling on the street corner. Heck, the bag lady probably has better insight into the state of the economy than some of the Heritage Foundation and American Enterprise Institute-types.

To get the deficit back under control, the key is going to be to grow the economy, allowing tax revenues to rise, while keeping spending under control. It is the long term budget deficits that are the problem. In the short term, we need to be running deficits.

Reducing our military commitments around the world, including getting out of both Iraq and Afghanistan as soon as safely possible, would go a long way towards bringing the long-term deficit under control. After all, we spend more on our military than the rest of the world combined, and many of the remaining countries in the top ten of military spending are our allies (the U.K., Germany, France, Israel), not our potential adversaries. On the other hand, when we have troops in the field putting their lives on the line, we owe it to them to not pinch pennies.

On-Budget vs. Off-Budget

Really there are two sides to the federal government, the on-budget side, and the off-budget side. The off-budget side is mostly Social Security, while the on-budget side is everything else the government does, both defense and non-defense.

Social Security has its own dedicated stream of tax revenues, the payroll tax. It is largely paid by the poor and working class. While on paper, half of it is paid by the employer, and half shows up on the pay stubs of workers in the form of FICA, in economic reality, it is impossible to distinguish who pays how much of it.

It is a wedge between what it costs the employer to hire someone, and what that person has available to spend. In that sense, it can be thought of as all being paid by the worker. It is levied on the very first dollar of income, but after someone has earned $106,000, the tax stops and that person gets a nice temporary “raise” in each paycheck. Thus, the vast majority of people pay the tax for the whole year, but CEOs and Investment bankers are finished paying the tax by the time their New Year’s Eve hangover has cleared up.

Ever since 1982, the Social Security system as been running a surplus, and in the process has built up a trust fund of over $2.5 trillion. That trust fund is designed to be drawn down as the Baby Boomers retire, and is expected to be depleted by 2037. At that point, the Social Security system would be back on a “pay as you go” basis, the way it was from its start during the New Deal until the Greenspan Commission Reforms kicked in (1983). That surplus has been invested in the safest and most conservative investment around: Treasury notes and bonds.

The on-budget side of government has persistently run deficits since the days of the Greenspan Commission (and before). Even the Clinton “surplus” was mostly a function of the big surplus in Social Security. The on-budget side got very close to being balanced in the late 1990’s, but never quite made it there. The George W. Bush on-budget deficits were FAR larger than is usually reported, since he presided over the period when the build up in the Social Security trust fund was the largest. That masked the true size of the on-budget deficit, to the tune of about $200 billion per year.

The on-budget side of the government is largely funded by the income tax, both personal and corporate, although the corporate side has been declining in significance for decades. That is probably OK since it is very hard to say exactly who actually pays the corporate income tax. Some of it results in lower after-tax profits and is thus borne by shareholders, but some is likely passed on to consumers, and some of it results in lower wages to employees. It is a convenient way of hiding the true tax burden, but it does not make for a lot of transparency as to actually who is paying it.

The individual income tax is largely paid by the upper middle class and the wealthy. The vast majority of Americans pay more in the payroll tax than they do in income taxes, particularly if the employer side of it is attributed to them, but even if just the FICA side is counted, it is more than half who pay more in payroll taxes.

In other words, the Bush tax cuts forced the poor and working class to lend to the wealthy. Over the next few decades, that loan has to be paid back. Obama has appointed a long-term budget commission to try to solve the long-term budget problem.

The GOP co-chair of the commission, former Senator Alan Simpson of Wyoming, is openly hostile to Social Security and has suggested that benefits have to be cut. Make no mistake, raising the retirement age is an across-the-board cut in benefits. In other words, he wants the rich to be able to walk away from the debt they have run up to the poor and working class.

Funny, when the poor guy who has a house that is now worth $50,000, but has a $100,000 mortgage on it, walks away from the debt (which he is perfectly entitled to do legally) he is demonized as a strategic defaulter and a deadbeat. But people who propose the largest rip-off in recorded history through cutting Social Security benefits that have been already paid for get put on prestigious presidential commissions.

But I Digress…

Overall, this report was very good news. Spending is not out of control; it is actually lower than it was last year, although still much higher than it was before the financial meltdown. As the economy has recovered a bit, tax revenues have started to increase again.

Spending is coming under control. This is a reversal of earlier trends. If we look at the first 11 months of fiscal 2008 relative to the first eleven months of fiscal 2007, the deficit was already rising fast. During that period, revenues fell 1.35% and spending rose 7.64%. Fiscal 2009, which incidentally was put into place by Bush (remember the fiscal year starts on October 1st of the prior year) and a Democratic congress was the year the wheels really fell off. Revenues declined by 16.25% and spending increased by 18.32%. So far this year, revenues are up 1.65% and spending is down 2.45%.

That is a good start, and more or less reverses the budgetary damage that was done during fiscal 2008, but does not put a dent into the much worse budgetary damage done during fiscal 2009. Over the medium term we need to repair that damage, but it would be foolish in the extreme to try to do so all at once.

To do this we need to work at the problem from both sides — both raising taxes and restraining spending. A stronger economy would help on both fronts. More people working means more individual income taxes, and higher profits mean more corporate income taxes. It would also mean that fewer people would have to be on extended unemployment benefits and food stamps.

Still, more measures will have to be taken given the huge size of the deficit. Those measures should, however, come from the side of the government that is the cause of the problem: the on-budget side, not the off-budget side, which has been ameliorating the problem for decades now.

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About Dirk van Dijk 112 Articles

Affiliation: Zacks Investment Research

Dirk van Dijk, CFA is the Chief Equity Strategist for With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

Visit: Zacks Investment Research

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