Budget Deficit Falling, Not Rising

The Budget Deficit is falling, not rising, although it remains at historically very high levels. In September, the Federal Government spilled $34.4 billion worth of red ink; that is $10.8 billion, or 23.9% less than it spilled in September 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.

As this was the last month of fiscal 2010, we can look at the revenues and spending for the whole fiscal year as well. In fiscal 2010, the government has spent $1.294 Trillion more than it has taken in from taxes. That is down $121.6 billion or 8.6% from the red ink in fiscal 2009. I’m sure that if the budget deficit had increased by $121.6 billion, it would have been a top news story. However, since the facts are at odds with the preferred narrative of “exploding deficits” and runaway government spending, most of the media will relegate this story to page B-5 if they mention it at all.

Where the Improvement Came From

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 12.0% to $245.2 billion while total spending rose just 5.9% to $279.7 billion.

For the full fiscal year numbers, the improvement came from both sides. Total revenues are up to $2.162 Trillion, an increase of 1.6%. Total spending fell 1.8% to $3.456 Trillion. Clearly, however, the government can not go on indefinitely spending $1.60 for every dollar of taxes it collects. Still, that is an improvement over the $1.67 spent per dollar collected last year.

Can Spending Cuts Cure the Deficit?

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, 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.

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 $1.294 Trillion. 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:

Department of Agriculture (including all crop subsidies and food stamps)
Department of Commerce
Department of Education
Department of Energy
Department of Homeland Security
Department of Housing and Urban Development
Department of Interior (shut down all of the National Parks)
Department of Justice (including Prisons and the FBI)
Department of Labor (including all Federal Unemployment Benefits)
Department of State
Department of Transportation (including all spending on highways)
Department of Veterans Affairs
The Environmental Protection Agency
The National Science Foundation
The Office of Personnel Management
The Small Business Administration
The entire Legislative Branch
The entire Judicial Branch
All international assistance
Food and Drug Administration
Center for Disease Control
The National Institutes of Health
The Indian Health Service
The Army Corps of Engineers
All Defense Procurement
All Family Housing for the Military

Together, those programs make up most of what we think of as the government outside of the Pentagon (and a god deal of military spending as well). In that list, the only major things spared were interest of the debt, Medicare and Social Security. For those of you who wish to play the game at home, you can find all the numbers you need here.

Another way of looking at it is that outlays for the Pentagon, Social Security, Health and Human Services (mostly Medicare/Medicaid) and the interest on the debt totaled 2.689 Trillion in fiscal 2010. Thus if we kept those as is, and totally eliminated everything else in the budget, we would have still run a budget deficit of $527.2 billion. This all assumes of course that the actions taken to cut spending did not also result in lower tax revenues, which does not seem very likely.

If, for example, we eliminated everything on the list above, the Defense companies like Lockheed Martin (LMT) and Raytheon (RTN) would lose almost all their revenues and have to lay off most of their workers. Neither the companies nor their (former) employees would be paying much in the way of taxes.

To get the deficit back under control, the key is going to be growing the economy, allowing tax revenues to rise while keeping spending under control. Some tax increases are probably needed as well. This, however, is probably not the time for either major spending cuts or big tax increases, particularly tax increases that hit the poor and the middle class.

It is the long-term budget deficits that are the problem. In the short-term we need to be running them. 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.

The Two Federal Governments

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 makes sense to think of it 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 CEO’s 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 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.

In fiscal 2010, the on-budget deficit was $1.371 Trillion, down $181.6 billion from fiscal 2009.  The off-budget surplus (mostly Social Security) fell by $60 billion or 43.8%, but was still $77 billion. Partly the declining surplus in Social Security is planned. The idea was to collect extra while the Baby Boomers were in their prime earning years and so the funds would be available when they started to retire. Well, now they are starting to retire.

The Baby Boom started in 1946, so the leading edge is turning 64 this year. Older workers when they get laid off have a particularly hard time getting a new job. As a result, many of those who have lost their jobs have decided to take the early retirement option (reduced benefits) since they have little hope of finding a new job (there are only a limited number of Wal-Mart (WMT) greeter jobs available). Partly it is just a function of fewer people on payrolls, and thus less payroll tax. In fiscal 2010 off budget revenues fell by 3.4% to $631.7 billion, while outlays rose by 7.3%.

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. However, this year that reversed. In fiscal 2010, the corporate income tax provided revenues of $191.4 billion, up $53.2 billion, or 38.5% from fiscal 2009. Corporate profits have been recovering nicely and as a result tax revenues have increased.

The longer-term decline in corporate income taxes as a share of overall revenues 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. With unemployment high, and very low wage growth, individual income tax receipts have been falling. In fiscal 2010, the government collected $898.5 billion in individual income taxes, down $16.8 billion, or 1.8% from fiscal 2009. 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.

The Poor Lend to the Rich

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. President 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. 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.

Very Good News

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 fiscal 2008 relative to fiscal 2007, the deficit was already rising fast. During that period, revenues fell 1.71% and spending rose 9.13%. That resulted in the deficit exploding by 181.6%.

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 16.61% and spending increased by 18.19%. That resulted in another 211.3% increase in the budget deficit.

In fiscal 2010 revenues increased by 2.73% and spending fell by 1.31% resulting in a 8.59% decline in the deficit. In absolute terms, it is the second largest single-year of deficit reduction in history (exceeded only by fiscal 2006 relative to fiscal 2005).

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 so, we need to work on the problem from both sides — 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 that 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 Zacks.com. 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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