Federal budget update

Federal spending and revenues continue to follow a semi-virtuous path: revenues are inching higher, thanks to a modestly-growing economy, more people working, and slightly higher incomes; and spending growth remains very low, thanks to fewer people receiving unemployment benefits, and a Congress that has been gridlocked for most of the past three years.

As the chart above shows, revenues have risen from $2 trillion in 2009 to $2.4 trillion over the past 12 months, while spending has increased by only $0.1 trillion from 2009 to the past 12 months. As my good friends Art Laffer and Steve Moore note in their op-ed in today's WSJ, this supports Obama's claim to have overseen an extended period of very slow growth in federal spending. But it is ironic that Obama should take pride in the slow growth of spending under his administration when he continues to be among the most vociferous proponents of increasing government spending. They argue, and I would agree, that if Obama were to pursue policies that reduce spending further, without raising taxes, the economy would be much stronger going forward.

The first of the above three charts shows spending as a percent of GDP. One of the best things to happen as a result of relatively flat spending over the past few years is that the size of government has shrunk by two percentage points of GDP. This is a step in the right direction, since as Moore and Laffer remind us, and as Milton Friedman argued long ago, "government spending is taxation ... government can't tax an economy into prosperity. Friedman made it clear time and again that restraining government spending stimulates the economy by liberating private resources." Excessive spending can be financed by selling debt, but ultimately it must be paid for by higher taxes. So it's not so much the size of the deficit that is important, but the magnitude of spending, especially as a percent of GDP. The good news is that we have been moving in the right direction in recent years, and as a result, the deficit has receded from a scary 10.4% of GDP to 7.7% currently (by my estimate). Spending is still very high relative to GDP, however, higher than at any time since WW II, and that continues to be a burden that is slowing economic growth.