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Fiscal policy update
















There's a wealth of information in these charts, and they speak volumes. I'll just highlight a few things:

The federal deficit increased marginally in the 12 months ended December, according to figures released today by Treasury, as revenues declined by more than outlays. Federal revenues as a % of GDP haven't been this low since 1943, even though the top marginal tax rate back then was 88%, and today it is 35%. Tax rates are thus not the major determinant of revenues—the health of the economy is. As a supply-sider, I believe the economy would be healthier today, and revenues would be higher as a result, if Congress and the Obama administration had focused their stimulus efforts on lowering marginal tax rates for individuals and businesses, rather than massively redistributing income and ramping up make-work projects.

Federal spending as a % of GDP hasn't been this high since World War II. If Obama's spending plans aren't cut back, spending is destined to remain at a level of GDP that we have only experienced during wartime. This would be a truly unprecedented (to use O's favorite word) expansion of the government's control of the economy. As Milton Friedman taught us long ago, it's not really the federal deficit that is bad for the economy, it's the level of government spending. The more government spends, and the more it takes out of one person's pocket and puts into another's, the less efficient the economy becomes. Roughly two-thirds of the $3.5 trillion spent last year by the federal government was entitlement spending. That's about $200 billion every month that the federal government collects from some people and hands out to others.

If these trends continue—permanently higher spending that focuses primarily on income redistribution—it is not clear at all that tax receipts can be raised sufficiently by raising tax rates. Our economy has never generated a level of of federal revenues sufficient to finance current spending projections, no matter how high tax rates have been.

As the bottom two charts show, we saw a huge reduction in top marginal rates since the mid-1960s, but tax revenues as a percent of national income have remained basically unchanged (with the exception of the recent recession).

I don't see impending disaster in these charts or in the numbers. But I do see that we are entering uncharted waters, and that the unprecedented expansion of the size and scope of the federal government, and its increasing focus on income redistribution, raise very troubling prospects. While these concern me greatly, I do believe that it is possible to reverse these trends, and I note some major shifts in the politicial winds this past year that are encouraging in that regard. Things look very grim, but I think the changes on the margin going forward will prove to be positive.

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