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Budget update: continued improvement

Although the November federal deficit was larger than expected, these charts show that key measures of Washington's finances continue to show gradual improvement. The budget is still in terrible shape, of course, with a $1.3 trillion deficit over the past 12 months that comes to just under 9% of GDP. But the encouraging signs are that revenues are picking up, having increased 6% over the past year, and at a 10% rate over the past three months. This is resulting—finally—in a modest rise in revenues as a % of GDP. If the economy continues to grow and improves just a little, then revenues should continue to rise relative to GDP even if the Bush tax rates are extended indefinitely. Another encouraging sign is that spending growth has already slowed rather dramatically; spending in the past 12 months was actually 0.5% less than it was a year ago. Spending has increased at a 4.2% annualized rate in the past 3 months, but that is less than the likely increase in nominal GDP.

We don't need higher tax rates to balance the budget, we need an extended period of much slower growth in spending. If revenues were to continue growing at the rate of the past six months, and if spending were to be frozen at current levels, the budget would be balanced within 5 years, with revenues and spending likely to be about 19% of GDP. That would put us back to the levels that prevailed, on average, for most of the postwar period.

UPDATE: To clarify a very important point, higher tax rates are not necessary to raise substantial new revenue. Revenues are already rising at a decent clip, and they should continue to do so as the economy grows and adds new jobs. Thus, it is fallacious to argue that extending the Bush tax cuts represents a "cost" in the form of foregone revenue; or that extending the tax cuts will increase the deficit.

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