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Federal revenue growth is impressive, believe it or not

It strikes me that the recent growth in federal tax revenue is not widely nor sufficiently appreciated, probably due to the pessimism that pervades just about every long-term outlook these days. The chart above, which plots the 6-mo. annualized growth in rolling 12-mo. federal revenues, shows that tax receipts are now rising at double-digit rates. Total federal receipts over the 12 months ended November '10 are more than 10% above (annualized) total receipts over the 12 months ending May '10. This is shown in the chart below: monthly revenues this past year have been consistently higher than they were a year ago. All that progress, without raising a single tax rate! In fact, as the charts above and the second one below document, the major determinant of federal revenues is the business cycle, not tax rates. During recessions, revenues collapse, and during recoveries revenues rise, usually faster than the growth in nominal GDP. Now that we are 18 months into a recovery, it is not surprising at all that tax revenues should be rising at a much faster rate than GDP.

The chart below helps put this into perspective. For 50 years, from 1955 through 2005, revenues on average rose at the same rate as nominal GDP (i.e., revenues as a % of GDP were relatively unchanged), even though tax rates changed dramatically. Revenues are still at a post-war low relative to GDP, of course, but that is mainly because this recession has been deeper than most others.

As the economy picks up, tax receipts accelerate because more people work and pay taxes, corporate profits rise, and incomes rise in our highly progressive tax system—the most progressive of any advanced economy. Recoveries always result in a huge increase in tax revenues. Unfortunately, when revenue growth is at its strongest, politicians inevitably figure out how to spend money even faster.

There is every reason to think that federal (and state and local) revenues will continue to grow at a relatively high rate as long as the economy continues to recover. Balancing the budget doesn't require higher tax rates, it just requires spending restraint and pro-growth policies. Holding spending constant, and assuming revenues grow at their current rate, the federal budget would be balanced in 5-6 years. If the new Congress can't make a significant move in this direction (i.e., holding the line on spending and keeping tax rates as low as possible), they deserve to be trounced in the next election.

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