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Federal budget update

February budget numbers released today were mixed. Revenue growth has slowed meaningfully over the past year, with the rolling 12-month revenue total rising at only a 1.7% annualized rate in the past six months. That partly reflects the payroll tax cut that began last year, but it also reflects the economy's huge output gap and only modest growth in jobs. On the other hand, there has been very little increase in spending since the end of the recession (a mere $60 billion), and that's good because otherwise the budget deficit would be truly frightening. Here's a little-known and under-appreciated fact: virtually all of the reduction in the budget deficit has come from increased tax revenues. Revenues have increased in spite of the payroll tax cut, and without any increase in tax rates; revenues are up because the economy has grown.

About a year ago I began noting that if spending could be frozen, the budget could be balanced within 7 years or so without any tax hikes. Amazingly, we seem to be following that virtuous path, thanks to a growing economy and Congressional gridlock. As a % of GDP, the federal budget has declined from a high of of 10.4% at the end of 2009 to 8% today. In nominal terms, the deficit has fallen from a high of $1.47 trillion to $1.24 trillion. Imagine if the next Congress actually figures out how to cut spending in nominal terms! Fiscal reform is not a pipe dream, and it is slowly happening without any apparent help from Washington.

Things could be a lot worse.

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