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Impressive progress in the federal budget

Thanks to a gridlocked Congress and a recovering economy, the federal budget has registered some impressive improvements in the past three years. Spending has not increased at all, while tax revenues have surged by over $550 billion, with the result that the burden of the federal budget deficit has dropped almost in half, from 10.5% of GDP to 5.75%. As the federal government absorbs less and less of the economy's output, this opens the door for a stronger private sector. This is a very encouraging development that is not widely appreciated or understood.

For the 12 months ended March, 2013, federal spending was $3.49 trillion. As the chart above shows, spending has not increased at all since the end of the 2008-09 recession. Revenues, in contrast, have risen from a post-recession low of $2.02 trillion to $2.58 trillion in 12 months ended March, 2013. The federal budget deficit has fallen from a high of $1.47 trillion in late 2009 to $910 billion in March of this year. Revenues are now only about $20 billion shy of an all-time high. This is real progress: the best way to grow revenues is to grow the economy without raising tax rates, and the easiest way to "cut" spending is to just not let it grow.

Despite no effective increase in tax rates in recent years (and in fact a 2-yr reduction in payroll taxes), revenues have grown much faster than GDP—as is typical during a recovery.

With spending flat but nominal GDP now up over 15% since the recovery started, federal spending as a percent of GDP has fallen from a high of 25.2% to about 22%. It is now within the post-war historical range.

The chart above combines the previous two charts for a better historical picture of what's happening. Both revenues and spending are slowly but surely coming back into line with their historical averages.

The reduction in the burden of the federal deficit has been impressive, although it is still a bit larger than it was at its Reagan-era peak.

One important source of the reduction in spending has been automatic stabilizers like unemployment insurance. As the economy has grown, the number of people receiving unemployment insurance has declined by 3.3 million from its peak in mid-2010.

Unfortunately, the impressive progress to date in the budget is threatened by the looming onset of Obamacare, which will almost certainly increase government spending significantly as it also raises healthcare costs. Moreover, the financial health of social security worsens with each passing year, due to the very low level of labor force participation and increasing life expectancies. But at least for now we are making excellent progress.

Note: in calculating revenues, spending, and the deficit as a % of GDP, I have assumed that nominal GDP grew at a 4.4% annual rate in the first quarter.

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