More on the Budget Deficit - Analyst Blog

After writing my post yesterday about the Treasury budget numbers for December (see here), I have decided to dig a little bit deeper in to the trends in revenues and outlays so far in this fiscal year, relative to the first three months of the 2009 fiscal year.

While I would encourage you to read the previous post, here is a quick wrap-up:

In the first three months of this fiscal year, the red ink has totaled $388.5 billion, up from $331.5 billion in fiscal 2009. However, total spending, both on-budget and off-budget (off-budget is mostly Social Security) was actually down by $3.6 billion to $876.3 billion. Even that understates things, since on-budget spending fell by $48.7 billion or 6.2%, while off-budget spending rose by $44.5 billion, or 49.2%.

The real cause of the higher budget deficit is lower revenues, with the vast majority of the decline coming from the on-budget side. Total revenues were down by $59.6 billion or 10.9%. However, on-budget revenues fell by $58.4 billion or 14.5%, while off-budget revenues (mostly Social Security taxes, half paid by individuals, half by their employers) fell by just $1.3 billion, or 0.9%, to $142.7 billion.

A Closer Look

Taking a closer look at the changes in both revenues and outlays, the main cause of the decline in on-budget revenues is a $47.6 billion (18.6%) decline in individual income tax levels, taking the figure to $207.7 billion. While not as big on an absolute basis, Corporate income tax revenues dropped by 32.7% to $33.9 billion, a decline of $16.5 billion.

If people are out of work, then their employers are no longer withholding their taxes. If people are working fewer hours, or making less per hour, they are going to be paying less in the way of income taxes. If a corporation’s profits are down, then there will be less in the way of corporate tax collections. (There are some on-budget parts of Social Security, and those tax collections fell by $3.3 billion or 6.7%.)

The biggest percentage decline was in the estate tax, which dropped by 39.4%, but it is a relatively small source of income for the government. So in absolute terms it was just a $2.6 billion decline. In calendar 2010, that will drop to $0, as there is a one-year elimination of the estate tax that is a legacy of the budget games Bush 43 pulled to pass his massive tax cuts back in 2001. I’m sure there were a fair number of very rich people being kept on life support over the holidays, just so their heirs didn’t have to pay the tax.

If the law is unchanged, the estate tax will jump back up to 45% in 2011. That could have all sorts of unintended consequences towards the end of the year (the “Throw Momma from the Train Act of 2010"). I am all in favor of the estate tax, but going from 0% in one year, and then having it at 45% after the ball drops in Times Square at the end of the year does not make a lot of sense to me. Personally, I would favor something along the lines of a $5 million individual and $10 million a couple exclusion and a 25% tax rate on the balance above that.

The Spending Side

Turning now to the spending side, the numbers are a little bit unfair, since a year ago the government shelled out $91.2 billion in TARP funds in the first three months of the year, and only spent $6.2 billion in the first three months of fiscal 2010. The biggest absolute increase in spending was off-budget, as Social Security payments jumped by $48.2 billion, or 28.4%, to $218.1 billion. With unemployment very high and persistent, there were probably lots of early-edge Baby Boomers who decided to take early retirement.

The Social Security trust fund was built up expressly to deal with the huge bulge of Baby Boomers who will be retiring over the next few years. Since the start of the Baby Boom was in 1946, the leading edge is now 63 years old and eligible for early social security benefits. If the economy were healthy, most of them would have probably kept working (and paying into the system) until they hit 65 in 2012. This is simply an acceleration of what would have happened anyway.

Breakdown of Expenditures

The largest single on-budget expenditure increase in absolute terms of any department came from the Department of Health and Human Services (HHS), with a $23.5 billion, or a 12.7% increase, to $208.3 billion. However, $13.8 billion of that, or 58.7% of the total increase, was due to increases in aid to the states to pay for Medicare. If that had not happened, the states would have had to either raise taxes (they are not allowed to run operating deficits) or cut other spending by that much.

The other program with a significant increase in costs at HHS was the Medicare prescription drug benefit program (Medicare Part D), which increased by $2.2 billion or 4.4%. The biggest percentage increase was in the Department of Labor, where spending surged by 80%, or $18.8 billion, to $42.3 billion. That is almost entirely attributable to higher unemployment benefits, which increased by $18.7 billion, or 113%, to $35.7 billion.

With almost 40% of all the unemployed now having been out of work for more than 26 weeks (the point at which regular state funded benefits expire), without those extended benefits, millions of Americans and their families would have been left with no income whatsoever. They would have been defaulting on their mortgages more, thus exacerbating the problems for the big mortgage operations at places like Bank of America (BAC) and Citigroup (C). They would have been unable to shop even at the Salvation Army, let alone Wal-Mart (WMT).

The next biggest increase in absolute terms was interest on the debt, which rose by $10.1 billion, or 7.5%, to $145.1 billion in the first three months of this fiscal year. We are fortunate that interest rates are still low, because that line item could be a lot worse -- and with the accumulating debt, it will be in the future.

Defense spending rose by $4.2 billion, or 2.4%. Almost all of that was due to a $3.9 billion, or 7.7%, increase in the salaries of uniformed personnel. The Department of Education had a large percentage increase of 45.3%, but in absolute terms it was just $7.2 billion, to a total of $23.1 billion. Of that $7.2 billion increase, $5.6 billion, or 77.8%, was due to federal aid to states for education, which was part of the ARRA.

Spending at the Department of Agriculture rose by $4.3 billion to $38.6 billion, a 12.5% increase. More than all of that increase was due to a $4.9 billion increase in food stamps, to $17.1 billion, a 40.2% increase. With people out of work, and out of work for a long time, the need for food stamps is rising. Currently, one in five children in the country are dependent on food stamps.

A Balanced Budget? Then What Would You Cut?

Those that argue that we need to balance the budget by cutting spending have to come up with where they would cut, and make those cuts really add up to a meaningful number. Talk about earmarks is essentially frivolous (there is a good point to be made on procedural grounds, though), as total spending on earmarks amounts to about $18 billion a year, which is a rounding error in the terms of the total budget. And some of those earmarks are actually worthwhile projects -- not all of them are "bridges to nowhere" in Alaska.

Would they propose defaulting on the interest payments on the national debt? How about not paying any extended unemployment benefits? Pulling out of Iraq and Afghanistan would make a serious dent in spending, but there are other considerations there, and the people who scream that spending is out of control generally want to spend more, not less, on foreign military ventures.

The big crop support payments at the Department of Agriculture were actually down a bit, and that seems to me to be a reasonable place to cut (certainly more so than cutting food stamps), but just try getting that through a Senate where states like North Dakota and Nebraska have as much say as California and New York.

An improving economy will do more than any cost-cutting to bring the budget deficit down. It will reduce the need to spend on things like extended unemployment benefits and it will cause tax revenues to rise, without a rise in tax rates. Still, there are major structural problems with the budget that need to be addressed.

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