Sunday, 27 May 2012

Federal Spending As A Share Of The Economy

In a previous post, I reviewed Rex Nutting’s report that the “Obama spending binge never happened” by reviewing annual percentage changes in federal spending. The numbers support Nutting's conclusion, but there are several ways of analyzing the federal budget and the results leave plenty of room for debate when it comes to summarizing the government’s fiscal rectitude, or the lack thereof. For example, another method of evaluating federal outlays is by looking at dollar amounts as a percentage of the economy (GDP). By this standard, the Obama administration is open to more criticism vs. comparisons based on the rate of change in spending.

Consider how federal spending compares on an annual basis as a share of nominal GDP over the past four decades. Total outlays as a percentage of the economy have recently been at heights unseen in recent history—roughly 23% to 25%.

Discretionary spending levels, by contrast, are a bit lower, running at roughly 9% in the last three years. That’s up slightly from the pre-recessions levels of 6% to 7%, but still under the 10% mark reached for a time in the 1980s. If you're a fiscal hawk, however, the recent trend is still cause for alarm.
Note that the comparison between calendar-year GDP and fiscal year spending isn’t an exact match (fiscal years for the federal government’s budget run from October 1 through September 30. Nonetheless, the analysis provides a reliable reflection of spending trends in relation to the size of the economy.

What are we to make of the recent rise in overall government spending by this measure? Here’s where the debate begins. Like everything in economics, there’s more than one interpretation. For example, one can argue that the rise in federal spending as a share of the economy is at least partly due to the Great Recession and the sluggish recovery in subsequent years.

Federal spending continued to grow even as the economy shrank, resulting in a higher spending/GDP ratio. If you accept the premise that cutting spending during a deep economic crisis is a bad idea, you’ll cut the government some slack when it comes to the recent rise in outlays relative to economic output. You might even marvel at the recognition that discretionary spending’s share of GDP didn’t surge higher (or that it’s dipped a bit in fiscal year 2011). Indeed, the chart above reminds that the overall rise in spending is due primarily to mandatory spending requirements that are baked into current law.

Nonetheless, the clock is ticking. As the Concord Coalition warns, "Without comprehensive reform, we will leave our children and future generations with huge government debts, higher taxes, lower living standards and a diminished international role for the United States."

The main issue is how we move from here to there. Medium- and long-term spending controls are critical, but doing too much, too fast, may harm the fragile recovery. The main questions are how should the government slow/cut/restructure spending growth and how quickly should it implement the reforms? Everyone has a plan, but consensus is missing in action. But doing nothing will have consequences, and soon. Until further notice, there’s really only one question lurking on the fiscal front: Are You Ready for Taxmaggedon?

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