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Elections Don't Matter That Much

Elections Don't Matter That Much

The New Rules of Taxing and Spending are Old Rules

Alan Pentz
August 25, 2024

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Let’s dive in…

TL;DR

Government spending and tax collection are far more stable over time than political rhetoric suggests
Current debt levels, while elevated, aren't far from historical norms
Long-term economic forces often matter more than short-term political promises

My goal with these posts on The New Rules is to go beyond the day to day of the news cycle to look at the trends that shape the structure of the system. Most politicians are simply actors on a stage set by far more powerful forces.

One area where we see this most clearly is with taxing and spending.

Like Maryland with crab cakes and football: that’s what government does. We engage in endless political fights about it. We hear from deficit scolds that the government spends too much. It’s unsustainable! Yet it sustains.

People on the left wear dresses that say, “Tax the rich,” and blame most problems on billionaires.

Taxes and Spending are Stable Over Time

This rhetoric is great for getting people riled up but the reality is, taxing and spending are relatively stable over the long term. You never look at a number like how much the government spends by itself. You always have to look at it in comparison to a total like Gross Domestic Product (GDP).

Once you do, things get a bit clearer. Here’s a chart from that fount of all economic charts, the St Louis Federal Reserve.

As you can see, federal spending has been pretty consistent over time as a percentage of GDP. World War Two was a huge aberration and we had big spikes around the Great Financial Crisis and Covid. Neither were anywhere close to WW2 though.

It’s 1982 All Over Again

Astute observers will also notice that we are currently about where we were in 1982-1983 at about 22.4%.

What was going on then?

The Fed had to raise interest rates really high to stifle inflation so interest payments on the federal debt rose quickly.

Sound familiar?

We were also facing a menacing geopolitical adversary in the Soviet Union with large defense expenditures into the foreseeable future. Again, similar.

As we can see, our current circumstance isn’t unprecedented. It is true that debt to GDP is much higher now at 120% than it was in 1982 at 32%. My counter is that while debt to GDP is higher, interest rates are correspondingly lower. Interest rates topped out in 1982 at just under 15%. Our current peak is 5.5%.

Cutting Spending is Hard

Despite these facts, many commentators think it is crucial that we cut spending. I don’t think it is but we can debate that. What I think is inarguable is that neither party is going to do it.

When you look at what we actually spend money on, there isn’t much either party would actually cut.

Here’s the budget breakdown for 2023:

Social Security: 22%
Medicare: 16.7%
Interest: 14%
Defense: 13%
Medicaid, Affordable Care Act Payments, Children’s Health Insurance, etc.: 11.4%
The rest is everything from food stamps to agriculture subsidies to road building to veterans benefits: 22.9%

Of course we can have important arguments about how to allocate that spending but almost all of it is mandatory spending on Medicare, Social Security, and interest on the debt. When you add in defense and health we’re at over 77% of the budget.

Both parties have candidates who have explicitly ruled out cutting these entitlements and a quick scan of the geopolitical environment should convince most reasonable people that there aren’t going to be any savings in defense.

If you want to go after the Affordable Care Act spending, I’d like to introduce you to the failed efforts of the early Trump Administration and no politician is cutting health insurance for kids.

In reality, we’re arguing over how to tweak the edges of the 22.9% of federal spending that is left over.

Even with in that amount you’ve got to pay for the FBI, border patrol, national parks, FEMA, food stamps, etc. So let’s be realistic here. The politicians don’t have a ton of flexibility.

So We’re F##$%ed?

When you look at the budget like that, it doesn’t seem likely that we’ll see any spending cuts. Voters hate austerity.

But let’s re-frame the problem a bit.

We don’t need to cut spending, all we need to do is restrain it’s growth as a percentage of GDP and not even by that much. We also have decreasing inflation which means the Federal Reserve will soon cut interest rates which in turn means the federal government will be paying less in interest costs.

So spending will come down on it’s own as interest rates do.

I don’t see much prospect of massive spending increases either. We’ll probably pump some money into AI and a few other priority areas but an Inflation Reduction Act Part 2 doesn’t seem likely.

And Now Taxes

Here are federal tax receipts over time:

The scale of this chart is interesting. It literally doesn’t go above 20% of GDP and has floated in a tighter range since the 1950s. People hate taxes!

I didn’t calculate the average but eyeing it, you could say somewhere around 17-17.5% range.

Of course, Trump is campaigning on extending his tax cuts. But I see the sanctity of tax cuts breaking down in the Republican Party. If Trump wins a landslide (which looks increasingly unlikely), you could see an extension of the current tax cuts that are due to expire. But even then I’d predict he’d pay for a lot of the extensions with claw backs from the IRA and other Covid era programs.

If Harris or Trump win in a tight race, I think you’ll see a mix of tax increases with a few modified extensions of Trump’s tax cuts. But nothing major either way.

I also think the corporate tax rate won’t stay at 21% for long. I see large corporations as a ripe source of revenue so while it will take some amount of time, taxes will generally rise back toward 17-17.5%.

Putting It All Together

Now add both sides of the ledger together and you get this.

The deficit is admittedly elevated at 6.7% of GDP currently. 1982 peaked out at 5.8% so we’re almost a percentage point higher.

7% of GDP seems a bit much but again, the trends I’m seeing make me think this will shrink on it’s own with the restrained spending, falling interest costs, and tax increases I’ve speculated on. My guess is we could see that gap narrow to 4-5% of GDP in the next 2-3 years. That seems more sustainable.

Why I Might Be Wrong

Of course I could be wrong. There are three main issues I worry about.

Social Security and Medicare: The retirement and increased lifespan of Baby Boomers will strain both programs. Spending on both is set to rise as a percentage of GDP. I do think we’ll need to implement some modest reforms to help with these costs. Some of the tax increases I’ve laid out could be for additional payroll taxes to support the programs and we could gradually raise the retirement age to 70. A combination of the two might just get us through.
Recessions and Wars: Both of these events lead to increased spending and recessions mean less in the way of tax collections. I tend to worry less about these possibilities unless they are protracted as they create temporary issues.
Inflation: The factor I worry about the most longer term is inflation. I think we are in a new era of higher and more variable inflation. I don’t think it will be the kind of out of control inflation many commentators worry about but it will still be a factor. We have some remedies we could employ to counter the trend like allowing more energy development including fossil fuels, relaxing zoning regulations to allow for more abundant and cheaper housing, and finding a sustainable immigration policy.

Keep growing,

Alan

P.S.

P.P.S.

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