The US Has Hit Record High Fiscal and Trade Deficits

A.  Introduction

The final figures to be issued before the election for the federal government fiscal accounts and for the US trade accounts have now been published.  The US Treasury published earlier today the Final Monthly Treasury Statement for the FY2020 fiscal year (fiscal years end September 30), and earlier this month the BEA and the Census Bureau issued their joint monthly report on US International Trade in Goods and Services, with trade data through August.  The chart above shows the resulting fiscal deficit figures (as a share of GDP) for all fiscal years since FY1948, while a chart for the trade deficit will be presented and discussed below.  The figures here update material that had been presented in a post from last month on Trump’s economic record.

The accounts show that the federal fiscal deficit as a share of GDP has reached a record level (other than during World War II), while the trade deficit in goods (in dollar amount, although not as a share of GDP) has also never been so high.  Trump campaigned in 2016 arguing that these deficits were too high, that he would bring them down sharply, and indeed would pay off the entire federal government debt (then at over $19 trillion) within eight years.  Paying off the debt in full in such a time frame was always nonsense.  But with the right policies he could have at least had them go in the directions he advocated.  However, they both have moved in the exact opposite direction.  Furthermore, this was not only a consequence of the economic collapse this year.  They were both already increasing before this year.  The economic collapse this year has simply accelerated those trends – especially so in the case of the fiscal deficit.

B.  The Record High Fiscal Deficit

The federal deficit hit 15.2% of GDP in FY2020 (using the recently issued September 2020 estimate by the CBO of what GDP will be in FY2020).  The highest it had been before (other than during World War II) was 9.8% of GDP in FY2009, in the final year of Bush / first year of Obama, due to the economic collapse in that final year of Bush.  In dollar terms, the deficit this fiscal year hit $3.1 trillion, which was not far below the entire amount collected in tax and other revenues of $3.4 trillion.

This deficit is incredibly high, which does not mean, however, that an increase this year was not warranted.  The US economy collapsed due to Covid-19, but with a downturn sharper than it otherwise would have been had the administration not mismanaged the disease so badly (i.e. had it not neglected testing and follow-up measures, plus had it encouraged the use of masks and social distancing rather than treat such measures as a political statement).  By neglecting such positive actions to limit the spread of Covid-19, the only alternative was to limit economic activity, whether by government policy or by personal decision (i.e. to avoid being exposed to this infectious disease by those unwilling to wear masks).

The sharp increase in government spending this year was therefore necessary.  The real mistake was the neglect by this administration of measures to reduce the fiscal deficit during the period when the economy was at full employment, as it has been since 2015.  Instead of the 2017 tax cut, prudent fiscal policy to manage the debt and to prepare the economy for the risk of a downturn at some point would have been to call for a tax increase under such conditions.  The tax cut, coupled also with an acceleration in government spending, led fiscal deficits to grow under Trump well before Covid-19 appeared.  Indeed, they grew to record high levels for periods of full employment (they have been higher during downturns).  As the old saying goes:  “The time to fix the roof is when the sun is shining.”  Trump received from Obama an economy where jobs and GDP had been growing steadily and unemployment was just 4.7%.  But instead of taking this opportunity to reduce the fiscal deficit and prepare for a possible downturn, the fiscal deficit was increased.

The result is that federal government debt (held by the public) has jumped to 102% of GDP (using the CBO estimate of GDP in FY2020):

The last time the public debt to GDP ratio had been so high was at the end of World War II.  But the public debt ratio will soon certainly surpass that due to momentum, as fiscal deficits cannot be cut to zero overnight.  The economy is weak, and fiscal deficits will be required for some time to restore the economy to health.

C.  The US Trade Deficit is Also Hitting Record Highs in Dollar Terms

In the 2016 campaign, Trump lambasted what he considered to be an excessively high US trade deficit (specifically the deficit in goods, as the US has a surplus in the trade in services), which he asserted was destroying the economy.  He asserted these were due to the various trade agreements reached over the years (by several different administrations).  He would counter this by raising tariffs, on specific goods or against specific countries, and through this force countries to renegotiate the trade deals to the advantage of the US.  Deficits would then, he asserted, rapidly fall.  They have not.  Rather, they have grown:

Trump has, indeed, launched a series of trade wars, unilaterally imposing high tariffs and threatening to make them even higher (proudly proclaiming himself “Tariff Man”).  And his administration has reached a series of trade agreements, including most prominently with South Korea, Canada, Mexico, Japan, the EU, and China.  But the trade deficit in goods reached $83.9 billion in August.  It has never been so high. The deficit in goods and services together is not quite yet at a record high level, although it too has grown during the Trump period in office.  In August that broader deficit hit $67.1 billion, a good deal higher than it ever was under Obama but still a bit less than the all-time record of a $68.3 billion deficit reached in 2006 during the Bush administration, at the height of the housing bubble.

The fundamental reason the deficits have grown despite the trade wars Trump has launched is that the size of the overall trade deficit is determined not by whatever tariffs are imposed on specific goods or on specific countries, nor even by what trade agreements have been reached, but rather by underlying macro factors.  As discussed in an earlier post on this blog, the balance in foreign trade will be equal to the difference between aggregate domestic savings and aggregate domestic investment.  Tariffs and trade agreements will not have a significant direct impact on those macro aggregates.  Rather, tariffs applied to certain goods or to certain countries, or trade agreements reached, may lead producers and consumers to switch from whom they might import items or to whom they might export, but not the overall balance.  Trade with China, for example, might be reduced by such trade wars (and indeed it was), but this then just led to shifts in imports away from China and towards such countries as Viet Nam, Cambodia, Bangladesh, and Mexico.  Unless aggregate savings in the US increases or aggregate investment falls, the overall trade deficit will remain where it was.

Tariffs and trade agreements can thus lead to switches in what is traded and with whom.  Tariffs are a tax, and are ultimately paid largely by American households.  Purchasers may choose either to pay the higher price due to the tariff, or switch to a less desirable similar product from someone else (which had been either more expensive, pre-tariff, or less desirable due to quality or some similar issue), but unless the overall savings / investment balance in the economy is changed, the overall trade deficit will remain as it was.  The only difference resulting from the trade wars is that American households will then need to pay either a higher price or buy a less desirable product.

It is understandable that Trump might not understand this.  He is not an economist, and his views on trade are fundamentally mercantilist, which economists had already moved beyond over 250 years ago.  But Trump’s economic advisors should have explained this to him.  They have either been unwilling, or unable, to do so.

Are the growing trade deficits nevertheless a concern, as Trump asserted in 2016 (when the deficits were lower)?  Actually, in themselves probably not.  In the second quarter of 2020 (the most recent period where we have actual GDP figures), the trade deficit in goods reached 4.5% of GDP.  While somewhat high (generally a level of 3 to 4% of GDP would be considered sustainable), the trade balance hit a substantially higher 6.4% of GDP in the last quarter of 2005 during the Bush administration.  The housing bubble was then in full swing, households were borrowing against their rising home prices with refinancings or home equity loans and spending the proceeds, and aggregate household savings was low.  With savings low and domestic investment moderate (not as high as a share of GDP as it had been in 2000, in the last year of Clinton, but close), the trade deficit was high.  And when that housing bubble burst, the economy plunged into the then largest economic downturn since the Great Depression (largest until this year).

Thus while the trade deficit is at a record level in dollar terms (the measure Trump refers to), it is at a still high but more moderate level as a share of GDP.  It is certainly not the priority right now.  Recovering from the record economic slump (where GDP collapsed at an annualized rate of 31% in the second quarter of 2020) is of far greater concern.  And while expectations are that GDP bounced back substantially (but only partially) in the third quarter (the initial estimate of GDP for the third quarter will be issued by the BEA on October 29, just before the election), the structural damage done to the economy from the mismanagement of the Covid-19 crisis will take substantial time to heal.  Numerous firms have gone bankrupt.  They and others who may survive but who have been under severe stress will not be paying back their creditors (banks and others), so financial sector balance sheets have also been severely weakened.  It will take some time before the economic structure will be able to return to normal, even if a full cure for Covid-19 magically appeared tomorrow.

D.  Conclusion

Trump promised he would set records.  He has.  But the records set are the opposite of what he promised.

Trump’s Economic Record in Charts

A.  Introduction

Donald Trump has repeatedly asserted that he built “the greatest economy in history”.  A recent example is in his acceptance speech for the Republican nomination to run for a second term.  And it is not a surprise that Trump would want to claim this.  It would be nice, if true.  But what is surprising is that a number of election surveys have found that Trump polls well on economic issues, with voters rating Trump substantially above Biden on who would manage the economy better.

Yet any examination of Trump’s actual record, not just now following the unprecedented economic collapse this year resulting from the Covid-19 crisis, but also before, shows Trump’s repeated assertion to be plainly false.

The best that can be said is that Trump did not derail, in his first three years in office, the economic expansion that began with the turnaround Obama engineered within a half year of his taking office in 2009 (when Obama had inherited an economy that was, indeed, collapsing).  But the expansion that began under Obama has now been fully and spectacularly undone in Trump’s fourth year in office, with real GDP in the second quarter of 2020 plummeting at an annualized rate of 32% – to a level that is now even well below what it was when Trump took office.  The 32% rate of decline is by far the fastest decline recorded for the US since quarterly data on GDP began to be recorded in 1947 (the previous record was 10%, under Eisenhower, and the next worst was an 8.4% rate of decline in the last quarter of 2008 at the very end of the Bush administration.

This post will look at Trump’s record in comparison to that not just of Obama but also of all US presidents of the last almost 48 years (since the Nixon/Ford term).  For his first three years in office, that Trump record is nothing special.  It is certainly and obviously not the best in history.  And now in his fourth year in office, it is spectacularly bad.

The examination will be via a series of charts.  The discussion of each will be kept limited, but the interested reader may wish to study them more closely – there is a lot to the story of how the economy developed during each presidential administration.  But the primary objective of these “spaghetti” charts is to show how Trump’s record in his first three years in office fits squarely in the middle of what the presidents of the last half-century have achieved.  It was not the best nor the worst over those first three years – Trump inherited from Obama an expanding and stable economy.  But then in Trump’s fourth year, it has turned catastrophic.

Also, while there is a lot more that could be covered, the post will be limited to examination of the outcomes for growth in overall output (GDP), for the fiscal accounts (government spending, the fiscal deficit, and the resulting public debt), the labor market (employment, unemployment, productivity, and real wages), and the basic trade accounts (imports, exports, and the trade balance).

The figures for the charts were calculated based on data from a number of official US government sources.  Summarizing them all here for convenience (with their links):

a)  BEA:  Bureau of Economic Analysis of the US Department of Commerce, and in particular the National Income and Product Accounts (NIPA, also commonly referred to as the GDP accounts).

b)  BLS:  Bureau of Labor Statistics of the US Department of Labor.

c)  OMB Historical Tables:  Office of Management and Budget, of the White House.

d)  Census Bureau – Foreign Trade Data:  Of the US Department of Commerce.

It was generally most convenient to access the data via FRED, the Federal Reserve Economic Database of the St. Louis Fed.

B.  Real GDP

Trump likes to assert that he inherited an economy that was in terrible shape.  Larry Kudlow, the director of the National Economic Council and Trump’s principal economic advisor recently asserted, for example in his speech to the Republican National Convention, that the Trump administration inherited from Obama “a stagnant economy that was on the front end of a recession”.  While it is not fully clear what a “front end” of a recession is (it is not an economic term), the economy certainly was not stagnant and there was no indication whatsoever of a recession on the horizon.

The chart at the top of this post shows the path followed by real GDP during the course of Obama’s first and second terms in office, along with that of Trump’s term in office thus far.  Both are indexed to 100 in the first calendar quarter of their presidential terms.  Obama inherited from Bush an economy that was rapidly collapsing (with a banking system in ruin) and succeeded in turning it around within a half year of taking office.  Subsequent growth during the remainder of Obama’s first term was then similar to what it was in his second term (with the curve parallel but shifted down in the first term due to the initial downturn).

Growth in the first three years of Trump’s presidency was then almost exactly the same as during Obama’s second term.  There is a bit of a dip at the start of the second year in Obama’s second term (linked to cuts in government spending in the first year of Obama’s second term – see below), but then a full recovery back to the previous path.  At the three-year mark (the 12th quarter) they are almost exactly the same.  To term this stagnation under Obama and then a boom under Trump, as Kudlow asserted, is nonsensical – they are the same to that point.  But the economy has now clearly collapsed under Trump, while it continued on the same path as before under Obama.

Does Trump look better when examined in a broader context, using the record of presidents going back to the Nixon/Ford term that began almost 48 years ago?  No:

The best that can be said is that the growth of real GDP under Trump in his first three years in office is roughly in the middle of the pack.  Growth was worse in a few administrations – primarily those where the economy went into a recession not long after they took office (such as in the first Reagan term, the first Bush Jr. term, and the Nixon/Ford term).  But growth in most of the presidential terms was either similar or distinctly better than what we had under Trump in his first three years.

And now real GDP has collapsed in Trump’s fourth year to the absolute worst, and by a very significant margin.

One can speculate on what will happen to real GDP in the final two quarters of Trump’s presidency.  Far quicker than in earlier economic downturns, Congress responded in March and April with a series of relief bills to address the costs of the Covid-19 crisis, that in total amount to be spent far surpass anything that has ever been done before.  The Congressional Budget Office (CBO) estimates that the resulting spending increases, tax cuts, and new loan facilities of measures already approved will cost a total of $3.1 trillion.  This total approved would, by itself, come to 15% of GDP (where one should note that not all will be spent or used in tax cuts in the current fiscal year – some will carry over into future years).  Such spending can be compared to the $1.2 trillion, or 8.5% of the then GDP, approved in 2008/09 in response to that downturn (with most of the spending and tax cuts spread over three years).  Of this $1.2 trillion, $444 billion was spent under the TARP program approved under Bush and $787 billion for the Recovery Act under Obama).

And debate is currently underway on additional relief measures, where the Democratic-controlled Congress approved in May a further $3 trillion for relief, while leaders in the Republican-controlled Senate have discussed a possible $1 trillion measure.  What will happen now is not clear.  Some compromise in the middle may be possible, or nothing may be passed.

But the spending already approved will have a major stimulative effect.  With such a massive program supporting demand, plus the peculiar nature of the downturn (where many businesses and other centers of employment had to be temporarily closed as the measures taken by the Trump administration to limit the spread of the coronavirus proved to be far from adequate), the current expectation is that there will be a significant bounceback in GDP in the third quarter.  As I write this, the GDPNow model of the Atlanta Fed forecasts that real GDP in the quarter may grow at an annualized rate of 29.6%.  Keep in mind, however, that to make up for a fall of 32% one needs, by simple arithmetic, an increase of 47% from the now lower base.  (Remember that to make up for a fall of 50%, output would need to double – grow by 100% – to return to where one was before.)

Taking into account where the economy is now (where there was already a 5% annualized rate of decline in real GDP in the first quarter of this year), what would growth need to be to keep Trump’s record from being the worst of any president of at least the last half-century?  Assuming that growth in the third quarter does come to 29.6%, one can calculate that GDP would then need to grow by 5.0% (annualized) in the fourth quarter to match the currently worst record – of Bush Jr. in his second term.  And it would need to grow by 19% to get it back to where GDP was at the end of 2019.

C.  The Fiscal Accounts

Growth depends on many factors, only some of which are controlled by a president together with congress.  One such factor is government spending.  Cuts in government spending, particularly when unemployment is significant and businesses cannot sell all that they could and would produce due to a lack of overall demand, can lead to slower growth.  Do cuts in government spending perhaps explain the middling rate of growth observed in the first three years of Trump’s term in office?  Or did big increases in government spending spur growth under Obama?

Actually, quite the opposite:

Federal government spending on goods and services did rise in the first year and a half of Obama’s first term in office, with this critical in reversing the collapsing economy that Obama inherited.  But the Republican Congress elected in 2010 then forced through cuts in spending, with further cuts continuing until well into Obama’s second term (after which spending remained largely flat).  While the economy continued to expand at a modest pace, the cuts slowed the economy during a period when unemployment was still high.  (There is also government spending on transfers, where the two largest such programs are Social Security and Medicare, but spending on such programs depends on eligibility, not on annual appropriations.)

Under Trump, in contrast, government spending has grown, and consistently so.  And indeed government spending grew under Trump at a faster pace than it had almost any other president of the last half-century (with even faster growth only under Reagan and Bush, Jr., two presidents that spoke of themselves, as Trump has, as “small government conservatives”):

The acceleration in government spending growth under Trump did succeed, in his first three years in office, in applying additional pressure on the economy in a standard Keynesian fashion, which brought down unemployment (see below).  But this extra government spending did not lead to an acceleration in growth – it just kept it growing (in the first three years of Trump’s term) at the same pace as it had before, as was seen above.  That is, the economy required additional demand pressure to offset measures the Trump administration was taking which themselves would have reduced growth (such as his trade wars, or favoritism for industries such as steel and aluminum, which harmed the purchasers of steel and aluminum such as car companies and appliance makers).

Trump has also claimed credit for a major tax cut bill (as have Reagan and Bush, Jr.).  They all claimed this would spur growth (none did – see above and a more detailed analysis in this blog post), and indeed such sufficiently faster growth, they predicted, that tax revenue would increase despite the reductions in the tax rates.  Hence fiscal deficits would be reduced.  They weren’t:

Fiscal deficits were large and sustained throughout the Reagan/Bush Sr. years.  They then moved to a fiscal surplus under Clinton, following the major tax increase passed in 1993 and the subsequent years of steady and strong growth.  The surplus was then turned back again into a deficit under Bush Jr., with his major tax cuts of 2001 and 2003 coupled with his poor record for economic growth.  Obama then inherited a high fiscal deficit, which grew higher due to the economic downturn he faced on taking office and the measures that were necessary to address it.  But with the economic recovery, the deficit under Obama was then reduced (although at too fast a pace –  this held back the economy, especially in the early years of the recovery when unemployment was still high).

Under Trump, in contrast, the fiscal deficit rose in his first three years in office, at a time when unemployment was low.  This was the time when the US should have been strengthening rather than weakening the fiscal accounts.  As President Kennedy said in his 1962 State of the Union Address: “The time to repair the roof is when the sun is shining.”  Under Trump, in contrast, the fiscal deficit was reaching 5% of GDP even before the Covid-19 crisis.  The US has never before had such a high fiscal deficit when unemployment was low, with the sole exception of during World War II.

This left the fiscal accounts in a weak condition when government spending needed to increase with the onset of the Covid-19 crisis.  The result is that the fiscal deficit is expected to reach an unprecedented 16% of GDP this fiscal year, the highest it has ever been (other than during World War II) since at least 1930, when such records began to be kept.

The consequence is a public debt that is now shooting upwards:

As a share of GDP, federal government debt (held by the public) is expected to reach 100% of GDP by September 30 (the end of the fiscal year), based on a simple extrapolation of fiscal account and debt data currently available through July (see the US Treasury Monthly Statement for July, released August 12, 2020).  And with its momentum (as such fiscal deficits do not turn into surpluses in any short period of time), Trump will have left for coming generations a government debt that is the highest (as a share of GDP) it has ever been in US history, exceeding even what it was at the end of World War II.

When Trump campaigned for the presidency in 2016, he asserted he would balance the federal government fiscal accounts “fairly quickly”.  Instead the US will face this year, in the fourth year of his term in office, a fiscal deficit that is higher as a share of GDP than it ever was other than during World War II.  Trump also claimed that he would have the entire federal debt repaid within eight years.  This was always nonsense and reflected a basic lack of understanding.  But at least the federal debt to GDP ratio might have been put on a downward trajectory during years when unemployment was relatively low.  Instead, federal debt is on a trajectory that will soon bring it to the highest it has ever been.

D.  The Labor Market

Trump also likes to assert that he can be credited with the strongest growth in jobs in history.  That is simply not true:

Employment growth was higher in Obama’s second term than it ever was during Trump’s term in office.  The paths were broadly similar over the first three years of Trump’s term, but Trump was simply – and consistently – slower.  In Obama’s first term, employment was falling rapidly (by 800,000 jobs a month) when Obama took his oath of office, but once this was turned around the path showed a similar steady rise.

Employment then plummeted in Trump’s fourth year, and by a level that was unprecedented (at least since such statistics began to be gathered in 1947).  In part due to the truly gigantic relief bills passed by Congress in March and April (described above), there has now been a substantial bounceback.  But employment is still (as of August 2020) well below what it was when Trump took office in January 2017.

Even setting aside the collapse in employment this year, Trump’s record in his first three years does not compare favorably to that of other presidents:

A few presidents have done worse, primarily those who faced an economy going into a downturn as they took office (Obama) or where the economy was pushed into a downturn soon after they took office (Bush Jr., Reagan) or later in their term (Bush Sr., Nixon/Ford).  But the record of other presidents was significantly better, with the best (which some might find surprising) that of Carter.

Trump also claims credit for pushing unemployment down to record low levels.  The unemployment rate did, indeed, come down (although not to record low rates – the unemployment rate was lower in the early 1950s under Truman and then Eisenhower, and again in the late 1960s).  But one cannot see any significant change in the path on the day Trump was inaugurated compared to what it had been under Obama since 2010:

And of course now in 2020, unemployment has shot upwards to a record level (since at least 1948, when these records began to be kept systematically).  It has now come down with the bounceback of the economy, but remains high (8.4% as of August).

Over the long term, nothing is more important in raising living standards than higher productivity.  And this was the argument Trump and the Republicans in Congress made to rationalize their sharp cuts in corporate tax rates in the December 2017 tax bill.  The argument was that companies would then invest more in the capital assets that raise productivity (basically structures and equipment).  But this did not happen.  Even before the collapse this year, private non-residential investment in structures and equipment was no higher, and indeed a bit lower, as a share of GDP than what it was before the 2017 tax bill passed.

And it certainly has not led to a jump in productivity:

Productivity growth during Trump’s term in office has been substantially lower (by 3%) than what it was during Obama’s first term, although somewhat better than during Obama’s second term (by a cumulative 1% point at the same calendar quarter in their respective terms).

And compared to that of other presidents, Trump’s record on productivity gains is nothing special:

Finally, what happened to real wages?  While higher productivity growth is necessary in the long term for higher wages (workers cannot ultimately be paid more than what is produced), in the short term a number of other factors (such as relative bargaining strength) will dominate.  When unemployment is high, wage gains will typically be low as firms can hire others if a worker demands a higher wage.  And when unemployment is low, workers will typically be in a better bargaining position to demand higher wages.

How, then, does Trump’s record compare to that of Obama?:

During the first three years of Trump’s tenure in office, real wage gains were basically right in the middle of what they were over the similar periods in Obama’s two terms.  But then it looks like real wages shot upwards at precisely the time when the Covid-19 crisis hit.  How could this be?

One needs to look at what lies behind the numbers.  With the onset of the Covid-19 crisis, unemployment shot up to the highest it has been since the Great Depression.  But two issues were then important.  One is that when workers are laid off, it is usually the least senior, least experienced, workers who are laid off first.  And such workers will in general have a lower wage.  If a high share of lower-wage workers become unemployed, then the average wage of the workers who remain employed will go up.  This is a compositional effect.  No individual worker may have seen an increase in his or her wage, but the overall average will go up if fewer lower-wage workers remain employed.

Second, this downturn was different from others in that a high share of the jobs lost were precisely in low-wage jobs – workers in restaurants, cafeterias, and hotels, or in retail shops, or janitors for office buildings, and so on.  As the economy shut down, these particular businesses had to close.  Many, if not most, office workers could work from home, but not these, commonly low-wage, workers.  They were laid off.

The sharp jump in average real wages in the second quarter of 2020 (Trump’s 14th quarter in office) is therefore not something to be pleased about.  As the lower-wage workers who have lost their jobs return to being employed, one should expect this overall average wage to fall back towards where it was before.

But the path of real wages in the first three years of Trump’s presidency, when the economy continued to expand as it had under Obama, does provide a record that can be compared.  How does it look relative to that of other presidents of the last half-century?:

Again, Trump’s record over this period is in the middle of the range found for other presidents.  It was fairly good (unemployment was low, which as noted above would be expected to help), but real wages in the second terms of Clinton and Obama rose by more, and performance was similar in Reagan’s second term.

E.  International Trade Accounts

Finally, how does Trump’s record on international trade compare to that of other presidents?  Trump claimed he would slash the US trade deficit, seeing it in a mercantilistic way as if a trade deficit is a “loss” to the country.  At a 2018 press conference (following a G-7 summit in Canada), he said, for example, “Last year,… [the US] lost  … $817 billion on trade.  That’s ridiculous and it’s unacceptable.”  And “We’re like the piggybank that everybody is robbing.”

This view on the trade balance reflects a fundamental lack of understanding of basic economics.  Equally worrisome is Trump’s view that launching trade wars targeting specific goods (such as steel and aluminum) or specific countries (such as China) will lead to a reduction in the trade deficit.  As was discussed in an earlier post on this blog, the trade balance ultimately depends on the overall balance between domestic savings and domestic investment in an economy.  Trade wars may lead to reductions in imports, but then there will also be a reduction in exports.  If the trade wars do not lead to higher savings or lower investment, such trade interventions (with tariffs or quotas imposed by fiat) will simply shift the trade to other goods or other nations, leaving the overall balance where it would have been based on the savings/investment balance.

But we now have three and a half years of the Trump administration, and can see what his trade wars have led to.  In terms of imports and exports:

Imports did not go down under Trump – they rose until collapsing in the worldwide downturn of 2020.  Exports also at first rose, but more slowly than imports, and then leveled off before imports did.  They then also collapsed in 2020.  Going back a bit, both imports and exports had gone up sharply during the Bush administration.  Then, after the disruption surrounding the economic collapse of 2008/9 (with a fall then a recovery), they roughly stabilized at high levels during the last five years of the Obama administration.

In terms of the overall trade balance:

The trade deficit more than doubled during Bush’s term in office.  While both imports and exports rose (as was seen above), imports rose by more.  The cause of this was the housing credit bubble of the period, which allowed households to borrow against home equity (which in turn drove house prices even higher) and spend that borrowing (leading to higher consumption as a share of current income, which means lower savings).  This ended, and ended abruptly, with the 2008/9 collapse, and the trade deficit was cut in half.  After some fluctuation, it then stabilized in Obama’s second term.

Under Trump, in contrast, the trade deficit grew compared to where it was under Obama.  It did not diminish, as Trump insisted his trade wars would achieve, but the opposite.  And with the growing fiscal deficit (as discussed above) due to the December 2017 tax cuts and the more rapid growth in government spending (where a government deficit is dis-saving that has to be funded by borrowing), this deterioration in the trade balance should not be a surprise.  And I also suspect that Trump does not have a clue as to why this has happened (nor an economic advisor willing to explain it to him).

F.  Conclusion

There is much more to Trump’s economic policies that could have been covered.  It is also not yet clear how much damage has been done to the economic structure from the crisis following the mismanagement of Covid-19 (with the early testing failures, the lack of serious contact tracing and isolation of those who may be sick, and importantly, Trump’s politicizing the wearing of simple masks).  Unemployment rose to record levels, and this can have a negative impact (both immediate and longer-term) on the productivity of those workers and on their subsequent earnings.  There has also been a jump in bankruptcies, which reduces competition.  And bankrupt firms, as well as stressed firms more generally, will not be able to repay their loans in full.  The consequent weakening of bank balance sheets will constrain how much banks will be able to lend to others, which will slow the pace of any recovery.

But these impacts are still uncertain.  The focus of this post has been on what we already know of Trump’s economic record.  It is not a good one. The best that can be said is that during his first three years in office he did not derail the expansion that had begun under Obama.  Growth continued (in GDP, employment, productivity, wages), at rates similar to what they were before.  Compared to paths followed in other presidencies of the last half-century, they were not special.

But this growth during Trump’s tenure in office was only achieved with rapid growth in federal government spending.  Together with the December 2017 tax cuts, this led to a growing, not a diminishing, fiscal deficit.  The deficit grew to close to 5% of GDP, which was indeed special:  Never before in US history has the fiscal deficit been so high in an economy at or close to full employment, with the sole exception of during World War II.

The result was a growing public debt as a share of GDP, when prudent fiscal policy would have been the reverse.  Times of low unemployment are when the country should be reducing its fiscal deficit so that the public debt to GDP ratio will fall.  Reducing public dis-saving would also lead to a reduction in the trade deficit (other things being equal).  But instead the trade deficit has grown.

As a consequence, when a crisis hits (as it did in 2020) and government needs to spend substantial sums for relief (as it had to this year), the public debt to GDP ratio will shoot upwards from already high levels.  Republicans in Congress asserted in 2011 that a public debt of 70% of GDP was excessive and needed to be brought down rapidly.  Thus they forced through spending cuts, which slowed the recovery at a time when unemployment was still high.

But now public debt under Trump will soon be over 100% of GDP.  Part of the legacy of Trump’s term in office, for whoever takes office this coming January 20, will therefore be a public debt that will soon be at a record high level, exceeding even that at the end of World War II.

This has certainly not been “the greatest economy in history”.

Andrew Yang’s Proposed $1,000 per Month Grant: Issues Raised in the Democratic Debate

A.  Introduction

This is the second in a series of posts on this blog addressing issues that have come up during the campaign of the candidates for the Democratic nomination for president, and which specifically came up in the October 15 Democratic debate.  As flagged in the previous blog post, one can find a transcript of the debate at the Washington Post website, and a video of the debate at the CNN website.

This post will address Andrew Yang’s proposal of a $1,000 per month grant for every adult American (which I will mostly refer to here as a $12,000 grant per year).  This policy is called a universal basic income (or UBI), and has been explored in a few other countries as well.  It has received increased attention in recent years, in part due to the sharp growth in income inequality in the US of recent decades, that began around 1980.  If properly designed, such a $12,000 grant per adult per year could mark a substantial redistribution of income.  But the degree of redistribution depends directly on how the funding would be raised.  As we will discuss below, Yang’s specific proposals for that are problematic.  There are also other issues with such a program which, even if well designed, calls into question whether it would be the best approach to addressing inequality.  All this will be discussed below.

First, however, it is useful to address two misconceptions that appear to be widespread.  One is that many appear to believe that the $12,000 per adult per year would not need to come from somewhere.  That is, everyone would receive it, but no one would have to provide the funds to pay for it.  That is not possible.  The economy produces so much, whatever is produced accrues as incomes to someone, and if one is to transfer some amount ($12,000 here) to each adult then the amounts so transferred will need to come from somewhere.  That is, this is a redistribution.  There is nothing wrong with a redistribution, if well designed, but it is not a magical creation of something out of nothing.

The other misconception, and asserted by Yang as the primary rationale for such a $12,000 per year grant, is that a “Fourth Industrial Revolution” is now underway which will lead to widespread structural unemployment due to automation.  This issue was addressed in the previous post on this blog, where I noted that the forecast job losses due to automation in the coming years are not out of line with what has been the norm in the US for at least the last 150 years.  There has always been job disruption and turnover, and while assistance should certainly be provided to workers whose jobs will be affected, what is expected in the years going forward is similar to what we have had in the past.

It is also a good thing that workers should not be expected to rely on a $12,000 per year grant to make up for a lost job.  Median earnings of a full-time worker was an estimated $50,653 in 2018, according to the Census Bureau.  A grant of $12,000 would not go far in making up for this.

So the issue is one of redistribution, and to be fair to Yang, I should note that he posts on his campaign website a fair amount of detail on how the program would be paid for.  I make use of that information below.  But the numbers do not really add up, and for a candidate who champions math (something I admire), this is disappointing.

B.  Yang’s Proposal of a $1,000 Monthly Grant to All Americans

First of all, the overall cost.  This is easy to calculate, although not much discussed.  The $12,000 per year grant would go to every adult American, who Yang defines as all those over the age of 18.  There were very close to 250 million Americans over the age of 18 in 2018, so at $12,000 per adult the cost would be $3.0 trillion.

This is far from a small amount.  With GDP of approximately $20 trillion in 2018 ($20.58 trillion to be more precise), such a program would come to 15% of GDP.  That is huge.  Total taxes and revenues received by the federal government (including all income taxes, all taxes for Social Security and Medicare, and everything else) only came to $3.3 trillion in FY2018.  This is only 10% more than the $3.0 trillion that would have been required for Yang’s $12,000 per adult grants.  Or put another way, taxes and other government revenues would need almost to be doubled (raised by 91%) to cover the cost of the program.  As another comparison, the cost of the tax cuts that Trump and the Republican leadership rushed through Congress in December 2017 was forecast to be an estimated $150 billion per year.  That was a big revenue loss.  But the Yang proposal would cost 20 times as much.

With such amounts to be raised, Yang proposes on his campaign website a number of taxes and other measures to fund the program.  One is a value-added tax (VAT), and from his very brief statements during the debates but also in interviews with the media, one gets the impression that all of the program would be funded by a value-added tax.  But that is not the case.  He in fact says on his campaign website that the VAT, at the rate and coverage he would set, would raise only about $800 billion.  This would come only to a bit over a quarter (27%) of the $3.0 trillion needed.  There is a need for much more besides, and to his credit, he presents plans for most (although not all) of this.

So what does he propose specifically?:

a) A New Value-Added Tax:

First, and as much noted, he is proposing that the US institute a VAT at a rate of 10%.  He estimates it would raise approximately $800 billion a year, and for the parameters for the tax that he sets, that is a reasonable estimate.  A VAT is common in most of the rest of the world as it is a tax that is relatively easy to collect, with internal checks that make underreporting difficult.  It is in essence a tax on consumption, similar to a sales tax but levied only on the added value at each stage in the production chain.  Yang notes that a 10% rate would be approximately half of the rates found in Europe (which is more or less correct – the rates in Europe in fact vary by country and are between 17 and 27% in the EU countries, but the rates for most of the larger economies are in the 19 to 22% range).

A VAT is a tax on what households consume, and for that reason a regressive tax.  The poor and middle classes who have to spend all or most of their current incomes to meet their family needs will pay a higher share of their incomes under such a tax than higher-income households will.  For this reason, VAT systems as implemented will often exempt (or tax at a reduced rate) certain basic goods such as foodstuffs and other necessities, as such goods account for a particularly high share of the expenditures of the poor and middle classes.  Yang is proposing this as well.  But even with such exemptions (or lower VAT rates), a VAT tax is still normally regressive, just less so.

Furthermore, households will in the end be paying the tax, as prices will rise to reflect the new tax.  Yang asserts that some of the cost of the VAT will be shifted to businesses, who would not be able, he says, to pass along the full cost of the tax.  But this is not correct.  In the case where the VAT applies equally to all goods, the full 10% will be passed along as all goods are affected equally by the now higher cost, and relative prices will not change.  To the extent that certain goods (such as foodstuffs and other necessities) are exempted, there could be some shift in demand to such goods, but the degree will depend on the extent to which they are substitutable for the goods which are taxed.  If they really are necessities, such substitution is likely to be limited.

A VAT as Yang proposes thus would raise a substantial amount of revenues, and the $800 billion figure is a reasonable estimate.  This total would be on the order of half of all that is now raised by individual income taxes in the US (which was $1,684 billion in FY2018).  But one cannot avoid that such a tax is paid by households, who will face higher prices on what they purchase, and the tax will almost certainly be regressive, impacting the poor and middle classes the most (with the extent dependent on how many and which goods are designated as subject to a reduced VAT rate, or no VAT at all).  But whether regressive or not, everyone will be affected and hence no one will actually see a net increase of $12,000 in purchasing power from the proposed grant  Rather, it will be something less.

b)  A Requirement to Choose Either the $12,000 Grants, or Participation in Existing Government Social Programs

Second, Yang’s proposal would require that households who currently benefit from government social programs, such as for welfare or food stamps, would be required to give up those benefits if they choose to receive the $12,000 per adult per year.  He says this will lead to reduced government spending on such social programs of $500 to $600 billion a year.

There are two big problems with this.  The first is that those programs are not that large.  While it is not fully clear how expansive Yang’s list is of the programs which would then be denied to recipients of the $12,000 grants, even if one included all those included in what the Congressional Budget Office defines as “Income Security” (“unemployment compensation, Supplemental Security Income, the refundable portion of the earned income and child tax credits, the Supplemental Nutrition Assistance Program [food stamps], family support, child nutrition, and foster care”), the total spent in FY2018 was only $285 billion.  You cannot save $500 to $600 billion if you are only spending $285 billion.

Second, such a policy would be regressive in the extreme.  Poor and near-poor households, and only such households, would be forced to choose whether to continue to receive benefits under such existing programs, or receive the $12,000 per adult grant per year.  If they are now receiving $12,000 or more in such programs per adult household member, they would receive no benefit at all from what is being called a “universal” basic income grant.  To the extent they are now receiving less than $12,000 from such programs (per adult), they may gain some benefit, but less than $12,000 worth.  For example, if they are now receiving $10,000 in benefits (per adult) from current programs, their net gain would be just $2,000 (setting aside for the moment the higher prices they would also now need to pay due to the 10% VAT).  Furthermore, only the poor and near-poor who are being supported by such government programs will see such an effective reduction in their $12,000 grants.  The rich and others, who benefit from other government programs, will not see such a cut in the programs or tax subsidies that benefit them.

c)  Savings in Other Government Programs 

Third, Yang argues that with his universal basic income grant, there would be a reduction in government spending of $100 to $200 billion a year from lower expenditures on “health care, incarceration, homelessness services and the like”, as “people would be able to take better care of themselves”.  This is clearly more speculative.  There might be some such benefits, and hopefully would be, but without experience to draw on it is impossible to say how important this would be and whether any such savings would add up to such a figure.  Furthermore, much of those savings, were they to follow, would accrue not to the federal government but rather to state and local governments.  It is at the state and local level where most expenditures on incarceration and homelessness, and to a lesser degree on health care, take place.  They would not accrue to the federal budget.

d)  Increased Tax Revenues From a Larger Economy

Fourth, Yang states that with the $12,000 grants the economy would grow larger – by 12.5% he says (or $2.5 trillion in increased GDP).  He cites a 2017 study produced by scholars at the Roosevelt Institute, a left-leaning non-profit think tank based in New York, which examined the impact on the overall economy, under several scenarios, of precisely such a $12,000 annual grant per adult.

There are, however, several problems:

i)  First, under the specific scenario that is closest to the Yang proposal (where the grants would be funded through a combination of taxes and other actions), the impact on the overall economy forecast in the Roosevelt Institute study would be either zero (when net distribution effects are neutral), or small (up to 2.6%, if funded through a highly progressive set of taxes).

ii)  The reason for this result is that the model used by the Roosevelt Institute researchers assumes that the economy is far from full employment, and that economic output is then entirely driven by aggregate demand.  Thus with a new program such as the $12,000 grants, which is fully paid for by taxes or other measures, there is no impact on aggregate demand (and hence no impact on economic output) when net distributional effects are assumed to be neutral.  If funded in a way that is not distributionally neutral, such as through the use of highly progressive taxes, then there can be some effect, but it would be small.

In the Roosevelt Institute model, there is only a substantial expansion of the economy (of about 12.5%) in a scenario where the new $12,000 grants are not funded at all, but rather purely and entirely added to the fiscal deficit and then borrowed.  And with the current fiscal deficit now about 5% of GDP under Trump (unprecedented even at 5% in a time of full employment, other than during World War II), and the $12,000 grants coming to $3.0 trillion or 15% of GDP, this would bring the overall deficit to 20% of GDP!

Few economists would accept that such a scenario is anywhere close to plausible.  First of all, the current unemployment rate of 3.5% is at a 50 year low.  The economy is at full employment.  The Roosevelt Institute researchers are asserting that this is fictitious, and that the economy could expand by a substantial amount (12.5% in their scenario) if the government simply spent more and did not raise taxes to cover any share of the cost.  They also assume that a fiscal deficit of 20% of GDP would not have any consequences, such as on interest rates.  Note also an implication of their approach is that the government spending could be on anything, including, for example, the military.  They are using a purely demand-led model.

iii)  Finally, even if one assumes the economy will grow to be 12.5% larger as a result of the grants, even the Roosevelt Institute researchers do not assume it will be instantaneous.  Rather, in their model the economy becomes 12.5% larger only after eight years.  Yang is implicitly assuming it will be immediate.

There are therefore several problems in the interpretation and use of the Roosevelt Institute study.  Their scenario for 12.5% growth is not the one that follows from Yang’s proposals (which is funded, at least to a degree), nor would GDP jump immediately by such an amount.  And the Roosevelt Insitute model of the economy is one that few economists would accept as applicable in the current state of the economy, with its 3.5% unemployment.

But there is also a further problem.  Even assuming GDP rises instantly by 12.5%, leading to an increase in GDP of $2.5 trillion (from a current $20 trillion), Yang then asserts that this higher GDP will generate between $800 and $900 billion in increased federal tax revenue.  That would imply federal taxes of 32 to 36% on the extra output.  But that is implausible.  Total federal tax (and all other) revenues are only 17.5% of GDP.  While in a progressive tax system the marginal tax revenues received on an increase in income will be higher than at the average tax rate, the US system is no longer very progressive.  And the rates are far from what they would need to be twice as high at the margin (32 to 36%) as they are at the average (17.5%).  A more plausible estimate of the increased federal tax revenues from an economy that somehow became 12.5% larger would not be the $800 to $900 billion Yang calculates, but rather about half that.

Might such a universal basic income grant affect the size of the economy through other, more orthodox, channels?  That is certainly possible, although whether it would lead to a higher or to a lower GDP is not clear.  Yang argues that it would lead recipients to manage their health better, to stay in school longer, to less criminality, and to other such social benefits.  Evidence on this is highly limited, but it is in principle conceivable in a program that does properly redistribute income towards those with lower incomes (where, as discussed above, Yang’s specific program has problems).  Over fairly long periods of time (generations really) this could lead to a larger and stronger economy.

But one will also likely see effects working in the other direction.  There might be an increase in spouses (wives usually) who choose to stay home longer to raise their children, or an increase in those who decide to retire earlier than they would have before, or an increase in the average time between jobs by those who lose or quit from one job before they take another, and other such impacts.  Such impacts are not negative in themselves, if they reflect choices voluntarily made and now possible due to a $12,000 annual grant.  But they all would have the effect of reducing GDP, and hence the tax revenues that follow from some level of GDP.

There might therefore be both positive and negative impacts on GDP.  However, the impact of each is likely to be small, will mostly only develop over time, and will to some extent cancel each other out.  What is likely is that there will be little measurable change in GDP in whichever direction.

e)  Other Taxes

Fifth, Yang would institute other taxes to raise further amounts.  He does not specify precisely how much would be raised or what these would be, but provides a possible list and says they would focus on top earners and on pollution.  The list includes a financial transactions tax, ending the favorable tax treatment now given to capital gains and carried interest, removing the ceiling on wages subject to the Social Security tax, and a tax on carbon emissions (with a portion of such a tax allocated to the $12,000 grants).

What would be raised by such new or increased taxes would depend on precisely what the rates would be and what they would cover.  But the total that would be required, under the assumption that the amounts that would be raised (or saved, when existing government programs are cut) from all the measures listed above are as Yang assumes, would then be between $500 and $800 billion (as the revenues or savings from the programs listed above sum to $2.2 to $2.5 trillion).  That is, one might need from these “other taxes” as much as would be raised by the proposed new VAT.

But as noted in the discussion above, the amounts that would be raised by those measures are often likely to be well short of what Yang says will be the case.  One cannot save $500 to $600 billion in government programs for the poor and near-poor if government is spending only $285 billion on such programs, for example.  A more plausible figure for what might be raised by those proposals would be on the order of $1 trillion, mostly from the VAT, and not the $2.2 to $2.5 trillion Yang says will be the case.

C.  An Assessment

Yang provides a fair amount of detail on how he would implement a universal basic income grant of $12,000 per adult per year, and for a political campaign it is an admirable amount of detail.  But there are still, as discussed above, numerous gaps that prevent anything like a complete assessment of the program.  But a number of points are evident.

To start, the figures provided are not always plausible.  The math just does not add up, and for someone who extolls the need for good math (and rightly so), this is disappointing.  One cannot save $500 to $600 billion in programs for the poor and near-poor when only $285 billion is being spent now.  One cannot assume that the economy will jump immediately by 12.5% (which even the Roosevelt Institute model forecasts would only happen in eight years, and under a scenario that is the opposite of that of the Yang program, and in a model that few economists would take as credible in any case).  Even if the economy did jump by so much immediately, one would not see an increase of $800 to $900 billion in federal tax revenues from this but rather more like half that.  And other such issues.

But while the proposal is still not fully spelled out (in particular on which other taxes would be imposed to fill out the program), we can draw a few conclusions.  One is that the one group in society who will clearly not gain from the $12,000 grants is the poor and near-poor, who currently make use of food stamp and other such programs and decide to stay with those programs.  They would then not be eligible for the $12,000 grants.  And keep in mind that $12,000 per adult grants are not much, if you have nothing else.  One would still be below the federal poverty line if single (where the poverty line in 2019 is $12,490) or in a household with two adults and two or more children (where the poverty line, with two children, is $25,750).  On top of this, such households (like all households) will pay higher prices for at least some of what they purchase due to the new VAT.  So such households will clearly lose.

Furthermore, those poor or near-poor households who do decide to switch, thus giving up their eligibility for food stamps and other such programs, will see a net gain that is substantially less than $12,000 per adult.  The extent will depend on how much they receive now from those social programs.  Those who receive the most (up to $12,000 per adult), who are presumably also most likely to be the poorest among them, will lose the most.  This is not a structure that makes sense for a program that is purportedly designed to be of most benefit to the poorest.

For middle and higher-income households the net gain (or loss) from the program will depend on the full set of taxes that would be needed to fund the program.  One cannot say who will gain and who will lose until the structure of that full set of taxes is made clear.  This is of course not surprising, as one needs to keep in mind that this is a program of redistribution:  Funds will be raised (by taxes) that disproportionately affect certain groups, to be distributed then in the $12,000 grants.  Some will gain and some will lose, but overall the balance has to be zero.

One can also conclude that such a program, providing for a universal basic income with grants of $12,000 per adult, will necessarily be hugely expensive.  It would cost $3 trillion a year, which is 15% of GDP.  Funding it would require raising all federal tax and other revenue by 91% (excluding any offset by cuts in government social programs, which are however unlikely to amount to anything close to what Yang assumes).  Raising funds of such magnitude is completely unrealistic.  And yet despite such costs, the grants provided of $12,000 per adult would be poverty level incomes for those who do not have a job or other source of support.

One could address this by scaling back the grant, from $12,000 to something substantially less, but then it becomes less meaningful to an individual.  The fundamental problem is the design as a universal grant, to all adults.  While this might be thought to be politically attractive, any such program then ends up being hugely expensive.

The alternative is to design a program that is specifically targeted to those who need such support.  Rather than attempting to hide the distributional consequences in a program that claims to be universal (but where certain groups will gain and certain groups will lose, once one takes fully into account how it will be funded), make explicit the redistribution that is being sought.  With this clear, one can then design a focussed program that addresses that redistribution aim.

Finally, one should recognize that there are other policies as well that might achieve those aims that may not require explicit government-intermediated redistribution.  For example, Senator Cory Booker in the October 15 debate noted that a $15 per hour minimum wage would provide more to those now at the minimum wage than a $12,000 annual grant.  This remark was not much noted, but what Senator Booker said was true.  The federal minimum wage is currently $7.25 per hour.  This is low – indeed, it is less (in real terms) than what it was when Harry Truman was president.  If the minimum wage were raised to $15 per hour, a worker now at the $7.25 rate would see an increase in income of $15.00 – $7.25 = $7.75 per hour, and over a year of 40 hour weeks would see an increase in income of $7.75 x 40 x 52 = $16,120.00.  This is well more than a $12,000 annual grant would provide.

Republican politicians have argued that raising the minimum wage by such a magnitude will lead to widespread unemployment.  But there is no evidence that changes in the minimum wage that we have periodically had in the past (whether federal or state level minimum wages) have had such an adverse effect.  There is of course certainly some limit to how much it can be raised, but one should recognize that the minimum wage would now be over $24 per hour if it had been allowed to grow at the same pace as labor productivity since the late 1960s.

Income inequality is a real problem in the US, and needs to be addressed.  But there are problems with Yang’s specific version of a universal basic income.  While one may be able to fix at least some of those problems and come up with something more reasonable, it would still be massively disruptive given the amounts to be raised.  And politically impossible.  A focus on more targeted programs, as well as on issues such as the minimum wage, are likely to prove far more productive.

The Growing Fiscal Deficit, the Keynesian Stimulus Policies of Trump, and the FY20/21 Budget Agreement

A.  The Growing Fiscal Deficit Under Trump

Donald Trump, when campaigning for office, promised that he would “quickly” drive down the fiscal deficit to zero.  Few serious analysts believed that he would get it all the way to zero during his term in office, but many assumed that he would at least try to reduce the deficit by some amount.  And this clearly should have been possible, had he sought to do so, when Republicans were in full control of both the House and the Senate, as well as the presidency.

That has not happened.  The deficit has grown markedly, despite the economy being at full employment, and is expected to top $1 trillion this year, reaching over 5% of GDP.  This is unprecedented in peacetime.  Never before in US history, other than during World War II, has the federal deficit hit 5% of GDP with the economy at full employment.  Indeed, the fiscal deficit has never even reached 4% of GDP at a time of full employment (other than, again, World War II).

The chart at the top of this post shows what has happened.  The deficit is the difference between what the government spends (shown as the line in blue) and the revenues it receives (the line in green).  The deficit grew markedly following the financial and economic collapse in the last year of the Bush administration.  A combination of higher government spending and lower taxes (lower both because the economy was depressed but also from legislated tax cuts) were then necessary to stabilize the economy.  As the economy recovered the fiscal deficit then narrowed.  But it is now widening again, and as noted above, is expected to top $1 trillion dollars in FY2019 (which ends on September 30).

More precisely, the US Treasury publishes monthly a detailed report on what the federal government received in revenues and what was spent in outlays for that month and for up to that point in the fiscal year.  See here for the June report, and here for previous monthly reports.  It includes a forecast of what will be received and spent for the fiscal year as a whole, and hence what the deficit will be, based on the budget report released each spring, usually in March.  For FY2019, the forecast was of a deficit of $1.092 trillion.  But these are forecasts, and comparing the forecasts made to the actuals realized over the last three fiscal years (FY2016 to18), government outlays were on average overestimated by 2.0% and government revenues by 2.2%.  These are similar, and scaling the forecasts of government outlays and government revenues down by these ratios, the deficit would end up at $1.075 trillion.  I used these scaled figures in the chart above.

The widening in the deficit in recent years is evident.  The interesting question is why.  For this one needs counterfactuals, of what the figures would have been if some alternative decisions had been made.

For government revenues (taxes of various kinds), the curve in orange show what they would have been had taxes remained at the same shares of the relevant income (depending on the tax) as they were in FY2016.  Specifically, individual income taxes were kept at a constant share of personal income (as defined and estimated in the National Income and Product Accounts, or NIPA accounts, assembled by the Bureau of Economic Analysis, or BEA, of the US Department of Commerce); corporate profit taxes were kept at a constant share of corporate profits (as estimated in the NIPA accounts); payroll taxes (primarily Social Security taxes) were kept at a constant share of compensation of employees (again from the NIPA accounts); and all other taxes were kept at a constant share of GDP.  The NIPA accounts (often referred to as the GDP accounts) are available through the second quarter of CY2019, and hence are not yet available for the final quarter of FY2019 (which ends September 30, and hence includes the third quarter of CY2019).  For this, I extrapolated the final quarter’s figures based on what growth had been over the preceding four quarters.

Note also that the base year here (FY2016) already shows a flattening in tax revenues.  If I had used the tax shares of FY2015 as a base for the comparison, the tax losses in the years since then would have been even greater.  Various factors account for the flattening of tax revenues in FY2016, including (according to an analysis by the Congressional Budget Office) passage by Congress of Public Law 114-113 in December 2015, that allowed for a more rapid acceleration of depreciation allowances for investment by businesses.  This had the effect of reducing corporate profit taxes substantially in FY2016.

Had taxes remained at the shares of the relevant income as they were in FY2016, tax revenues would have grown, following the path of the orange curve.  Instead, they were flat in nominal dollar amount (the green curve), indicating they were falling in real terms as well as a share of income.  The largest loss in revenues stemmed from the major tax cut pushed through Congress in December 2017, which took effect on January 1, 2018.  Hence it applied over three of the four quarters in FY2018, and for all of FY2019.

An increase in government spending is also now leading, in FY2019, to a widening of the deficit.  Again, one needs to define a counterfactual for the comparison.  For this I assumed that government spending during Trump’s term in office so far would have grown at the same rate as it had during Obama’s eight years in office (the rate of increase from FY2008 to 16).  That rate of increase during Obama’s two terms was 3.2% a year (in nominal terms), and was substantially less than during Bush’s two terms (which was a 6.6% rate of growth per year).

The rate of growth in government spending in the first two years of Trump’s term (FY2017 and 2018) then almost exactly matched the rate of growth under Obama.  But this has now changed sharply in FY19, with government spending expected to jump by 8.0% in just one year.

The fiscal deficit is then the difference, as noted above, between the two curves for spending and revenues.  Its change over time may be clearer in a chart of just the deficit itself:

The curve in black shows what the deficit has been, and what is expected for FY2019.  The deficit narrowed to $442 billion in FY2015, and then started to widen.  Primarily due to flat tax revenues in FY2016 (spending was following the path it had been following before, after several years of suppression), the deficit grew in FY2016.  And it then continued to grow until at least through FY2019.  The curve in red shows what the deficit would have been had government spending continued to grow under Trump at the pace it had under Obama.  This would have made essentially no difference in FY2017 and FY2018, but would have reduced the deficit in FY2019 from the expected $1,075 billion to $877 billion instead.  Not a small deficit by any means, but not as high.

But more important has been the contribution to the higher deficit from tax cuts.  The combined effect is shown in the curve in blue in the chart.  The deficit would have stabilized and in fact reduced by a bit.  For FY2019, the deficit would have been $528 billion, or a reasonable 2.5% of GDP.  Instead, at an expected $1,075 billion, it will be over twice as high.  And it is a consequence of Trump’s policies.

B.  Have the Tax Cuts Led to Higher Growth?

The Trump administration claimed that the tax cuts (and specifically the major cuts passed in December 2017) would lead to such a more rapid pace of GDP growth that they would “pay for themselves”.  This clearly has not happened – tax revenues have fallen in real terms (they were flat in nominal terms).  But a less extreme argument was that the tax cuts, and in particular the extremely sharp cut in corporate profit taxes, would lead to a spurt of new corporate investment in equipment, which would raise productivity and hence GDP.  See, for example, the analysis issued by the White House Council of Economic Advisors in October 2017.

But this has not happened either.  Growth in private investment in equipment has in fact declined since the first quarter of 2018 (when the law went into effect):

The curve in blue shows the quarter to quarter changes (at an annual rate), while the curve in red smooths this out by showing the change over the same quarter of a year earlier.  There is a good deal of volatility in the quarter to quarter figures, while the year on year changes show perhaps some trends that last perhaps two years or so, but with no evidence that the tax cut led to a spurt in such investment.  The growth has in fact slowed.

Such investment is in fact driven largely by more fundamental factors, not by taxes.  There was a sharp fall in 2008 as a result of the broad economic and financial collapse at the end of the Bush administration, it then bounced back in 2009/10, and has fluctuated since driven by various industry factors.  For example, oil prices as well as agricultural prices both fell sharply in 2015, and the NIPA accounts indicate that equipment investment in just these two sectors reduced private investment in equipment by more than 2% points from what the total would have been in 2015.  This continued into 2016, with a reduction of a further 1.3% points.  What matters are the fundamentals.  Taxes are secondary, at best.

What about GDP itself?:

Here again there is quarter to quarter volatility, but no evidence that the tax cuts have spurred GDP growth.  Over the past three years, real GDP growth on a quarter to quarter basis peaked in the fourth quarter of 2017, before the tax cuts went into effect, and has declined modestly since then.  And that peak in the fourth quarter of 2017 was not anything special:  GDP grew at a substantially faster pace in the second and third quarters of 2014, and the year on year rate in early 2015 was higher than anything reached in 2017-19.  Rather, what we see in real GDP growth since late 2009 is significant quarter to quarter volatility, but around an average pace of about 2.3% a year.  There is no evidence that the late 2017 tax cut has raised this.

The argument that tax cuts will spur private investment, and hence productivity and hence GDP, is a supply-side argument.  There is no evidence in the numbers to support this.  But there may also be a demand-side argument, which is basically Keynesian.  The argument would be that tax cuts lead to higher (after-tax) incomes, and that these higher incomes led to higher consumption expenditures by households.  There might be some basis to this, to the extent that a portion of the tax cuts went to low and middle-income households who will spend more upon receiving it.  But since the tax cut law passed in December 2017 went primarily to the rich, whose consumption is not constrained by their current income flows (they save the excess), the impact of the tax cuts on household consumption would be weak.  It still, however, might be something.

But this still did not lead to a more rapid pace of GDP growth, as we saw above.  Why?  One needs to recognize that GDP is a measure of production in the domestic economy (GDP is Gross Domestic Product), and not of demand.  GDP is commonly measured by adding up the components of demand, with any increase or decrease in the stock of inventories then added (or subtracted, if negative) to tell us what production must have been.  But this is being done because the data is better (and more quickly available) for the components of GDP demand.  One must not forget that GDP is still an estimate of production, and not of total domestic demand.

And what the economy can produce when at full employment is constrained by whatever capacity was at that point in time.  The rate of unemployment has fallen steadily since hitting its peak in 2009 during the downturn:

Aside from the “squiggles” in these monthly figures (the data are obtained from household surveys, and will be noisy), unemployment fell at a remarkably steady pace since 2009.  One can also not discern any sharp change in that pace before and after January 2017, when Trump took office.  But the rate of unemployment is now leveling off, as it must, since there will always be some degree of frictional unemployment when an economy is at “full employment”.

With the economy at full employment, growth will now be constrained by the pace of growth of the labor force (about 0.5% a year) plus the growth in productivity of the average labor force member (which analysts, such as at the Congressional Budget Office, put at about 1.5% a year in the long term, and a bit less over the next decade).  That is, growth in GDP capacity will be 2% a year, or less, on average.

In such situations, Keynesian demand expansion will not raise the growth in GDP beyond that 2% rate.  There will of course be quarter to quarter fluctuations (GDP growth estimates are volatile), but on average over time, one should not expect growth in excess of this.

But growth can be less.  In a downturn, such as that suffered in 2008/09, GDP growth can drop well below capacity.  Unemployment soars, and Keynesian demand stimulus is needed to stabilize the economy and return it to a growth path.  Tax cuts (when focused on low and middle income households) can be stimulative.  But especially stimulative in such circumstances is direct government spending, as such spending leads directly to people being hired and put to work.

Thus the expansion in government spending in 2008/09 (see the chart at the top of this post) was exactly what was needed in those circumstances.  The mistake then was to hold government spending flat in nominal terms (and hence falling in real terms) between 2009 and 2014, even though unemployment, while falling, was still relatively high.  That cut-back in government spending was unprecedented in a period of recovery from a downturn (over at least the past half-century in the US).  And an earlier post on this blog estimated that had government spending been allowed to increase at the same pace as it had under Reagan following the 1982 downturn, the US economy would have fully recovered by 2012.

But the economy is now at full employment.  In these circumstances, extra demand stimulus will not increase production (as production is limited by capacity), but will rather spill over into a drawdown in inventories (in the short term, but there is only so much in inventories that one can draw down) or an increase in the trade deficit (more imports to satisfy the domestic demand, or exports diverted to meet the domestic demand).  One saw this in the initial estimates for the GDP figures for the second quarter of 2019.  GDP is estimated to have grown at a 2.1% rate.  But the domestic final demand components grew at a pace that, by themselves, would have accounted for a 3.6% point increase in GDP.  The difference was accounted for by a drawdown in inventories (accounting for 0.7% points of GDP) and an increase in the trade deficit (accounting for a further reduction of 0.8% points of GDP).  But these are just one quarter of figures, they are volatile, and it remains to be seen whether this will continue.

It is conceivable that domestic demand might fall back to grow in line with capacity.  But this then brings up what should be considered the second arm of Trump’s Keynesian stimulus program.  While tax cuts led to growing deficits in FY2017 and 18, we are now seeing in FY2019, in addition to the tax cuts, an extraordinary growth in government spending.  Based on US Treasury forecasts for FY2019 (as adjusted above), federal government spending this fiscal year is expected to grow by 8.0%.  This will add to domestic demand growth.  And there has not been such growth in government spending during a time of full employment since George H. W. Bush was president.

C.  The Impact of the Bipartisan Budget Act of 2019

Just before leaving for its summer recess, the House and the Senate in late July both passed an important bill setting the budget parameters for fiscal years 2020 and 2021.  Trump signed it into law on August 2.  It was needed as, under the budget sequester process forced on Obama in 2011, there would have otherwise been sharp cutbacks in the discretionary budgets for what government is allowed to spend (other than for programs such as Social Security or Medicare, where spending follows the terms of the programs as established, or for what is spent on interest on the public debt).  The sequesters would have set sharp cuts in government spending in fiscal years 2020 and 2021, and if allowed, such sudden cuts could have pushed the US economy into a recession.

The impact is clear on a chart:

The figures are derived from the Congressional Budget Office analysis of the impact on government spending from the lifting of the caps.  Without the change in the spending caps, discretionary spending would have been sharply reduced.  At the new caps, spending will increase at a similar pace as it had before.

Note the sharp contrast with the cut-backs in discretionary budget outlays from FY2011 to FY2015.  Unemployment was high then, and the economy struggled to recover from the 2008/09 downturn while confronting these contractionary headwinds.  But the economy is now at full employment, and the extra stimulus on demand from such spending will not, in itself and in the near term, lead to an increase in capacity, and hence not lead to a faster rate of growth than what we have seen in recent years.

But I should hasten to add that lifting the spending caps was not a mistake.  Government spending has been kept too limited for too long – there are urgent public needs (just look at the condition of our roads).  And a sharp and sudden cut in spending could have pushed the economy into a recession, as noted above.

More fundamentally, keeping up a “high pressure” economy is not necessarily a mistake.  One will of course need to monitor what is happening to inventories and the trade deficit, but the pressure on the labor market from a low unemployment rate has been bringing into the labor force workers who had previously been marginalized out of it.  And while there is little evidence as yet that it has spurred higher wages, continued pressure to secure workers should at some point lead to this.  What one does not want would be to reach the point where this leads to higher inflation.  But there is no evidence that we are near that now.  Indeed, the Fed decided on July 31 to reduce interest rates (for the first time since 2008, in part out of concern that inflation has been too low.

D.  Summary, Implications, and Conclusion

Trump campaigned on the promise that he would bring down the government deficit – indeed bring it down to zero.  The opposite has happened.  The deficit has grown sharply, and is expected to reach over $1 trillion this fiscal year, or over 5% of GDP.  This is unprecedented in the US in a time of full employment, other than during World War II.

The increase in the deficit is primarily due to the tax cuts he championed, supplemented (in FY2019) by a sharp rise in government spending.  Without such tax cuts, and with government spending growth the same as it had been under Obama, the deficit in FY2019 would have been $530 billion.  It is instead forecast to be double that (a forecast $1.075 trillion).

The tax cuts were justified by the administration by arguing that they would spur investment and hence growth.  That has not happened.  Growth in private investment in equipment has slowed since the major tax cuts of December 2017 were passed.  So has the pace of GDP growth.

This should not be surprising.  Taxes have at best a marginal effect on investment decisions.  The decision to invest is driven primarily by more fundamental considerations, including whether the extra capacity is needed given demand for the products, by the technologies available, and so on.

But tax cuts (to the extent they go to low and middle income households), and even more so direct government spending, can spur demand in the economy.  At times of less than full employment, this can lead to a higher GDP in standard Keynesian fashion.  But when the economy is at full employment, the constraint is not aggregate demand but rather production capacity.  And that is set by the available labor force and how much each worker can produce (their productivity).  The economy can then grow only as fast as the labor force and productivity grow, and most estimates put that at about 2% or less per year in the US right now.

The spur to demand can, however, act to keep the economy from falling back into a recession.  With the chaos being created in the markets by the trade wars Trump has launched, this is not a small consideration.  Indeed, the Fed, in announcing its July 31 cut in interest rates, indicated that in addition to inflation tracking below its target rate of 2%, concerns regarding “global developments” (interpreted as especially trade issues) was a factor in making the cut.

There are also advantages to keeping high pressure on the labor markets, as it draws in labor that was previously marginalized, and should at some point lead to higher wages.  As long as inflation remains modest (and as noted, it is currently below what the Fed considers desirable), all this sounds like a good situation.  The fiscal policies are therefore providing support to help ensure the economy does not fall back into recession despite the chaos of the trade wars and other concerns, while keeping positive pressure in the labor markets.  Trump should certainly thank Nancy Pelosi for the increases in the government spending caps under the recently approved budget agreement, as this will provide significant, and possibly critical, support to the economy in the period leading up to the 2020 election.

So what is there not to like?

The high fiscal deficit at a time of full employment is not to like.  As noted above, a fiscal deficit of more than 5% of GDP during a time of full employment is unprecedented (other than during World War II).  Unemployment was similarly low in the final few years of the Clinton presidency, but the economy then had fiscal surpluses (reaching 2.3% of GDP in FY2000) as well as a public debt that was falling in dollar amount (and even more so as a share of GDP).

The problem with a fiscal deficit of 5% of GDP with the economy at full employment is that when the economy next goes into a recession (and there eventually always has been a recession), the fiscal deficit will rise (and will need to rise) from this already high base.  The fiscal deficit rose by close to 9 percentage points of GDP between FY2007 and FY2009.  A similar economic downturn starting from a base where the deficit is already 5% of GDP would thus raise the fiscal deficit to 14% of GDP.   And that would certainly lead conservatives to argue, as they did in 2009, that the nation cannot respond to the economic downturn with the increase in government spending that would be required to stabilize and then bring down unemployment.

Is a recession imminent?  No one really knows, but the current economic expansion, that began five months after Obama took office, is now the longest on record in the US – 121 months as of July.  It has just beaten the 120 month expansion during the 1990s, mostly when Clinton was in office.  Of more concern to many analysts is that long-term interest rates (such as on 10-year US Treasury bonds) are now lower than short-term interest rates on otherwise similar US Treasury obligations.  This is termed an “inverted yield curve”, as the yield curve (a plot of interest rates against the term of the bond) will normally be upward sloping.  Longer-term loans normally have to pay a higher interest rate than shorter ones.  But right now, 10-year US Treasury bonds are being sold in the market at a lower interest rate than the interest rate demanded on short-term obligations.  This only makes sense if those in the market expect a downturn (forcing a reduction in interest rates) at some point in the next few years.

The concern is that in every single one of the seven economic recessions since the mid-1960s, the yield curve became inverted prior to that downturn.  While this was typically two or three years before the downturn (and in the case leading up to the 1970 recession, about four years before), in no case was there an inverted yield curve without a subsequent downturn within that time frame.  Some argue that “this time is different”, and perhaps it will be.  But an inverted yield curve has been 100% accurate so far in predicting an imminent recession.

The extremely high fiscal deficit under Trump at a time of full employment is therefore leaving the US economy vulnerable when the next recession occurs.  And a growing public debt (it will reach $16.8 trillion, or 79% of GDP, by September 30 of this year, in terms of debt held by the public) cannot keep growing forever.

What then to do?  A sharp cut in government spending might well bring on the downturn that we are seeking to avoid.  Plus government spending is critically needed in a range of areas.  But raising taxes, and specifically raising taxes on the well-off who benefited disproportionately in the series of tax cuts by Reagan, Bush II, and then Trump, would have the effect of raising revenue without causing a contractionary impulse.  The well-off are not constrained in what they spend on consumption by their incomes – they consume what they wish and save the residual.

The impact on the deficit and hence on the debt could also be significant.  While now a bit dated, an analysis on this blog from September 2013 (using Congressional Budget Office figures) found that simply reversing in full the Bush tax cuts of 2001 and 2003 would lead the public debt to GDP ratio to fall and fall sharply (by about half in 25 years).  The Trump tax cuts of December 2017 have now made things worse, but a good first step would be to reverse these.

It was the Bush and now Trump tax cuts that have put the fiscal accounts on an unsustainable trajectory.  As was noted above, the fiscal accounts were in surplus at the end of the Clinton administration.  But we now have a large and unprecedented deficit even when the economy is at full employment.  In a situation like this, one would think it should be clear to acknowledge the mistake, and revert to what had worked well before.

Managing the fiscal accounts in a responsible way is certainly possible.  But they have been terribly mismanaged by this administration.

Taxes on Corporate Profits Have Continued to Collapse

 

The Bureau of Economic Analysis (BEA) released earlier today its second estimate of GDP growth in the fourth quarter ot 2018.  (Confusingly, it was officially called the “third” estimate, but was only the second as what would have been the first, due in January, was never done due to Trump shutting down most agencies of the federal government in December and January due to his border wall dispute.)  Most public attention was rightly focussed on the downward revision in the estimate of real GDP growth in the fourth quarter, from a 2.6% annual rate estimated last month, to 2.2% now.  And current estimates are that growth in the first quarter of 2019 will be substantially less than that.

But there is much more in the BEA figures than just GDP growth.  The second report of the BEA also includes initial estimates of corporate profits and the taxes they pay (as well as much else).  The purpose of this note is to update an earlier post on this blog that examined what happened to corporate profit tax revenues following the Trump / GOP tax cuts of late 2017.  That earlier post was based on figures for just the first half of 2018.

We now have figures for the full year, and they confirm what had earlier been found – corporate profit tax revenues have indeed plummeted.  As seen in the chart at the top of this post, corporate profit taxes were in the range of only $150 to $160 billion (at annual rates) in the four quarters of 2018.  This was less than half the $300 to $350 billion range in the years before 2018.  And there is no sign that this collapse in revenues was due to special circumstances of one quarter or another.  We see it in all four quarters.

The collapse shows through even more clearly when one examines what they were as a share of corporate profits:

 

The rate fell from a range of generally 15 to 16%, and sometimes 17%, in the earlier years, to just 7.0% in 2018.  And it was an unusually steady rate of 7.0% throughout the year.  Note that under the Trump / GOP tax bill, the standard rate for corporate profit tax was cut from 35% previously to a new headline rate of 21%.  But the actual rate paid turned out (on average over all firms) to come to just 7.0%, or only one-third as much.  The tax bill proponents claimed that while the headline rate was being cut, they would close loopholes so the amount collected would not go down.  But instead loopholes were not only kept, but expanded, and revenues collected fell by more than half.

If the average corporate profit tax rate paid in 2018 had been not 7.0%, but rather at the rate it was on average over the three prior fiscal years (FY2015 to 2017) of 15.5%, an extra $192.2 billion in revenues would have been collected.

There was also a reduction in personal income taxes collected.  While the proportional fall was less, a much higher share of federal income taxes are now borne by individuals than by corporations.  (They were more evenly balanced decades ago, when the corporate profit tax rates were much higher – they reached over 50% in terms of the amount actually collected in the early 1950s.)  Federal personal income tax as a share of personal income was 9.2% in 2018, and again quite steady at that rate over each of the four quarters.  Over the three prior fiscal years of FY2015 to 2017, this rate averaged 9.6%.  Had it remained at that 9.6%, an extra $77.3 billion would have been collected in 2018.

The total reduction in tax revenues from these two sources in 2018 was therefore $270 billion.  While it is admittedly simplistic to extrapolate this out over ten years, if one nevertheless does (assuming, conservatively, real growth of 1% a year and price growth of 2%, for a total growth of about 3% a year), the total revenue loss would sum to $3.1 trillion.  And if one adds to this, as one should, the extra interest expense on what would now be a higher public debt (and assuming an average interest rate for government borrowing of 2.6%), the total loss grows to $3.5 trillion.

This is huge.  To give a sense of the magnitude, an earlier post on this blog found that revenues equal to the original forecast loss under the Trump / GOP tax plan (summing to $1.5 trillion over the next decade, and then continuing) would suffice to ensure the Social Security Trust Fund would be fully funded forever.  As things are now, if nothing is done the Trust Fund will run out in about 2034.  And Republicans insist that the gap is so large that nothing can be done, and that the system will have to crash unless retired seniors accept a sharp reduction in what are already low benefits.

But with losses under the Trump / GOP tax bill of $3.1 trillion over ten years, less than half of those losses would suffice to ensure Social Security could survive at contracted benefit levels.  One cannot argue that we can afford such a huge tax cut, but cannot afford what is needed to ensure Social Security remains solvent.

In the nearer term, the tax cuts have led to a large growth in the fiscal deficit.  Even the US Treasury itself is currently forecasting that the federal budget deficit will reach $1.1 trillion in FY2019 (5.2% of GDP), up from $779 billion in FY2018.  It is unprecedented to have such high fiscal deficits at a time of full employment, other than during World War II.  Proper fiscal management would call for something closer to a balanced budget, or even a surplus, in those periods when the economy is at full employment, while deficits should be expected (and indeed called for) during times of economic downturns, when unemployment is high.  But instead we are doing the opposite.  This will put the economy in a precarious position when the next economic downturn comes.  And eventually it will, as it always has.