Thursday, October 27, 2016

U.S. Government Has A Spending Problem

As of the end of the second quarter the U.S. government's budget deficit is once again widening and stands at $664 billion compared to $543 billion at the end of 2015. As can be seen in the below chart, government outlays as a percentage of GDP equals 22.4% and above the long run average of 20.3%. Additionally, government revenue as a percentage of GDP equals 18.8% versus the long run average of 17.7%. The gap is real but the percentages are elevated due to the continued weak growth of the economy in this recent expansion and hence the below trend GDP level.

In absolute dollar terms, the deficit has widened in spite of record tax receipts/revenue collected by the government. The below chart shows revenue is up 30% since just before the the start of the last recession. Government receipts have increased from $2.669 trillion to $3.472 trillion. At the same time, government expenses have increased at a far faster pace, up 39% over the same time period to $4.137 trillion from $2.979 trillion.

A significant issue with government expenditures is the high level of non-discretionary items. Additionally, net interest expense stands at $248 billion, 6% of the budget. If the recent move in interest rates is any indication of future interest expense on the government's debt, the budget deficit will likely continue to widen without implementation of policies that are pro-economic growth. Since July 6, the yield on the 10-year Treasury has increased 53 basis points from 1.32% to 1.85%. As new debt is issued to fund the deficit, these higher interest rates will be problematic for the government's budget.

Aside from interest on the government debt, explosive growth in entitlement spending will need to be addressed in order to bring discipline to the government's budget as well. Rhetoric that the middle class will not be impacted by tax hikes is just that, rhetoric. It was recently announced that wages subject to the social security tax will increase from $118,500 this year to $127,200 in 2017, a 7.3% increase and thus directly impacting the middle class tax payer. There are no easy solutions to addressing the government's budget deficit, but addressing this sooner versus later can ease any potential pain.

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