Fiscal Slope Negotiations in the Context of Current Expenditures and Current Receipts

The latter is stabilizing at extremely low levels.


To place matters in perspective, note that even before 2008, tax revenues were low by historical standards. That was due to tax reductions passed in 2001 and 2003 (EGTRRA and JGTRRA), which helped overheat the economy in 2006-07.


receiptsarelow1.gif

Figure 1: Current Federal receipts (blue) and current Federal expenditures (red), as a share of potential GDP, 1967-2012. NBER recession dates shaded gray. Source: BEA, 2012Q3 2nd release, CBO, August 2012, NBER, and author’s calculations.

In the wake of the second Bush recession, low tax receipts and high expenditures (i.e., a deficit) is an outcome of the attempt to stimulate the economy particularly in the depth of the great recession, either through direct discretionary measures (e.g., ARRA) and automatic stabilizers. Interestingly, while receipts are rising, spending is falling even faster. This point is highlighted in this detail, in Figure 2.


receiptsarelow2.gif

Figure 2: Current Federal receipts (blue) and current Federal expenditures (red), as a share of potential GDP, 1999-2012. NBER recession dates shaded gray. Source: BEA, 2012Q3 2nd release, CBO, August 2012, NBER, and author’s calculations.

Note that today, the Republican leadership came up with a proposal of $800 billion additional revenue, all to be achieved by unspecified reductions in tax expenditures, to wit: “… new revenue would be generated through pro-growth tax reform that closes special-interest loopholes and deductions while lowering rates.” While lowering rates? Doesn’t that make it harder to hit the $800 billion target? I am pervaded by a sense of déjà vu. It is of import to note that $800 billion over ten years works out to only $80 billion per year, or 0.47 percent of nominal potential GDP. (For more on the Republican proposal, see here.)

While Republican arguments that entitlement reform is eventually necessary is correct, it is not clear to me voucherizing Medicare (for instance) and shoving costs onto patients will “solve” the problem — unless we as a society are happy to see a return of senior poverty and unloading onto hospital emergency rooms. As Jeffry Frieden and I argued in Lost Decades regarding the health entitlements issue, “The only way to deal with this problem is to “bend the curve,” that is, reduce the growth rate of national health expenditures and its resultant drain on the federal budget.” That is, a solution requires a comprehensive approach to reducing health care costs imbedded into the entire system.

In any case, drastic changes to major entitlement programs should not be made in a rush, during the next few weeks. To meet the deadline, tax revenues, by necessity, will have to constitute the bulk of the solution to the fiscal slope.


For more on the fiscal slope, see [1], [2], [3] and here.


Update, 9:40pm Pacific 12/4:
pew_blame.gif

Source: Pew Research Center poll via WaPo (Dec. 4, 2012)

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44 thoughts on “Fiscal Slope Negotiations in the Context of Current Expenditures and Current Receipts

  1. Edward Lambert

    WE have to be very careful about raising capital’s share of income any further. As we do, capacity utilization gets pushed down more and more, and it has been pushed too low already.
    The equation for this is…
    Capital income max = unemployment + unutilized capacity
    Thus by pushing capital income up we are forcing a situation where capacity utilization is pushed lower.
    Corporate profits are capital income, as if no one noticed. and are they up or what?
    What will the labor income number tell us on Wednesday?

  2. John Jansen

    It is hard to continue to read after confronting the Orwellian phrase “tax expenditure”. That mindset pre supposes that the sovereign begins with a right to 100 per cent of my money and it is only with the largesse of the state that I am lucky enough to hold the residue.

  3. rana

    It is pretty sneaky of you using data to show that taxes under Socialism are at historically low levels and that spending has been falling as a share of potential for two years. Now the expiration of the payroll tax cut and partial expensing (along with some ACA related taxes) should push revenues up by about 1% of GDP.
    Back to the content of the post. We have a structural deficit now and if we want to close it over the next five years then much of the heavy lifting will have to come from taxes. We should also modify health care spending to slow its growth and prevent the structural deficit from widening. But the initial focus should be on the existing problem, which is that taxes are lower than desired spending. (As revealed by numerous Republican votes during the Bush years, desired spending is higher than our current tax system can support.)

  4. Buzzcut

    “That is, a solution requires a comprehensive approach to reducing health care costs imbedded into the entire system.”
    Making individuals responsible for a larger fraction of their healthcare spending might be the best way to address costs. I don’t think that most Americans will accept a top-down approach to addressing costs (death panels and such).

  5. tj

    Menzie
    Can you add “tax receipts on corporate income” and “personal current taxes” to Figure 2?
    If you do, you will see that personal tax receipts continued to grow until the start of the recession. However, corporate tax receipts peaked in 2006 and began to decline afterward.
    It appears the peak and decline in corporate tax receipts is associated with the flat part of total tax receipts in your chart around 2006-2007.
    As far as I know, corporate tax rates have not changed since the Clinton years.
    Thus, even with the Bush tax cuts, a slight decrease in the growth rate of expenditures would have brought the budget into balance without any growth retarding tax hikes.
    This chart clearly demonstrates my point.
    http://research.stlouisfed.org/fredgraph.png?g=ds7
    A clear takeaway is that once economic activity returns to a normal rate, no changes to the personal or corporate tax code are necessary.
    Reasonable changes to entitlement spending that redcues its rate of growth will solve the problem.
    However, I would still suggest “loophole” reform by capping deductions on incomes over $1 million to appease progressives and provide a revenue stream to offset Obamacare induced additions to expenditures. (I realize the almighty CBO has spoken and claims Obamacare is ~budget neutral, but we are kidding ourselves if we think Obamacare will be budget neutral.)

  6. steve

    “It is hard to continue to read after confronting the Orwellian phrase “tax expenditure”.”
    It is, so let’s rephrase it. I see no reason why your special interest group should pay taxes at a lower rate than my special interest group.
    Steve

  7. Ricardo

    Menzie wrote:
    To place matters in perspective, note that even before 2008, tax revenues were low by historical standards. That was due to tax reductions passed in 2001 and 2003 (EGTRRA and JGTRRA), which helped overheat the economy in 2006-07.
    The lengths you will go to to support your politics is wonderfully amusing. Your graph shows a steep slope upward when the 2003 tax cuts reversed the Clinton recession and tax revenue increased sharply.
    After the election of a Democrat congress in 2006 the bottom fell out. You make the point that this rapid increase in tax receipts is “low by historical standards” but revenue under the Democrats has been not just “low” but disastrous as demonstrated by your graph. Receipts are the lowest they have been since 1975 yet you criticize the results from EGTRRA and JGTRRA! If we only had the tax receipts that grew from these programs. Currently we have to look up to see bottom.
    Then your graph of expenditures and receipts demonstrates the lie of the demand side theorists. Has government spending actually increased tax revenue? Once again we see a Keynesian economist straining at a gnat to justify failed Keynesian stimulus policies while trying to explain away supply side success.
    Thanks for the graphs.

  8. Ricardo

    Menzie is so fixated on finding bad news about Wisconsin I thought folks might like to see some good news. Wisconsin Tops Morningstar State Pension Analysis
    Excerpt:
    “The State of State Pension Plans: A Deep Dive into Shortfalls and Surpluses,” which analyzed current data for pension plans administered by all 50 states, revealed that Wisconsin had the strongest-funded pension plan system while Illinois had the weakest.
    Most of us know that bloated state pension plans are destroying many states. I think Menzie should send Gov. Walker a big thank you for facing slander and abuse but still seeing that his pension is fully funded.

  9. Brian

    Saying “unspecified reductions in tax expenditures” clearly exhibits your political slant. The Republicans have been on record for months now saying that they would go ahead with an overall cap of $40,000 or $50,000 per household on itemized deductions. Timmy Geithner then said over the weekend that the WH will not budge unless rates go up. The Republicans put a legitimate offer on the table that could raise well over a half a trillion dollars over a decade, entirely from upper income people; and yet the liberals in the White House would rather play class warfare and insist on raising rates to stick it to the rich. I’m convinced the Democrats really don’t care so much about raising revenue as they do about punishing upper income people. Is it envy or what?

  10. Edward Lambert

    Comment to Ricardo, who wrote… “a Keynesian economist straining at a gnat to justify failed Keynesian stimulus policies while trying to explain away supply side success.”
    Supply side says that corporate profits need to be great. Business needs money to invest and create jobs. Well… let’s look at this equation, which cuts right through supply-side delusions.
    UT = unemployment – capacity utilization + labor income – 22.5
    UT = total unused available capacity of capital and labor and is non-negative.
    labor share is 2005=100.
    UT has a zero lower bound, which it has reached 6 times since 1967. As labor income has been decreasing over time (meaning capital income increases), capacity utilization is pushed to lower levels.
    full stop right there…
    Supply side seeks to give capital income more of a share of national income and it has ruined the US economy.
    As it stands right now, UT is at its zero lower bound again, and there is very little room to lower unemployment or raise capacity utilization. Supply side has gone too far and now the US economy is in deep trouble looking forward.

  11. Ricardo

    Edward wrote:
    Supply side says that corporate profits need to be great. Business needs money to invest and create jobs. Well… let’s look at this equation, which cuts right through supply-side delusions.
    Supply side seeks to give capital income more of a share of national income and it has ruined the US economy.
    I don’t know who signed your supply side diploma but you should ask for your money back.

  12. Rich Berger

    I also like MC’s use of potential GDP to show how receipts and expenditures are falling. Sort of like the ether except you can’t prove it doesn’t exist.

  13. Brian

    Menzie: we keep them as they are for now. Interest deductions, charitable givings, everything. But if the sum of your deductions goes over $40,000 then you only get to write $40,000 on your 1040. That way, for now we don’t even have to get into arguments about whether mortgage interest should be deductible etc. That can be discussed as part of broader tax reform. Putting a $40,000 cap can be done in 5 minutes and will bring in revenue from wealthier households.

  14. Joseph

    Brian, who is this “We” you speak of? The only Republican proposal that counts is the one that John Boehner presented to President Obama. You can read the full text of Boehner’s proposal right from his official government web site.
    http://www.speaker.gov/sites/speaker.house.gov/files/documents/letter_to_wh_121203.pdf
    That’s it. The whole plan. Please point out the specifics on deductions and caps that you speak of. The best I can tell it consists entirely of magic beans and pixie dust.

  15. Brian

    Menzie: carried interest is something that should be left unchanged until we do comprehensive tax reform later, as President Obama and Republicans have both said they would like to tackle. I suppose it takes some real experts in both corporate and personal tax law to go through the issues related to it. But isn’t the argument for low rates on carried interest the same as for dividends: the profits have already been taxed once at the corporate level.

  16. 2slugbaits

    Brian Capping deductions is something that really hits those in the top quintile, but not the top 0.1%. That’s the dirty little secret that Team Romney did not want to discuss. Capping deductions has almost no effect on the plutocrats. And it wouldn’t be long before the cap would be abolished.
    The kind of carried interest that most folks are talking about is really just disguised ordinary income. And labor also bears some of the burden of the corporate tax, so it is not like only dividends are subject to double taxation.

  17. Menzie Chinn

    Brian: I thought you said it was clear that all deductions were fair game…So I guess it depends what you think the definition of “all” is. Maybe not so clear?

  18. tj

    *Receipts grew rapidly (much faster than expenditures) from ~2003 to ~2006 with the Bush tax cuts in place even though GDP growth was in decline throughout all of 2004 and 2005.
    *”Personal current taxes” (taxes paid by persons on income, including realized net capital gains, and on personal property) continued to increase until the recession began in 2008, even though the Bush tax cuts were in place.
    *The budget deficit was closing between 2003 and 2007 even though the Bush Tax cuts in place.
    It appears individual income tax receipts did just fine with the Bush tax cuts in place right up until the recession started.
    Given these facts, it’s obvious our current and future fiscal problems are driven by slow income growth and unsustainable rates of entitlement spending.
    Why are we letting our attention be diverted by this “tax the rich” vs “don’t tax the rich” side show? Restore the higher rate on the “rich” and it provides little revenue and accounts for about $.06T per year in extra revenue. Our annual deficits are ~$1T. Tax the rich gets you 6 cents on every dollar of deficit spending.

  19. ppcm

    “Il etait digne de notre nation de singes de regarder nos assassins comme nos protecteurs;nous sommes des mouches qui prenons le parti des araignées » Voltaire
    This post is painting through fig 1 the largest yawning gap between fiscal receipts and expenditures. Comments are quantitatively demonstrating the marginal decreasing potency of the fiscal receipts.
    It is time to visit the full efficiency of the public expenditures at national levels, as well as, at supranational kevels. France has built during this last decades an aggregate indebt ness public, private and municipal (source INSEE) at historical height. It becomes compulsory,to evaluate the contribution of the public services, the cost of the marginalized public functions, defined as unable to perform their assigned functions (parliament, senat, cour des comptes,conseil d’état and not exclusively)
    Proper analytical accounts will reveal the obesity of the French administrative structures, the lack of clear assignments,where public money should be the remedy of last resort, the over representation of non elected and elected representatives, the real cost of the EEC versus its benefit and real contribution.
    No doubt that the national and public representatives,whom are known to have « mal à leurs peuples » will adopt very quickly speedy measures as to lighten their social cost burden and to increase and explain their economic efficiency in the public expenditures.

  20. Rich Berger

    C’mon TJ, why would you think restating the obvious would get any traction here? Here’s an entertaining little piece from Obama’s cousin, in the same vein as your comments.
    I heard snippets of the BSer-in-Chief’s interview with Bloomberg this morning. He defended the increases in the top two brackets as a “down payment”, and that we can talk about spending cuts and tax reform later. Make him own it – make the voters understand that all this additional spending is going to be paid for by them, sooner or later.

  21. Rich Berger

    I know it’s not sporting to hit the stupid when they are down, but note that the tax on the “rich” is insignificant. It doesn’t even cover the deficit for the first month of the current fiscal year.
    We have some dumb voters out there. Thanks a trillion, all you Obama voters!

  22. Steven Kopits

    Carried interests are earned income. Period. They are no different than bonuses for CEOs or other management.

  23. aaron

    The Pew question is biased. They should have asked “If an agreement is reached, who do you think would be more to blame?”

  24. ppcm

    Hard to let anybody infer that these economies have no anteriority,the genetics are not the culprits.
    Econbrowser posts and comments have covered fiscality,leverages macro and micro,wages imbalances,primary functions and derivatives,comparative between micro and macro accounts,structural imbalances 1929 and actual.
    The genetics are the culprits as they are the memory.

  25. 2slugbaits

    tj even though GDP growth was in decline throughout all of 2004 and 2005.
    Where do you get this stuff? The GDP growth rate may have been lower in 2004 and 2005, but that does not mean GDP was lower. GDP was still increasing, albeit at a slightly lower rate. Given that GDP was still growing wouldn’t you expect personal tax receipts to go up?
    But the part that you somehow forgot to mention was that personal federal income taxes fell dramatically after the Bush tax cuts were implemented. In 2001 some of the Bush tax cuts had just been implemented and nominal tax personal receipts were $991.8B, or 9.6% of GDP. In 2003 personal taxes fell to $774.2, or 6.9% of GDP. By 2006, with the economy near its 2007 peak, taxes in nominal dollars were still only $1049.9B, or 7.8% of GDP.
    Why is it so difficult for you to understand the cyclical behavior of government receipts and expenditures? When the economy recovers tax receipts are supposed to increase…and they better increase faster than expenditures! That is hardly evidence that the Bush tax cuts did not blow the structural deficit. Let’s take Bush’s best year, 2007. The on-budget deficit was 2.5% of GDP. Yes, that was an improvement over Bush’s earlier years, but it was at the peak of the business cycle. That’s only marginally better than Jimmy Carter’s worst performance (2.7%) when the economy was in recession (1980). That’s pathetic.
    You need to look at things over the complete business cycle. The federal government should be running a deficit during a recession and then run a surplus once the economy is fully recovered. The Bush tax rates don’t get you there. At best the Bush tax rates leave you with what is only a relatively smaller deficit at full recovery. This is called building in a permanent structural deficit. It’s the structural deficit you should worry about, not the transient cyclical component of the deficit. To give you a humble household example, the Bush tax cuts are similar to only making minimum credit card payments during the good times and then further running up the debt during the bad times. You will never recover. At some point you have to at least run a primary surplus.
    Rich Berger No wonder you seem so uninformed. You read The Washington Times…a Moonie’s version of Fox News. Just wondering if you bothered to count all of the factual errors in that guy’s screed. Just as something fun to do at home, you might want to try fact checking some of his claims against the BEA data.

  26. Edward Lambert

    The news came out today… (3rdQ, Q to Q)
    Real hourly wages = -1.4%
    productivity = +2.9%
    unit labor costs = -1.9%
    let’s analyze this..
    labor income = real wages/productivity
    labor income = -1.4/2.9
    labor income = -0.48%
    labor income = unit labor costs/price level
    Here, with unit labor costs down -1.9%, labor income is going down…
    Folks, this is not good news… according to the constraints of the UT equation, we are precipitously close to a recession. Capacity utilization is now stuck and unemployment will not decrease much at all. The UT could be within 1% point of the zero lower bound.
    A recession is likely forming right under our feet at this very moment.

  27. 2slugbaits

    tj Restore the higher rate on the “rich” and it provides little revenue and accounts for about $.06T per year in extra revenue. Our annual deficits are ~$1T. Tax the rich gets you 6 cents on every dollar of deficit spending.
    Huh? First, deficits have been coming down, so we will not see $1T deficits forever. CBO says that we need to close about a $4T gap over 10 years, not $10T over 10 years. Second, allowing the Bush tax cuts to expire except for the bottom four tax rates results in $1.6T in additional revenues over the next 10 years. That gets us about 40% of where we need to go. As I said before, Obama is wrong to want to permanently extend the middle class tax cuts. Eventually middle class taxpayers will have to see their taxes go up as well. And of course I don’t think we necessarily have to stop at 39.6% on the high end. That too could go up a few more percentage points.
    I have no idea where you got this 6 cents on the dollar nonsense. Sounds like more crap from the WSJ op-ed page.

  28. tj

    2slugs
    On this we agree: The federal government should be running a deficit during a recession and then run a surplus once the economy is fully recovered. with “should” being the key word.
    Why is it so difficult for you to understand the cyclical behavior of government receipts and expenditures?
    Not difficult at all. Just pointing out that we were near balance with the Bush Tax cuts, ($200B deficit in 2007). Yes, that was a business cycle peak. However, I don’t think it was the Bush tax cuts that forced Barney Frank to push lenders to write crappy mortgages. It wasn’t the Bush tax cuts that failed to enforce rules on the books that would have prevented the mortgage crisis. Thus, there is every reason to belive the expansion would have continued beyond 2008.
    If the 2nd recession had started 3 years later, the budget would have been in balance, even with the Bush tax cuts. The deficit in 2007 was less than $200B. Take a look at corporate tax revenue, growing at $60B to $80B per year in 2005 and 2006. 3 more years of moderate growth, and corporate tax receipts would have closed the deficit all by themselves, holding individual tax receipts constant.
    The Bush tax cuts had nothing to do with the drop in corporate tax revenue. Thus, we can balance the budget and run a surplus, even with the Bush tax cuts.
    Corporate tax receipts:
    http://research.stlouisfed.org/fredgraph.png?g=dvU
    Budget Deficit:
    http://research.stlouisfed.org/fredgraph.png?g=dvW

  29. 2slugbaits

    tj Oh my. You really don’t have a clue.
    3 more years of moderate growth, and corporate tax receipts would have closed the deficit all by themselves, holding individual tax receipts constant.
    We don’t need no stink’n econometrics! All we need to do is connect a couple of data points and draw a straight line. Yikes.
    Just pointing out that we were near balance with the Bush Tax cuts, ($200B deficit in 2007).
    No. No, no, no, no, no. You cannot look at the deficit as a percent of GDP at the peak of the business cycle and conclude that the budget is in balance. Let me repeat: Balancing the budget means balancing the budget over the business cycle. It does not mean coming close to balance when the economy is at the peak.
    I don’t think it was the Bush tax cuts that forced Barney Frank to push lenders to write crappy mortgages.
    Not only do you not know econometrics, you don’t seem to understand the basics of risk analysis. There is no problem with lending to risky customers provided the risk is transparent and the covariance of the risk is correctly measured. Payday loan companies do just fine making loans to very high risk customers. Risky mortgages are only a problem when ratings agencies aren’t doing their jobs and when we have asleep-at-the-switch regulatory bodies (see Menzie’s book Lost Decades for some tidbits of Team Bush regulators). Barney Frank did not cause the Great Recession. This is just another stupid Fox News talking point that has been thoroughly studied and reviewed in the academic literature.
    Thus, we can balance the budget and run a surplus, even with the Bush tax cuts.
    No, we cannot. Learn some math. You cannot point to a single year in which we actually ran a surplus with the Bush tax cuts, but yet you won’t let go of this fantasy that you can still defy the laws of arithmetic. Go look at the CBO reports. Even if the economy were to fully recover in the next couple of years, and even if the economy didn’t face another recession until well into the next decade (how likely is that?), there is no scenario in which we keep the Bush tax cuts and run anything like a balanced budget. Go check CBO. Go check CBPP.

  30. Edward Lambert

    revision on the labor share of income came out today. I use business sector labor share. (July 1, 2012)
    Using the UT equation given above…
    The previous UT was calculated at 2.2% points total unused capacity available for capital and labor.
    The revised UT is now 1.3%.
    We are much closer to the zero lower bound of UT than I originally thought. The economy is hitting the wall. Since then capacity utilization has backed down. The economy is adjusting its momentum toward a recession.

  31. aaron

    The Clinton surplus was during an obscene bubble as well. 2sb, you need to let you political bias go.
    Your argument is that credit expansion is fine, as long as it’s well considered. I agree, and once it’s loosened, it must be reined in very carefully. It must be well considered.
    So now, revenue drops because credit is contracted and somehow tax cuts are responsible is what you’re implying. Care to rethink?

  32. Rich Berger

    “Even if the economy were to fully recover in the next couple of years, and even if the economy didn’t face another recession until well into the next decade (how likely is that?), there is no scenario in which we keep the Bush tax cuts and run anything like a balanced budget.”
    Nice bit of dissembling there, Mr. Slug. As long as Il Duce refuses to rein in his wasteful spending, you are correct. Time to take the bottle away from the drunkard. The fiscal cliff is just a move to sobriety, and the end of the illusion that the rich can support this binge.

  33. tj

    2slugs
    There is no problem with lending to risky customers provided the risk is transparent and the covariance of the risk is correctly measured.
    This typifies your point of view. You get so caught up in the math and the models that you lose sight of reality. The ACTUAL risk was transparent, but it was ignored. The ACTUAL covariance was higher than forecast. Barney Frank reached the exact same conclusion that you did – A diversified pool of risky loans will reduce exposure to default risk inherent in MBS’s, CDO’s etc, to a manageable level.
    However, we all (except you, apparently) understand that you can’t diversify away market risk. Exposure to market risk caused too many assets (subprime loans)to behave as a single asset when home prices stopped rising. (Look up CAPM, there is an entire literature and a Nobel Prize on the concept).
    You need to learn to apply a little common sense in the interpretation of your math and models.
    Go look at the CBO reports.
    You mean this one from 2004 where the crackerjack staff at the CBO forecast tax receipts for the next 10 years that include forecast errors ~10% ?
    2005-2007 CBO forecast(04) = 2,212 2,357 2,508.
    2005-2007 Actual receipts = 2,154 2,407 2,568.
    The error in their 2007 tax receipt forecast was greater than the actual deficit in 2007.
    Here is a simple analysis. Begin with actual revenues for 2005 – 2007. Subtract actual outlays. Subtract the cost of ‘fighting terrorism’. The result is a budget surplus of $10B in 2007.
    I try to give you facts that show that current tax policy is not to blame for the fiscal mess. It’s spending. The costs of fighting Iraq/Afgan wars are going away. Curb the growth of entitlement spending and we are close to balance without hiking personal and corporate tax rates. Close some loopholes on the top 1%. Eliminate them if it makes you feel better.

  34. 2slugbaits

    tj The risk on subprime mortgages was not well known; it was well hidden. Hiding the true risk was how those respectable “job creators” on Wall St made (and lost) their money. Bankers were not compelled by Congress to lend to risky customers; bankers were falling all over themselves trying to line-up risky customers. Those subprime mortgages were then faked, bundled, sliced, diced and sold all over the globe. There is nothing inherently wrong with lending to risky customers provided the asset is priced correctly. Bankers went out of their way to disguise the true risk.
    Begin with actual revenues for 2005 – 2007. Subtract actual outlays. Subtract the cost of ‘fighting terrorism’. The result is a budget surplus of $10B in 2007.
    The on-budget deficit in FY2007 was $342B. I’m sorry, but there is no way that you get to a $10B surplus by subtracting the cost of fighting terrorism. And why should you subtract that cost? Just because much of it is going away is not a reason to go back and retroactively subtract it from the FY2007 figures. Oh wait, you want to include the off-budget receipts to get to a unified budget that is only $181.4B in deficit. But there’s a problem with your approach because you also said: “Curb the growth of entitlement spending and we are close to balance without hiking personal and corporate tax rates.” It’s a problem because it’s the surpluses in those entitlement accounts that helped bring down the unified budget deficit. If you’re going to “curb the growth” in those accounts, then shouldn’t you also curb the revenue receipts?
    In any event, your entire argument is irrelevant because balancing the budget does not mean only coming close to a balanced budget when the economy is at the peak of the business cycle and actual output is temporarily above potential GDP. It means balancing the budget across the entire business cycle, running deficits when the economy is in recession and running surpluses when the economy is at full employment. The current personal and corporate tax rates do not balance the budget over the business cycle.

  35. 2slugbaits

    tj You might want to explain why these two statements do not contradict each other:
    The ACTUAL covariance was higher than forecast.
    …followed by…
    too many assets (subprime loans)to behave as a single asset

  36. tj

    2slugs
    Those figures come from the 2005 and 2010 CBO budget projections. Look them up. The 2005 report has the 2004 actuals plus the 2005-2007 projections. The 2010 report has the actuals for 2005 – 2007. Thus, the comparison of actual to projected is “CBO consistent”.
    The point of backing out the war expenditures is that the magnitude of those expenditures was not anticipated when the Bush tax cuts were passed.
    A further point is that in 2007 we had a surplus EVEN WITH THE BUSH TAX CUTS, after removing those unanticipated expenses.
    You reveal your ignorance on a topic you should be well-versed – covariance and risk.
    The ACTUAL covariance was higher than forecast.
    …followed by…
    too many assets (subprime loans)to behave as a single asset

    Pretty simple, the return on the “market portfolio” fell. The forecast was that the covariance between the market portfolio and subprime was small because each subprime mortgage was a unique asset. That releationship drives the benefit of diversification. However, the covariance between the market portfolio and subprime turned out to be higher than forecast, when all those individual subprime mortgages behaved as a single asset, and followed the market down. Thus, actual covariance was higher than forecast and the benefits from diversificatin were oversated, so that losses were greater than expected.
    You can see that right? For (m-mbar)(i-ibar), let m-mbar be 10 and the forecast for i-ibar to be small, say 2. Then, for a given change in hte market, m-mbar, if the actual individual subprimes deviate from the mean more than forecast, say i-ibar = 5, then the actual deviation is 50, and contributes more to covariance than the expected deviation of 20.
    That’s pretty intuitive, and I didn’t think anyone contested that it’s a key reason for the failure of the models.
    You must have misinterpeted, because that is really basic stuff.

  37. 2slugbaits

    tj Then why did you disagree with my statement: “There is no problem with lending to risky customers provided the risk is transparent and the covariance of the risk is correctly measured” Your response was: “This typifies your point of view. You get so caught up in the math and the models that you lose sight of reality.” You then went on to say that the true risk was known but simply ignored. Whose fault is it if the risk is ignored? Is that the borrower’s fault or the fault of the dishonest loan originator?
    In portfolio theory it’s not the riskiness of a particular investment or loan that’s important, but how that asset’s risk contributes to the riskiness of the overall portfolio. And that is driven by the extent to which a particular asset’s risk is correlated with other assets in that portfolio. So it is entirely possible to reduce the overall riskiness of a portfolio by making individually risky investments. The whole point of diversification is to buy things that don’t all move in the same direction. Clearly, a lot of the information normally used to make those kinds of trade-offs was faked, hidden and buried. And it was lax regulators who tolerated all that faking and hiding and burying. It was not the fault of those who borrowed the money. In a normally functioning housing market their risk characteristics would have denied many of those loans, but it was not in the interests of the loan originators to see those loans denied. And it wasn’t the job of the borrowers to self-deny…that’s why we pay people to objectively evaluate risk.
    If loan originators hide the true risk and if the correlation of that loan to the rest of the portfolio is unknown because the composition of the portfolio is also unknown, then that’s a recipe for trouble. But it’s also a recipe for some quick profits as long as the bubble doesn’t pop. If you want to blame folks then try blaming the guilty parties. Blame your friends at Countrywide. Blame the Bush regulators. Blame the capital inflows due to Bush’s deficits. But it’s pretty hard to pull a Fox News and lay the blame entirely at the feet of poor subprime borrowers…especially since there were plenty of prime borrowers who also lost their mortgages.
    As to the CBO forecasts…are you familiar with the concept of conditional forecasts?

  38. tj

    2slugs
    I interpreted your risky assets statement to be what you believed to be true for the MBS market. I thoroughly understand how diversifaction works.
    Barney Frank-But in a recent CNBC interview, Frank told me that he was ready to say goodbye to Fannie and Freddie.
    “I hope by next year we’ll have abolished Fannie and Freddie,” he said.
    Remarkable.
    And he went on to say that “it was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.” He then added, “I had been too sanguine about Fannie and Freddie.”
    http://www.cnbc.com/id/38791383/In_Praise_of_Barney_Frank
    There is plenty of blame to around but to give big spending progressives a free-pass on it is ridiculous.
    These are all side issues, the fact remains that we would have had a surplus in 2007 without the war spending.

  39. 2slugbaits

    tj You can make a perfectly good argument that Fannie and Freddie were bad ideas. And it’s certainly true that Fannie and Freddie made a bad situation worse. But Fannie and Freddid did not cause the Great Recession. Lending to risky customers did not by itself cause the great recession. To get to the Great Recession you have to have corrupt loan originators, brain dead ratings agencies, and asleep-at-the-switch regulators.
    The housing bubble was well underway long before Congress allowed Fannie and Freddie to jump into the subprime market. In fact, the reason Fannie and Freddie petitioned Congress was because they were losing market share to shadow lending organizations.
    You cannot subtract away the war spending and claim that there would have been a surplus. For one thing, the war spending provided significant stimulus to GDP. Subtract the war spending from GDP and you have lower GDP and lower tax revenues.

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