Business Perspectives

August 11, 2011

Data shows U.S. has a revenue problem

The popular mantra that "we have a spending problem, not a revenue problem" has been repeated so often that most Americans accept it as true without ever looking at the data.

The popular mantra that "we have a spending problem, not a revenue problem" has been repeated so often that most Americans accept it as true without ever looking at the data.

It would improve the level of the public debate if they did.

Anyone who examines historic trends on federal tax revenue and spending quickly will see that there are problems on both fronts. Spending is high compared with historic levels. But revenue also is low.

What might surprise most people is that current revenue levels, compared with the size of the overall economy, are further below historic levels than spending is above them.

Furthermore, increases in spending are dominated by increases in two categories: medical and Social Security. Here "medical" includes the big entitlement programs of Medicare and Medicaid, plus smaller ones like the State Children's Health Program, the Indian Health Service and so forth.

Take away these two categories, and general government spending — including the military and interest on the national debt — is lower than it was 50 years ago, or 30 years ago.

There certainly is no question that spending has increased sharply since 2007, when the ongoing financial debacle began to unfold, nor that it is at its highest levels since World War II.

But the outlays over the past two fiscal years, as a percent of Gross Domestic Product, are only about 2 percentage points higher than the average for the first five years of the Reagan administration. If we were to return spending on either Social Security or medical programs to the same relative size they had been back then, the overall size of government compared with the general economy would be smaller now rather than larger.

For the fiscal years 2010 and 2011, government revenue from all sources averaged 14.5 percent of GDP. During the Reagan administration, for the fiscal years 1982-1986, revenue averaged 17.5 percent of GDP. For the two decades from 1980 to 2000, it averaged 18.2 percent.

The current reduction in revenue relative to the economy is the single largest factor in deficits today. Overall tax revenues compared with GDP have not been this low since 1950.

Some of the drop in revenue is due to a sick economy that has reduced taxable incomes for both households and corporations. Some is due to the tax reductions embodied in the Obama administration's stimulus packages. But much is due to unwise cuts in tax rates, particularly those made in 2001 and 2003.

A Tax Foundation study using IRS data found that four-person households at all income levels pay a smaller proportion of income in federal income tax now than 20 or 30 years ago. A household that earned the median national income paid 10.1 percent of its income in federal income tax in the 1980s and 4.6 percent in 2009. A household earning twice the median income paid 16.6 percent in the 1980s and 12.6 percent in 2009.

The IRS periodically analyzes the returns of the 400 highest-income taxpayers, and other researchers have used IRS data to make the same calculations over longer stretches of time. In 2008, this highest-income cohort averaged $270 million in reported income and paid an average of 18 percent of that in income taxes.

In the 1960s, the 400 taxpayers with the highest income paid over 40 percent of their income in federal income taxes. Effective tax rates for this group now are even lower than immediately after the Reagan administration tax changes because the rates on capital gains and dividend income have been cut even more.

Looking at the growth of medical costs and Social Security outlays, one may well ask how much "general government" we can afford now that we are spending more on benefits for retirees and for medical services. That is a key question.

But we should be careful to phrase it that way rather than falsely implying that all of government is growing. It is not.

Areas of the federal government outside of Social Security and medical programs have grown more slowly than the overall economy. They are thus smaller relative to the economy than they were decades ago.

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