Spending AND Taxes Got Us Into This Mess, And Only BOTH Can Get Us Out

Since we are right in the heat of the debt ceiling/budget deficit debate, I made a point to devote a section of my July quarterly client letter to the topic, but I also wanted to share some of that publicly as well. As old as these arguments back and forth in Washington are getting, they are important issues for our economic and financial futures. To try and boil it down to something (relatively) simple, below are two graphs I created to help people visualize exactly how we got into this deficit mess, and more importantly, the only way we can get out.

The first chart shows tax collections and government spending, as a percentage of GDP, in fiscal 2001 (the last year we had a balanced budget in the U.S.) compared with the projections for fiscal 2012 (which begins on October 1st of this year).

You can clearly see how we have gone from a surplus of 1% of GDP to a deficit of 7% of GDP; taxes went down by 4% of GDP and spending went up by 4% of GDP. If there was ever a question of whether the federal government has a spending problem or a taxation problem, this should end that debate. We have both, and each has contributed equally to our budget deficit woes over the course of the last decade.

To counter one of the most common rebuttals to this conclusion (that taxes are too high) consider that federal taxes (payroll taxes, income taxes, gift and estate taxes, etc) today are at their lowest point since 1950 (again, as a percentage of GDP). In order to balance the budget, we need to close an annual deficit of $1.4 trillion, the product of $3.6 trillion in spending versus just $2.2 trillion in tax collections. If we do not raise taxes at all, government spending would have to be cut by that $1.4 trillion figure, which would be a cut of 40% (and is impossible).

The second chart below shows the sources of our budget deficit, by comparing our finances in 2001 to those that the CBO projects for fiscal 2012. It shows in another way how increased spending and tax cuts are equally responsible for the fiscal problem we have, but it goes a step further by showing that nearly half of the increase on the spending side is due to huge increases in defense spending (which has more than doubled since 2001, from $300 billion in 2001 to $700 billion today).

So not only do we have to get taxes up and cut spending, but we have to cut defense spending meaningfully within that context. If we don’t increase taxes and we don’t cut defense spending, a balanced budget would require we cut the non-defense portion of the government’s budget by a whopping 50% (again, impossible).

If you weren’t ticked off at the childish crap going on now on Capitol Hill, you probably should be after reviewing these numbers. The solution to the problem is easy to identify if you want to be honest about it. But without even admitting to that in public, how will our politicians ever actually solve the problem? A depressing thought indeed.