Over the past two years, there has been much discussion regarding our Federal Government Fiscal Crisis. Most of the discussion has involved whether we have a revenue or a spending problem.
When one looks at historical data, it is clear that we have a spending problem. To illustrate this point, the most appropriate measure is to gauge our revenue and spending as a percentage of our Gross Domestic Product (GDP). This is very similar to a person or business applying for a loan. To determine if one qualifies for a loan, two common measures are used with one being the debt to income ratio for consumers and debt service coverage for businesses. Both of these measures quantify if one has too much debt based upon their income or revenues.
For the Federal Government, comparing spending and revenues to GDP is very similar to quantifying consumer and business debt, income, and spending. In the graph below, this shows our historical Revenue to GDP ratio.
- Federal Government Revenue to GDP for 1950 to 2010
The blue line shows our total revenue to GDP and the red line shows the portion of income taxes collected to GDP. From 1950 to 2010, the total revenue generated by the Federal Government to GDP has remained in a tight range of 15% to 20%. For all of the data, I found it amazing to see that our total revenue to GDP was the same for both 1950 and 2010 at 15% of GDP. Income tax revenue has also maintained a consistent ratio to GDP from 8% to 14%.
The percentages are somewhat misleading due to the strong economic growth (GDP) our country has experienced over time. With very few exceptions, our GDP has grown consistently each year from 1950 to 2010.
The graph below shows our historical Spending to GDP:
- Federal Government Spending to GDP for 1950 to 2010
From 1950 to 2010, our Federal Government Spending experienced a wider range than our revenue with 15% to 25%. In 1950, our Federal spending was 15% of GDP and this increased to a record 25% in 2009. It should be noted that beginning in 1965, the rate of spending began to increase dramatically. The rate of spending peaked in 1981 at 23% and began to decline at a rapid pace, falling to 18% in 2000.
One of the reasons for the large increase in federal spending is due to the large growth of entitlement programs to include: Medicare, Social Security, and Welfare Programs. The interest paid on the national debt has also increased consistently over time. The growth of interest spending is due to our rising debt while the growth in entitlement spending is due to the increased number of recipients for these programs. In a future article, I will provide in detail the growth in entitlement and interest spending.
The conclusion to be drawn from the data (revenue and spending) clearly shows that revenues as a percentage of GDP has been consistent while the spending as a percentage of GDP has increased at an unsustainable rate. Two other issues must be reviewed to further show the impact of our spending and the strain this puts on our economy.
The graph below shows our Federal Debt to GDP for 1950 to 2010:
- Federal Government Debt to GDP Ratio for 1950 to 2010
Immediately following World War II, our Debt to GDP Ratio was 85%. This rate declined consistently until 1981 when government spending began to increase due to higher entitlement spending. From 1995 to 2007, the debt to GDP ratio remained steady at 65%. By 2009, the rate increased to 80% and further increased to 92% by 2010.
During the time period for 2005 to 2010, revenues declined from 17% to 15% of GDP. However, over this same period, spending increased from 19% to 24% of GDP. Given the consistent rise in spending through this period, one can conclude that increased government spending has driven our Debt to GDP Ratio to a level not seen in our history.
The graph below shows our Federal Government Annual Surpluses (Deficits) for 1950 to 2010:
- Federal Government Annual Surplus (Deficit) to GDP Ratio for 1950 to 2010
Surpluses occurred in the early 1950's, briefly during the 1960's, and the mid to late 1990's. In 1951 and 2000, the annual surplus to GDP reached the most favorable numbers at (-2%) of GDP. The Annual Deficit reached 6% of GDP in 1983 and began a steady decline from that time to 2001. The Annual Deficit to GDP increased to 3% in 2002, 4% in 2008, 13% in 2009, and 9% in 2010.
Based on current projections at the time of this writing, the Debt to GDP Ratio and the Deficit to GDP Ratio are both expected to continue their unsustainable growth. Both Moody's and S&P, the two largest rating agencies, are considering a downgrade to the USA's credit rating due to the deficits and debt when compared to our GDP.
In a later article, I will cover the consequences of losing our AAA Rating to a AA Rating. The most devastating impact will be a 2% (minimum) increase in our borrowing costs (interest rates), which will further increase our deficits.
Given the information presented, I hope you can draw the conclusion that we have a spending problem and not a revenue problem. In the private sector, when revenues are down companies lower their spending.
Why can our Federal Government not do the same? This is the $14 Trillion Dollar question.