CBO and the Long-Term Budget Outlook

The Congressional Budget Office (CBO) is an agency within the legislative branch of the US government. It is a non-partisan government agency that provides economic data to Congress.

The CBO recently submitted its long-term US budget outlook. It is a grim picture. The CBO shows that things are suddenly getting out of control. No wonder many Americans are becoming increasingly concerned about all the spending coming out of Washington.


According to the CBO report The current recession has little effect on long-term projections ... CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of these deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010.

If outlays grew as projected and revenues did not rise at a corresponding rate, annual deficits would climb and federal debt would grow significantly. Over time, the accumulation of debt would seriously harm the economy.

The report goes on to say, Under current laws and policies, rapidly rising health care costs and an aging population will sharply increase federal spending for Medicare, Medicaid and Social Security.

Unless increases in revenues kept pace with escalating spending, or spending growth was sharply reduced, soaring federal debt would weigh heavily on economic output and incomes.

The Long Debt Road

A recent Wall Street Journal/NBC News poll found that 58% of Americans want President Obama and Congress to concentrate on keeping the budget deficit down. Many Americans are getting concerned with the rapid increase in spending.

The following video provides an illustration of how fast the US debt has increased in the past 100+ years. Note that this has been adjusted for inflation.

You may recall legitimate concerns with heavy deficit spending under the Reagan, Bush 41 and Bush 43 administrations. Some things don't change in Washington, other than the speed of projected spending.




In the opinion of Morgan Stanley’s chief economist, Richard Berner, America’s long-awaited fiscal train wreck is now under way.

By “train wreck,” he means out-of-control federal budget deficits that he’s sure will finally drag the economy under.


Depending on policy actions taken now and over the next few years, federal deficits will likely average as much as 6 percent of Gross Domestic Product through 2019, contributing to a jump in debt held by the public to as high as 82 percent of GDP by then — a doubling over the next decade.

Worse, barring aggressive policy actions, deficits and debt will rise even more sharply thereafter as entitlement spending accelerates relative to GDP. Keeping entitlement promises would require unsustainable borrowing, taxes or both, severely testing the credibility of our policies and hurting our long-term ability to finance investment and sustain growth.

And soaring debt will force up real interest rates, reducing capital and productivity and boosting debt service.

Not only will those factors steadily lower our standard of living, Berner concludes, but they will imperil economic and financial stability.

In the next post, we will find out what the non-partisan Congressional Budget Office (CBO) thinks about all of this.

When Big Can Mean Small

About 10 years ago a study was prepared for the Joint Economic Committee. This is one of four standing joint committees of the U.S. Congress.

The committee was established as a part of the Employment Act of 1946. This committee is responsible for reporting the current economic condition of the United States and for making suggestions for improvement to the economy.

This research paper was prepared to investigate The Size and Functions of Government and Economic Growth. The study was conducted by three economics professors:

• James Gwartney, Florida State University
• Robert Lawson, Capital University (Columbus, OH)
• Randall Holcombe, Florida State University

Their basic conclusion: the bigger the government, the more its economy suffers.


Their findings are vital to know in the context of my series of blog articles about the rapid increase in the US deficit, and accompanying growth in aggregate debt level.

Here are a few of their key conclusions:

• Rather than devising new programs to spend any surplus that may emerge from the current economic expansion (circa 1998), Congress should develop a long-range strategy to reduce the size of government so we will be able to achieve a more rapid rate of economic growth in the future.

• Government should provide for a legal/physical infrastructure for the operation of a market economy and a limited set of public goods in order to provide a framework conducive for economic growth.

• However, as government moves beyond these core functions, it will adversely affect economic growth because of:

  1. The disincentive effects of higher taxes,

  2. The diminishing returns as governments undertake activities for which they are ill-suited, and

  3. An interference with the wealth creation process, because government is not as good as markets at adjusting to changing circumstances and finding innovative new ways of increasing the value of resources.
  

Now before I go on to cite a few more findings, you will want to reflect on the current debates in Congress. These discussions and actions have led to a rapidly increasing size of government. While the growth in government is now at seemingly hyper-speed pace, readers can appreciate that this growth has outpaced our commercial economic expansion for many years now. (Refer to the graph in my August 18 blog posting.)

That has been apparent in many ways most recently (but not limited to just this year), including:

• Many aspects of the $787 billion stimulus package which frankly are just for spending and not clearly to stimulate the US out of recession in the near term,
• A $410 billion omnibus spending bill, packed with lots of pork from both political parties,
• Economic impact of proposed cap & trade legislation to curb greenhouse emissions, and
• The latest debate about health care reform along with nearly a $1 trillion cost over the next ten years according to the Congressional Budget Office (see my July 30 post).
  

Now in the latest attempt to pay for this, our government talks about increasing the taxes only on the wealthiest of Americans, ie, those who make $1 million and more a year.

Notice how all of this runs contrary to the research conducted just a decade ago for the Joint Economic Committee.

• In the US, government expenditures as a share of GDP have grown during the last several decades. At the same time, the investment rate has declined and the growth rates of both productivity and real GDP have fallen.

  An empirical analysis of the data from 23 leading countries shows a strong negative relationship between both (a) the size of government and GDP growth and (b) increases in government expenditures and GDP growth.

  A 10 percentage point increase in government expenditures as a share of GDP is associated with approximately a one percentage point decline in the growth rate of real GDP.

  An analysis of a larger data set of 60 countries reinforces this conclusion.
  

So bottom line:

If government expenditures as a share of GDP in the United States had remained at their 1960 level, real GDP in 1996 would have been $9.16 trillion instead of $7.64 trillion, and the average income for a family of four would have been $23,440 higher.

Leading countries currently spend 15 percent of GDP or less on the core functions of government-protection of persons and property, national defense, education, monetary stability, and physical infrastructure. When governments move beyond these core functions, the empirical evidence indicates that they retard economic growth.

These findings help provide a foundation for upcoming articles about the rapidly growing size of the US debt.

How Big Government Can Hurt Economic Growth

In my previous post we examined how Big Government can help economic growth--according to Keynesian economic theory. By the way, in order that you say this properly, it's pronounced cane-ze-an.

Now let's examine the other point of view.

The Cato Institute is a libertarian think tank. They have released a video that explains how and why excessive government spending can undermine economic growth.

Libertarians generally stand for:

• Individual liberty
• Limited government
• Free markets
• Peaceful international relations

My blogs are never about politics--but about economics. On occasion, however, discussions about economic principles will be flavored by someones political point of view--in this case libertarian. I provide this perspective so that you can compare & contrast alternative viewpoints...and draw your own conclusions.

This video discusses eight ways that Big Government can hamper economic growth.



In a 1998 study by James Gwartney, Robert Lawson and Randy Holcombe, The Size and Functions of Government and Economic Growth, they found that as the size of government (share of GDP) increases, economic growth (real GDP) suffers. We will examine their study in my next blog.

Big Government, Big Deficits & Big Debt

John Maynard Keynes was a British economist. He advocated interventionist government policy. He maintained that governments should use fiscal (eg, spending & taxation) and monetary (eg, the Feds control of the money supply & short-term interest rates) measures to mitigate the adverse effects of business cycles and economic recessions.


Keynes's influence waned in the 1970s, partly as a result of problems (eg, stagflation) that began to afflict the western economies. And partly due to critiques from Milton Friedman and other economists who were pessimistic about the ability of governments to regulate the business cycle with fiscal policy.


However, the advent of the recent financial crisis has caused a resurgence in Keynesian thought. Keynesian economics has provided the theoretical underpinning for the plans of President Barack Obama,

Keynes believed that Big Government spending was necessary to help alleviate the economic growth and unemployment problems that arise during a recession. This naturally leads to government deficit spending.

However, Keynes would also maintain that in better economic times surpluses should arise from tax collections that exceed current government spending--and this should in turn reduce or eliminate the current federal deficit.

It's a great theory--but it rarely plays out in practice. The closest we get in modern times is surplus created for a short time during the Clinton administration. This came about when spending growth was held down in relation to tax collections.


The Wall Street Journal recently helped put things in perspective. Europe has resisted the US's massive stimulus spending. Here is the WSJ opinion piece.

We witnessed that rarest of things last week—a politician's public humility. When France, along with Germany, reported an unexpected uptick in economic growth for the second quarter, French Finance Minister Christine Lagarde called the return to growth "very surprising." Imagine that—a major global economy stops shrinking, without the benefit of trillion-dollar stimulus packages or major reforms, and a politician doesn't rush to claim credit for the achievement.

…it's refreshing to hear the minister responsible for France's economy speak the truth about growth. It is the product of literally millions of decisions made by millions of people about what to produce, buy and sell. Politicians can influence all that decision making, especially by increasing or decreasing the incentives to produce, work and innovate. But they can't control today's multi-trillion-dollar economies, no matter how much they'd like to take credit for doing so…

Stimulus 1; Stimulus 2

There is an interesting promotional pitch these days about the need for a second stimulus package...as well as the effectiveness of the stimulus package that was signed into law by President Obama in February.

As Paul Krugman wrote in the New York Times, So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.


Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.)

Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

From the beginning, I argued that the American Recovery and Reinvestment Act, aka the Obama stimulus plan, was too small.

For the past several weeks I have featured a poll (see upper right hand corner) on my blog asking if you think the US should have a second stimulus package. I guess all those who responded are dead wrong (at least according to Nobel prize winning economist, Krugman). You see, 93% of you say the US should not implement a second stimulus package.

Krugman has written for months as though we were on the road to depression unless Congress followed his advice and installed an even bigger stimulus. Despite the fact that the stimulus has only paid out a fraction of what's been authorized to help the economy, Krugman credits it with saving jobs.

However, there is no governmental statistic that calculates saved jobs. Instead, all we have seen is an unemployment rate that has continue to rise...and to exceed the administration's projections of how the unemployment rate would be contained by the current stimulus package.


Recessions are measured more aptly by declines in the Gross Domestic Product (GDP), ie, all the goods & services produced in the US. As I have written in several previous blog articles, we seem to be coming out of this latest recession. Several economists now believe the US may have ended this recession in the past month or two (ie, as early as June, 2009).


The Wall Street Journal has weighed in on this debate. Here is what they say:

The larger story here is that the economy’s natural healing tendencies are asserting themselves.

• Banks are writing down bad loans, raising new capital, and in general cleaning up their balance sheets.
  

• Having reduced their inventories to the nub, manufacturers are looking to increase production at the first sign of demand.
  

• Households have also been improving their balance sheets by saving more.
  

• The rush to exploit the federal “cash for clunkers” car-purchase subsidy testifies that consumers have money that they will spend when they conclude that their jobs are safe and they have some financial breathing room.

Aiding all of this has been the unprecedented monetary stimulus provided by the Federal Reserve, pushing liquidity that has helped to revive the credit and stocks markets.

The $800 billion Obama spending stimulus has by definition been a bit player, since only a little more than 10% of it has even been spent. We’d be better off recalling the money.

Just One Thing

This article is a tribute to my fantastic son, Matthew. He recently landed his dream job at Oregon State University.

Matthew will be working at the OSU Center for Genome Research and Biocomputing. Their Core Laboratories is a computational service center for faculty researchers and students--who wish to perform DNA sequencing and other biocomputing analysis.

Matthew will develop computational algorithms & graphic displays, train researchers how to use these tools and provide personal support to end users.

One of my favorite movies is City Slickers. In it stars a crusty old cowpoke named, Curly, played by Jack Palance.


Curly asks: Do you know what the secret of life is? [He holds up one finger]

This.


Mitch: Your finger?

Curly: One thing. Just one thing.
You stick to that and the rest don't mean squat.

Mitch: But, what is the "one thing?"

Curly: That's what you have to find out.

I have used this as a teaching principle for years in my Financial Planning University courses. It's a principle that everyone can apply. I apply this is a very special way--to get things done.

I can teach and teach wonderful people about financial matters--and they learn. But it is all for naught if they can't get that finger moved regularly to their cell phone to call people for appointments.


This is how productive people get things done. They are persistent in their efforts to contact others--to take initiative--to keep on going, until they either achieve their goal, or perhaps the person on the other end says, "no."

My friend, Jim Perry, dean of the University of Wisconsin-Fox, noticed and appreciated this when I volunteered to help him with a project.

He told me he often finds that people on his committees have good intentions, but some of them never seem to get around to making the effort. Oh, they may try once, and then seem to give up on the task.

He quickly realized the difference in my approach--which reminded me to tell him--and to tell Y O U--of this important lesson, the lesson Curly taught us.

When it comes to success, one of the most important things one needs to do is persistently pursue your task or goal until completion.

Or using the real-life metaphor of a phone call--you MUST be able to consistently get your finger on to the phone to make that call--and make it again--and make it again--and make it again...for as long as it takes until you reach resolution on the issue.

That's how you become knows as a doer - a person who acts and gets things done. People recognize that when they want something done, they get a doer. He's the miracle worker.

Cash for Clunkers

The government program affectionately known as Cash for Clunkers has been exceptionally popular among Americans. In just 4 days last week, the entire $1 billion allotted to it had been used up!

This is one form of financial stimulus, albeit a small one at only $1 billion, that worked very quickly, and perhaps effectively.

Here in a nutshell is how the program works (click on image if you wish to enlarge):


In general, your used vehicle must be less than 25 years old and get less than 18 mpg (there are exceptions).

The program requires the scrapping of your eligible trade-in vehicle.


Since Americans jumped at the opportunity to get a new car under these terms, Congress allotted another $2 billion.

Some are concerned that the "buy American" provision was not included in this program. However, when one considers what "American" means anymore in a car (or many other products for that matter), we see that cars are really the composite of goods & services from many countries--all combined into the vehicle that we may call "Chrysler" and find that it has less American content than the vehicle that we call "Toyota."


Foreign-owned plants located here in the US are the foundation of the new U.S. auto industry. In 2008, 3.1 million cars of the total 8.7 million sold, or just over a third, were produced by foreign-owned companies making their products here.

Last year, plants for foreign-owned auto companies purchased $53 billion in parts from U.S. suppliers.

Anytime a program is devised, it always has some unintended consequences. That's pretty much an economic fact of life.

For example, with all those used cars being scrapped, poor people who can’t afford new cars, or expensive used cars, will be hurt. If you can only afford $1,000 for a car, you’ll find many of these vehicles are now unavailable.

Also, many people had previously planned to take their car to the local mechanic to help squeeze some more miles out of it. Not now--that they have a shinny new car. But of course, that means your local garage is going to sit by idly.

And yes, it’s quite possible that government rebates today will steal car sales from next year.

But in the meantime, we have some consumer money being spent. Car lots are being cleared of new vehicles. Plants will need to get to work to build more cars. That means workers will have jobs. They spend money--and that further stimulates the cities they hail from--and ultimately benefit the entire nation.

Economists see this program boosting 3rd quarter growth. Several firms, including Goldman Sachs, have recently raised their GDP forecasts. Goldman now sees third-quarter growth at a 3% annualized rate, up from its earlier forecast for just 1%, in part because the clunkers program has helped revive auto manufacturing.

The Tipping Point

Economic data of late are looking hopeful. Have you noticed the good news? Let's take a look at what has been reported.

Builders are getting back to work, as we see in Phoenix.


Single-family housing starts have increased for the last four months in a row. This is the first four consecutive month increase for single-family starts in four years.

According to my favorite economist, Brian Wesbury, We are now witnessing the long-awaited end of the bust in home building and the birth of what will be a substantial recovery in residential construction over the next few years.

He further says, Most areas around the country should see some price increases by year end. Home construction is going to increase substantially over the next few years. Although there are still excess inventories in the housing market (roughly 1.5 to 2 million homes), the rate of home building got so low that inventories can continue to fall rapidly even as building activity recovers.


It would appear that we have finally seen the bottom in the housing construction market.


The number of US workers claiming unemployment benefits have fallen from their peak in January.


Corporate layoffs have dropped 70% from their peak late last year. Now with business downsizing nearly finished, companies are poised for higher productivity and efficient growth.


The Economic Cycle Research Institute (ECRI) reports its gauge of future U.S. economic growth edged higher suggesting a near-term end to the recession.

ECRI Managing Director Lakshman Achuthan states that, It is increasingly evident that, despite widespread misgivings based on backward-looking economic data, the end of recession is at hand.


Let's wrap this good news up by looking in the rear-view mirror. We again recognize that this was not "your grandfather's Great Depression II."

I am especially thankful for Fed Chairman Ben Bernanke's quick action last September that helped us overcome a much more significant decline in US Gross Domestic Product (GDP).


This past week we received a report on GDP in the second quarter. It was down 1%--less than most economists expected. The healing of the US economy continues--consistent with a V-shaped recovery, as we've talked about in prior blogs.


Astute readers will recall that a significant slowdown in the velocity of money was a major factor in this recession. That's why action by Fed Chairman Bernanke was so critical last September, and in following months.

That velocity appears to be picking up, as you can see evidence from the following graph. This is the ratio of GDP and a measure of the US money supply (M2). Money that people have been hoarding is starting to be spent.



Post script: Recovery from a recession is not the same as return to normal rates of employment. Typically, a recession ends and job growth significantly trails resumed GDP growth.

I believe this time that job recovery is going to take even longer than usual, notwithstanding some favorable unemployment claim statistics which I shared with you.