September 11, 2010
Two Years That Changed the WorldBy Randall Hoven
(Part II of a series. Part I was "The Good Old Days.")
The 2009 federal deficit was $1.413 trillion dollars, the largest in history. In fact, it was triple the 2008 deficit, which was the largest in history up until then. Even as a fraction of GDP, it was the largest ever in peacetime. What caused such a deficit? Was it tax cuts? Was it war? Was it bailouts? How, exactly, did Bush pull it off?
The tricky part about answering such questions is that all we know is what happened. We do not know what would have happened had we done something different. So we have to guess. That is, if you blame a tax cut, you have to guess what federal revenue would have been without that tax cut. Then the difference between that guess and the actual revenue is what you blame on the tax cut.
Key word: guess.
Bush-bashers like to guess (figure below). They like to guess, for example, that revenues would have been larger than they'd ever been in history as a fraction of GDP if Bush hadn't cut the top marginal rate from 39.6% to 35%.
Source: Ezra Klein, The Washington Post.
Here is how I am going to guess: I will use 2007 as a baseline year, and then see what the differences were between 2007 and 2009. (For more on FY 2007 and the years just preceding it, see Part I, "The Good Old Days.")
This is reasonable for several reasons. First, 2007 was about "normal" in terms of economic activity, federal budget, and debt, with good trends in all of those areas. (Unless otherwise stated, a "year" here is the fiscal year October through September, since that is the way the government keeps its books.)
Secondly, there were no huge policy changes in 2007 or the years just preceding it. The Bush tax cuts took effect several years before, in 2001 and 2003. The Afghanistan and Iraq wars had been ongoing for years. If the tax cuts and wars caused bad deficits, 2007 should have seen a bad deficit.
Third, 2007 and 2009 were not that far apart. One would think that significant differences in budgets between two such close years could be attributed to real differences in events or policies between those two years. That is, we should look for "blame" in the areas where those years differ (e.g., recession, bailouts, stimuli) and not where they don't (e.g., tax rates, war on terror).
Fourth, and perhaps most importantly, this method does not require exotic mathematical models to predict the would-have-beens. In effect, I'm using 2007 as what 2009 would have been, everything else equal. In this way, we compare actual counted dollars, not macroeconomic models and equations.
So how do those two years compare? The tables below list the primary federal budget numbers.
GDP and Federal Budget in Then-Year Dollars ($Billions)
Federal Budget as Percentage of GDP
In raw numbers, revenue fell $463B from 2007 to 2009 and outlays grew $789B, causing an "extra" $1,252B of deficit. It was mostly extra spending, but not all. As percentages of GDP, revenue fell by 3.7% of GDP and outlays grew by 5.1% of GDP.
Now here is where I will introduce a "model" of sorts. My model says we should expect two fiscal years so close together to have roughly equal revenues and outlays as percentages of GDP, everything else equal.
Why is that reasonable? Because that had been the case for the past half-century. (For the statistically inclined, the linear regression estimates of revenue and outlays for 2007, based on the previous fifty years, are 18.4% and 21.1% of GDP. The actual values were 18.5% and 19.6%. One could also invoke Hauser's Law for revenue.)
Notice a couple of things. First, FY 2007 saw above-average revenues and below-average spending. This was a good half-decade after the Bush tax cuts and Afghanistan and Iraq wars. Also, deficits were on a shrinking trend through the Republican-controlled Congress years of 2003 through 2007.
The next things to notice are the 2009 values. Revenues were lower than the lowest of the previous half-century (14.8% vs 16.1%), and outlays were higher than the highest of the previous half-century (24.7% vs 23.5%) -- extreme values on both ends of the budget. FY 2009 was bad!
FY 2007 was a completely nominal, average, white-bread year following a string of fairly nominal, average, white-bread years. FY 2009 was way out of whack in all respects, both on the revenue side and the outlay side. There was no eight-year trend leading to 2009; it was big, bad, and sudden. The 2009 deficit was unprecedented in U.S. peacetime history, including the Great Depression (9.9% of GDP vs 5.9%).
A reasonable person would look at what happened between 2007 and 2009 to try to explain the 2009 budget numbers. In those two years, the world changed.
Things that happened after FY2007, but before or during FY2009:
Things that didn't:
Bush Tax Cuts? There were no Bush tax cuts between 2007 and 2009; they became effective in 2001 and 2003. If you blame the Bush tax cuts for the low revenue in 2009, how do you explain the perfectly normal, even above normal, revenues in 2006 and 2007?
Iraq, Afghanistan, War on Terror? Total spending on the entire WOT was lower in 2009 than in 2007. The Congressional Budget Office put the 2007 figure at $171B and the 2009 figure at $155B. These figures include not only funding for all military operations, but also funding for diplomatic operations, foreign aid, funding to indigenous Iraq and Afghan forces, etc. Were it not for the WOT, 2007 would have been in surplus by $10B.
Bush's Debt? Interest on the debt went down between 2007 and 2009. It was $237B in 2007 and $187B in 2009. So you cannot blame the interest payments on the debt accrued from previous years of Bush tax cuts and wars, either.
Bush's Wall Street Bailout? You probably heard that TARP, which Senator Obama voted for along with most Democrats, cost $700B. No it didn't. Per the CBO, its actual cost in FY 2009 was $151B. (The CBO now estimates TARP's total cost, with many loans repaid, to come in at $66B.)
Obama's Stimulus? Obama's stimulus explains $180B of the FY 2009 deficit, according to the CBO. (In total, the stimulus is expected to add $814B to the cumulative 2009-2019 deficit.)
The Recession? Bingo. For starters, a revenue fall of 3.7% of GDP is $527B. However, the CBO says Obama's stimulus accounts for $69B in revenue losses and tax credits in FY 2009. So we can chalk up $458B to the recession based on tax rates in place prior to 2009. That's not because tax rates fell, but because revenue-generating activity fell -- jobs, corporate profits, dividends, capital gains, interest income.
When people lose their jobs due to a recession, government spending on functions like unemployment payments and Medicaid go up. The federal government spent $233B more in 2009 than in 2007 on what it calls "health care services" and "income security." But $67B of that came from the stimulus. So the part due to policies in place prior to Obama is $166B.
"Natural" Cost Growth. After the above, we are left with $313B that can't be cleanly accounted for. Some of that could be costs that grew at about the rate of GDP. But nominal GDP went up only 2.5%. The costs of old-age programs grew a bit faster due to the aging population. I'm willing to generously allocate $150B to such natural cost growth.
Other Spending by Democrats. What remains is $163B. The Obama stimulus was not the only Democrat-authored spending. For example, Congress passed and Obama signed an "omnibus" spending bill of $410B for FY 2009 in 2009, after Bush was out of office. Not all of that $410B was above the Bush-approved level, but much of it was. Democrats wrote both the FY 2008 and 2009 budgets, then passed more spending (e.g., Cash for Clunkers) in 2009 on top of the stimulus. It is hard to pin down an exact number, but $163B is probably an underestimate.
The above accounting can be summarized in a pie chart.
I agree with the JournoListers that the recession itself had a lot to do with it. But Bush had little to do with it, especially the two things normally blamed on him: tax cuts and Iraq. Bush "policies," absent the WOT and the recession/financial crisis, would have led to a surplus, not a deficit at all.
TARP was pretty darned bipartisan. But even so, it was only 11% of that 2009 deficit. Even the WOT was fairly bipartisan. (Obama is still spending about the same on the WOT; he just shifted out of Iraq and into Afghanistan.)
I could also say natural cost growth was inevitable or bipartisan, but Republicans tried to deal with entitlement growth multiple times. In fact, the Republican Congress passed Medicare reform in 1995, but President Clinton vetoed it. Democrats killed Bush's Social Security reform initiatives in the crib.
Whatever exactly happened between 2007 and 2009, the before and after pictures are completely different. The House, Senate, and presidency all switched parties. We now talk in spending units of "trillions." The CBO foresees no future deficit as low as 2007's, even after all the wars and recessions are assumed over. The federal government owns two of the Big Three auto companies. And all the above was before national health care.
To return to our Part I analogy of the U.S. economy as an airplane, Flight USA went from "all systems nominal" under Captain Bush and his Republican crew to stormy weather, mechanical malfunction, an all-new Democrat crew under Captain Obama, and a dangerous loss of altitude. All in two years.
The passengers are nervous and restless, to say the least. Some even believe they heard "Allahu Akbar!" coming from the cockpit. Stay tuned for Part III of our flight.