Straight Talk About the Federal Deficit

We all know that there’s a huge imbalance between what the government takes in and what it spends, but how did we get in this mess? On this subject the public has been bombarded with misinformation. Let’s look at some facts.

Spending vs. Income

Politicians like to talk about cutting spending. All you have to do is cut spending on the wasteful programs and our deficit will disappear, right? Spending is certainly part of the equation. But revenue is an equally important part.

According to the U.S. Office of Management and Budget, the federal government since the end of World War II has had an average annual “income” (from taxes and other sources) of approximately 18% of our gross domestic product (GDP). At the same time, the government has been busy spending 20% of GDP. You wouldn’t want to run your household checkbook like that, but it works for Uncle Sam.

In 2010 the federal government spent $3.5 trillion. The top three expenses were Social Security (20.4%), defense (20.1%), and Medicare (13.1%). In fifth place was interest payments on the federal debt (5.7%), topping even low-income assistance (5.3%) and unemployment compensation (4.6%).

The economic collapse of 2008 accelerated government spending. Some of this spending was the result of policies that had been set in motion before the collapse. Some was automatic, as more people ran into financial trouble and entered the social safety net. The government spent 20.7% of GDP in 2008. This year it’s estimated that the government will spend 24.3% of GDP, the highest since our all-out effort to defeat Germany and Japan.

On the revenue side, the government took in 17.5% of GDP in 2008. This year it’s likely to be 15.5%. What happened to the government’s income? The stock market and the housing market declined, steeply and quickly, erasing enormous amounts of value. Unemployment and underemployment skyrocketed, holding wages down along with the taxes that workers would have paid on them.

In addition, individual income tax receipts are down considerably following the Bush tax cuts: 10.2% of GDP in 2000, 6.2% in 2010. When you consider that individual income-tax payers provided 41.5% of all federal revenues in 2010, you can imagine the enormous effect of this drop.

Corporate Taxes

As the presidential campaign season heats up, we’re hearing talk about the heavy tax burden on U.S. corporations. Granted, the official tax rate on corporate income, 35%, is one of the highest in the world. Even the effective rate (what companies actually paid) was nearly 28% from 2006-2008.

However, if you look at corporate taxes as a percentage of corporate profit, you see a downward trend. According to the U.S. Department of Commerce, in 2006 corporations paid income taxes equal to 29.4% of their profits. This dropped to 20% in 2009. Tax revenue rose to 22.8% in 2010, but this is still a significant overall decline in just five years.

Why is Corporate America paying less tax as a percentage of their profits? Because the losses that corporations sustained during the economic collapse are helping them now. Businesses do much better tax planning than the average person. Also, businesses can take advantage of such devices as “net operating loss carry-forwards,” in which past losses offset present gains and reduce taxes.

The Bottom Line on the Deficit

At the beginning of this article we asked, how did we get in this mess? In a nutshell, we are spending more while taking in less from taxes. Ultimately, the federal government must find a way to balance cutting expenses and raising taxes. That sounds simple, but few people like paying more taxes or cutting defense spending or assistance programs for retirees or the poor. We will be debating what actions to take to tame the deficit for some time to come. Keep in mind that political statements made in the heat of an election campaign are not necessarily objective or even true. It will help if we can all take a calm, clear look at the deficit and its causes.