Do Deficits Matter?

This is a classic question posed to Economics students for several decades. In fact, I can remember being asked that question in Econ 1 in 1978. Most of the students said yes, the professor answered "not really". A better, although less precise answer would have been, "it depends".

First some terminology so we are on the same page. A deficit is the amount of money spent in a year that is more than revenue. This amount gets added to the national debt, which is the accumulation of all annual debts and surpluses over the years. Sometimes, perhaps because they both begin with the same letter, they are used interchangeably. We will actually use both terms to help give some depth to the discussion.

The graph below measures the entire national debt as a percentage of GDP (Gross Domestic Product) or the amount of goods and services produced in the US in a year. I like this measure because it gives us a sense of how big the debt is compared with our economy and also effectively adjusts the amount for inflation.

(Numbers courtesy of presidentialdebt.org)
As you can see by looking at the graph for 1978, my professor was probably more correct than the students as that level of 34% is lower than the level for almost any year since. We would be very happy now to get our Debt/GDP ratio down to 34%. This ratio floated up from a low of 32.9% at the end of 1981 to 67.1% at the end of 1993. At that point it hovered and then dropped during the Clinton Administration. However, only the only surplus was in 2000 (drop of 2% in actual dollars). In the preceeding years, the debt just didn't rise as fast as GDP, and therefore became a smaller percentage.

While that might seem like it is obscuring debt increases (and to some extent it is), it is giving a better picture of the impact. To get a better look at it, imagine that we are running a deficit and adding to the debt every year for 10 years and that each year, our GDP grows by 3%. However, our annual deficit is only a single dollar. At the end of this 10 year period, our deficit will be $10 larger (insignificant on a $13 Trillion debt) but our GDP will be almost 35% larger. Our national debt as a percentage of GDP will have shrunk by about 25%.

So again, why is that important? Well, assuming that our Government Revenue (read taxes) as a percentage of GDP remains fairly constant, our ability to pay the interest on our national debt is relative to our GDP. If the debt becomes too large as a percentage of GDP, the interest payments begin to take on too large a percentage of our tax revenue, thereby squeezing out other expenditures and/or increasing the debt even further. In fact, the US has among the lowest ratio of tax revenue to GDP among developed countries. This chart also includes state and local taxes and shows that almost all of Europe is higher than the US with only Mexico, Turkey, Korea, and Japan lower.

So what is the correct level of debt/GDP? Well, assuming that there is no reasonable way we can make this 0% anytime within our lifetime, it appears that bringing it back to a level under 70% would be prudent. Once we are there, we should attempt to find non-draconian ways to bring it back into the 50% range which is the long-term post-WWII average.

So now that we have that question answered, how do we make that happen? Well that is a topic for at least a few future posts, but just a few comments and a nice toy for you to play with. I am happy the Republican Party with a large assist from the Tea Party has gotten religion about deficits. I won't slap them about that belief running in stark contrast to their last 30 years of leadership because I really hope they mean it this time. I think they will be in trouble in 2 years if they don't follow through on it this time, so, for their sake and the sake of the country, I hope they are good on their word. They will also have to face the fact that you can't reduce the deficit significantly without increasing taxes and making reductions in defense spending and Social Security and Medicare benefits.

However, you can make adjustments to Defense, Social Security and Medicare and make some tax adjustments that don't seem devastating. Want to play King of the World (or at least Chief Poo-bah of the US Economy? Try your hand at this nifty interactive toy from the New York Times that lets you figure out how to balance the budget. Let me know what percentage of tax increases and spending cuts you come up with by leaving a comment. Enjoy.

2010 Mid-Term Elections Review

Well, not too bad a prediction job by The Voting Booth.

We called the Senate final tally on the button 51(+2) - 47. We were a little bit low on the number of seats Republicans would take in the House. We said 55 and they have picked up 60 to date with a few more seats still being determined by recounts.

Definitely a wave election or at least a swinging of the pendulum back to somewhere around the levels prior to the 2006 & 2008 elections. The Senate is still a little more Democratic than prior to the 2008 elections, but is a little more Republican than prior to the 2006 elections. 2012 shapes up to be a very interesting election on all fronts.

First, a congratulations to the Republican Party. Just two years ago, it seemed more likely that the party would be disbanded than that they would take back the House and make major gains in the Senate. Republicans are just better at the political game than Democrats. Occasionally, in situations like 2008, the Dems can message and GOTV equal to or better than the Republicans they have a registration advantage over. However, 2010 proved to be a storm too big for a good GOTV hampered by horrible messaging.

As in most election years, if the economy is an issue, it will bury the party in power. Combined with a mid-term trend away from the party in power probably explains 50-75% of the outcome. Regardless of what they did, there was no way Democrats were going to lose less than 30-40 seats in the House or less than 3-4 seats in the Senate. The remaining difference was created by a brutal, ruthless and persistent messaging from Republicans starting from when they got their breathe back in early 2009. True, it was filled with fact stretches and outright lies (see Death Panels, "useless" Stimulus and Bailouts, etc.), but they were made believable at least to enough people who were motivated to vote and pull the "R" lever. It may not have much to do with statesmanship, but it was textbook politics.

A special mention goes to the Tea Party, who can reasonably claim to have put the lift back in the step of Republicans, generate anger and organize it. They can also be blamed for loosing the Senate as their primary wins in Delaware, Colorado and Nevada removed more mainstream candidates who would almost certainly have defeated their Democratic opponents. That would have made the Senate Dems 48(+2) Reps (50) and the chance for the Reps to pull Lieberman or one of the conservative Dem senators would have been pretty significant. Also a shout out to Lisa Murkowski for apparently winning the Alaska Senate seat as a write-in after she lost the Republican primary. By far the biggest slap in the face for Sarah Palin who despite some significant successes supporting Tea Party candidates during Republican primaries failed in the overwhelming majority of races on Nov 2nd against the Democratic candidates. The Tea Party giveth and the Tea Party taketh away.

Calling the 2010 Election

The Pendulum is swinging back.

For good or bad, the last 2 elections have swung dramatically in the direction of the Democrats taking the House, Senate and White House from the Republicans. During the last 2 election cycles, Democrats have gained 52 seats in the House and 14 seats in the Senate, giving them significant majorities during the past 2 years, larger than most differentials since the landslide elections of 1964. Under almost any circumstances, especially being the party in the White House, the Democrats could have expected some significant losses in the 2010 elections as the pendulum swings back a bit. Add to that an economy that continues to be bad, marked by almost 10% unemployment and a great deal of underemployment and those who have just plain left the workforce and you will get substantial losses. On top of all that is the politically wonderful (but in many cases morally deplorable and dishonest) job the Republican Party has done over the last 2 years, fighting the President on almost every issue and winning the message wars on almost every action taken by the Obama Administration. All this despite the fact that Republican Party has lower favorables than the Democratic Party and far lower than President Obama.

The question is not whether Republicans will have a very good day nationally on November 2nd, the question is how large will it be? Predictions are all over the place, but here is my call:

Republicans take the House gaining 55 seats to take a 17 seat majority (226-209)

Democrats lose 6 seats, but hold onto the Senate 51-47 with the 2 independents caucusing with the Democrats for an effective 53-47 edge.

This brings the House pretty much back to the balance that existed just prior to the 2006 elections, but the Democrats still have a slightly larger majority in the Senate than they had entering the 2008 elections. There are a lot of Democratic Senate seats up for reelection in 2012, so unless Obama wins convincingly in 2012 and has some coattails, the Senate could turn Republican in 2 more years. even if it doesn't happen Nov 2.