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History Lesson – Deficits as a % of GDP, Tax Rates

Reader Matthew McOsker writes more on the deficit:

History Lesson – Deficits as a % of GDP, Tax Rates

DISCLAIMER: This is not a defense of Bush II. Just the facts on the deficit, and a further discussion of sectoral balances and some tax rate info.

Let’s look at some history, because the belief is that Bush II ran the biggest budget deficits ever, and ruined the Clinton surpluses. I wish we did not spend so much on the military under Bush. However, the Bush deficits were not that large as a % of GDP. His father, and Reagan ran bigger ones. The deficits were not that far off where we were at the end of the 70’s either. Now keep in mind, that the trade deficit does factor in – been having trouble assembling historical data on this. When running a trade deficit we need to run a federal deficit to keep the private sector in balance.
See Credit write downs  on sectoral balances:

The key formulas is as follows:

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0
Via Business Insider L Randall Wray

Lastly, the Obama deficits are exactly what we needed to make up for the deficits that were probably too small under Clinton and Bush II.

Now, much of the talk on historical Tax Rates focuses on marginal rates- I found this table to be quite interesting as it looks beyond the top marginal rates, and breaks out lower income folks.

Data is for 3 groups 1/2 median income; Median Income ; Twice Median income respectively

Year — Average Combined Rates for each group that includes payroll taxes and EITC , and the last numbers are the top and bottom marginal rates that excludes payroll taxes ( I just sampled a few years, go to the link to see more. I used average cause that better reflects what one actually pays) :

1970 — 9.45% — 12.7%   — 15.15% — 14% and 70% Nixon
1979 — 11.24% — 16.97% — 20.32% — 14% and 70% Carter
1982 — 13.21% — 17.76% — 21.94% — 12% and 50% Reagan
1990 — 12.77% — 16.98% — 19.83% — 15% and 28% Bush I
1992 — 12.2%   — 16.83% — 20.13% — 15% and 31% Bush I
2002 — 5.42%   — 14.18% — 19.83% — 10% and 38.6% Bush II as Clinton Rates still in effect
2003 — 3.45%   — 12.99% — 18.05% — 10% and 35% Bush II

From Tax Policy Center

Chart 1

It’s not structural unemployment, it’s the corporate saving glut

Mark Thoma rightly points out the hypocrisy of the deficit hawks’ intent to cut spending while approving military spending in the same sentence. Ryan Avent furthers the dicussion by stating that Washington has used the ‘dire fiscal’ rhetoric to sell short-term cuts that were unwarranted, given that the fiscal problems are structural in nature.

Me, I’d argue that the fiscal deficit is simply the consequence of corporate America’s excess saving: the corporate saving glut – no I didn’t mean the ‘global saving glut’. Furthermore, the corporate saving glut is manifesting itself into the labor market, creating high and persistent unemployment. Some economists are wrongly referring to this as higher structural unemployment.

Exhibit 1: The 3-sector financial balance model demonstrates that elevated excess private saving (firms and households) keeps the government deficit in the red. For a discussion of the 3-sector financial balances, see Scott Fullwiler and Rob Parenteau; and I’ve written on this as well.

The excess saving rate for the public sector, external sector, and household sector is constructed using the Federal Reserve’s Flow of Funds accounts as: (Gross Saving – Gross Investment)/GDP. The excess corporate saving rate is the residual of the Current Account (external saving) net of government and household excess saving. If the corporate excess saving rate is positive, then investment spending falls short of asset purchases (financial or tangible).

* In Q4 2010, the household excess saving rate dropped to +3.5% of GDP
* In Q4 2010, the government excess saving rate dropped to -10.4% of GDP
* In Q4 2010, the current account deficit dropped to -3% of GDP
* In Q4 2010, the corporate excess saving rate jumped to 3.9% of GDP – this is the Corporate Saving Glut because while firms are investing, they’re saving more, thereby breaking the positive feedback loop.

The positive feedback loop remains broken: higher demand increases sales rates, revenues and production which grows firm profits that are translated into wage and income gains, only to drive demand further upward. It’s broken right between ‘grows firm profits’ and ‘translated into wage and income gains’.

The funny thing is, too, that economists sell this broken feedback loop as rising structural unemployment. Actually, unemployment is not structurally higher, it’s that when firms do not reinvest corporate profits, the lack of income flow manifests itself into the unemployment rate.

Exhibits 2 and 3. It’s not structural unemployment, it’s the corporate saving glut!

The chart below illustrates a simple univariate regression of the unemployment rate on the corporate saving glut. The correlation is very strong, 85%, and suggests that the structural unemployment rate is less than 5.8%. Furthermore, while the unemployment rate seems to be perpetually higher than normal (the upper-right circle), that perfectly coincides with a high corporate saving glut.

If the corporate excess saving glut just equaled zero, i.e., firms invested and saved at the same rate, the unemployment rate would be 5.8%. Now, if the corporate saving glut fell below zero to -2%, i.e., firms reinvested in the economy by way of capital investment in excess of saving, the simple model implies an unemployment rate of 4.7%.

The government doesn’t need to add jobs, per se, the government needs to figure out how to get corporate America to drop the saving glut and re-invest in the economy.

Rebecca Wilder