How Bad is Bad?
How Bad is Bad?
Given the year we’ve had and how deep governments have had to dig in order to keep their economies from sinking without trace, it is worth checking in with how the government finances are looking. All the data below relates to the US and is taken directly from a monthly publication on the Treasury website. https://fiscal.treasury.gov/files/reports-statements/mts/mts1020.pdf.
The most recent publication for October 2020 below, shows the US Government had total receipts of $238bn and total outlays of $522bn, leading to a deficit of $284bn. In one month.
Clearly these are exceptional times, however what is more eye-opening than these headline numbers during a crisis is the realisation that all the pandemic has done is taken an incipient structural finance crisis and made it acute. We can try to get a rough gauge on the effects of the pandemic by looking at how things looked in the month of October 2019 which we can do from the two tables for receipts and outlays for the last 12 months below.
In October 2019, receipts were c.$250bn and expenditures were c. $390bn giving a deficit of $140bn. As the figures show, October was a normal month from both an income and expenditure perspective. We can see the spike in outlays over the summer as the relief spending kicked in etc. These “exceptional” deficits are not going away in the short-term. Recently, US Secretary of commerce Wilbur Ross said he expected the 2021 deficit to be around $3.5tn, which coincidentally is almost exactly $284bn per month on average and roughly 17% of US GDP.
Over time, any attempt to bring things closer to balance will require either receipts to go up, outlays to go down, or a combination of both. If we look at the outlays first, we can group Medicare, Social Security, and Health spending together, and while there has been some pandemic-related uplift, these outlays are both non-discretionary and growing structurally for as far as the eye can see. Defence spending is another huge item. The US spent 73% of all individual income tax receipts in October on Defence. The US has recently announced troop withdrawals from certain regions but this is a drop in the ocean. More importantly, the US is embarking on a “Great Power Competition” https://fas.org/sgp/crs/natsec/R43838.pdf with China, which in order for it to win will require this category of spending to also be non-discretionary. Income security payments are higher because of the pandemic ($73bn in October 2020 versus c.$30bn in October 2019). The overwhelming point is that while there is some short-term crisis-related spending that will reverse in time, structurally, these outlays are only going one way.
Looking at the revenue side is more straightforward. Virtually all the revenue comes from individual income taxes and social insurance and retirement receipts. Income tax receipts are down ($109bn versus c. $130bn in October 2019) but again this is a drop in the ocean compared to the deficit. There are things that can be done on the tax side, particularly given the new Democrat administration, but not much. The bottom 50% of income earners account for only around 3% of income tax receipts but increasing taxes on low earners is both economic and political suicide. There are tweaks to be made at the higher end but there are limits to how far you can go with tax rates before they have a negative impact on receipts. A few billion here, a few billion there really doesn’t make much of a difference.
The graphics above highlight not only the magnitude of the short-term impact of the pandemic but more importantly the structural nature of government deficits. This brings us to the obvious question of how those deficits will be financed? Let us say that next year the deficit is $3.5tn and maybe $2tn the year after. Who will buy these bonds? The US domestic sector will buy some, but nowhere near enough. The foreign sector which is running a $500bn trade surplus with the US will buy some, but nowhere near enough. That leaves only one buyer. The US central bank, with newly printed money.
As the pandemic moves into the rear-view mirror these realities will become clear and the insights of Modern Monetary Theory will become more mainstream, whether we agree with them or not. Any alternative prescription will not pass the political hurdle. The intellectual chord that links taxation and spending will have been severed.