I have drawn some ire from fellow libertarians for my criticism of their fiscal policy priorities. My review of the book Trumponomics by Steve Moore and Art Laffer, which concluded that tax cuts have become ineffective, rendered a couple of surprising comments from fellow libertarian economists. Nevertheless, as I explained in my series Tax Cuts or Spending Cuts, facts are facts; cutting taxes to close the budget gap in a big welfare state is about as futile as ignoring gravity.
The only way to close the budget gap is by means of structural spending reductions. Since such reforms are no longer being discussed in the public discourse, nor being given attention by leading libertarian thinkers, pundits and scholars, starting today I am rolling out a series of articles on how to structurally reform away the welfare state.
In this the first installment we will condense the case for structural spending reform. I find it necessary to do so, partly – again – in response to the conventional wisdom that tax cuts can save us, but partly also in response to another idea being floated around among conservatives and libertarians: fiscal rule making.
Many people with influence have suggested that all Congress needs in order to end our deficits and prevent a debt crisis, is to follow a set of fiscal rules. A new book from the Cato Institute offers a collection of 20 essays centered around this notion; as I explained in my review of the book, for two reasons fiscal rule-making does not work:
- The rules are “Pippi rules”, i.e., they are self enforced with impunity for non-compliance;
- Without exception, the rules rely on healthy levels of GDP growth in order to work.
The last point applies not only to fiscal rule-making but also to the unending pursuit of tax cuts. In the case of rule-making, the prevailing wisdom is that GDP growth is exogenous to fiscal policy, in other words that it is not affected by the enforcement of a fiscal rule. However, as we will see in a coming article, fiscal rules can actually undermine the very basis for their own enforcement.
In other words, GDP growth is not exogenous, but endogenous to fiscal policy.
Proponents of tax cuts recognize this: in fact, the endogenity of GDP is the very life blood of the tax-cut argument. The problem here, though, is that tax cutters limit the endogenity to taxes; there is no explicit consideration of the effects of government spending on GDP growth. Right there we have the mistake that prevents the tax cutters from seeing how their budget-balancing strategy has run its course and no longer works.
It is essential for any attempt to save us from a debt crisis, that we understand why GDP growth is affected by the size of government spending. Before we get to the analytical explanation, let us start with empirical evidence. Figure 1 summarizes what this evidence says, namely:
- When government spending as share of GDP increases, i.e., when G/Y goes up (horizontal axis), initially the growth rates of taxes (t) and government spending (g) are largely similar;
- As the size of government passes a certain point, the growth rates of t and g divert, with the former declining and the latter increasing;
- when government spending grows faster than tax revenue, we get a structural budget deficit.
Let us review some data that confirm the image in Figure 1. First, Figure 2 reports data from Europe on the relationship between government spending as share of GDP, G/Y, and real GDP. Covering 31 countries, almost all of them over a 25-year period (1995-2019), it paints a stark image of the negative relationship between economic growth and the size of the welfare state:
Next up: numbers from the U.S. economy, which gives us an opportunity to link the size of government to the root cause of the budget deficit: the welfare state.
Government growth in America can be divided into five distinct phases. The first era runs from 1950 to 1963. This is the first phase of stability (Stability 1 in Figure 3 below). During this phase the welfare state was still ideologically conservative and did not engage in economic redistribution. It was, simply, confined to the provision of a safety net for the poor and needy. This was the welfare state that Congress and the Franklin Roosevelt administration created in response to the Great Depression.
The second phase of government growth begins with President Lyndon Johnson’s State of the Union speech in 1964. There, he declares his War on Poverty and marks the beginning of a fundamental overhaul and expansion of the welfare state. New entitlement programs like Medicare and Medicaid are created, others revamped for much more comprehensive purposes.
At the heart of the War on Poverty is a new, relative definition of poverty. A person is no longer poor because he lives below a certain, fixed standard of living. A person is now poor because he earns below a certain percentage of median income. When median income rises – as it does when the economy is doing well – the poverty limit rises as well. More people qualify for government handouts.
As I explained in my book The Rise of Big Government, the significance of this welfare-state metamorphosis cannot be understated.
After this roll-out phase for the new, socialist welfare state, it was time for the implementation phase: government needed to consolidate its new spending programs. Fiscally, this meant that government grew to the new, larger proportions that all the War-on-Poverty legislation prescribed. During this phase, which essentially coincided with the 1970s, government spending increased significantly.
This is also the phase during which government spending outpaced tax revenue on a permanent basis. The structural budget deficit was born.
Once the new welfare state was consolidated, government went into a new phase of relative stability. It lasted from 1980 to 2007, the year before the Great Recession started. During this Stability 2 phase (again, see Figure 3 below), government spending remained largely constant as share of GDP, but that stability was attainable thanks only to two tax reforms. Government spending was still small enough to let tax cuts work – there was a Laffer effect to be counted on.
If it had not been for the Reagan tax cuts fundamentally overhauling the tax code, there would not have been a long, stable growth period through the 1990s; the Bush tax cuts generated a more limited, yet visible growth spurt that helped carry the economy through most of his presidency.
With their growth record, these two tax reforms generated enough growth to essentially keep steady the ratio of government spending to GDP.
It is easy to get the impression from this long phase of stability that America had struck a golden balance between the welfare state and free-market capitalism. That was not the case, as evidenced by the perpetuated deficit. The Reagan and Bush tax reforms were not enough to close the budget gap, and the difference in effect of the two, with the first having stronger effects than the second, remains unrecognized in the literature.
The reason why the two reforms failed to fully fund the welfare state is simply that this structure of government spending grows by its own volition. Government spending is exogenous to economic growth, a fact that originates in the very ideological design of the welfare state.
Phase five, the Stagnation phase in Figure 3, is when the welfare state has grown big enough to permanently depress economic growth. This phase provides ample evidence of how the welfare state overpowers its host economy. During this phase, which begins in 2008 with the Great Recession, total government outlays average more than 37 percent of GDP. Economic growth is so poor that its annual average for the entire period is only 1.7 percent:
Predictably, the decline in growth has taken a toll on government revenue. When taxes have not delivered sufficient money to fund the growing welfare state, government – especially states and municipalities – have resorted to non-tax revenue. As Figure 4 explains, the rise of fees, charges and other revenue sources has coincided in time with the transformation, implementation and growth of the socialist welfare state. However, not even the rise of non-tax revenue has been enough: the deficit reported in Figure 4 (red) is mostly federal but also includes overspending by state governments.
De facto, deficits have become a permanent source of government funding:
It is worth noting that as taxes become less important as a revenue source for government, the effectiveness of tax cuts also declines.
With declining GDP growth under an increasingly burdensome welfare state, government debt keeps rising. Figure 5 compares the debt-to-GDP ratio to real GDP growth. To highlight trends, the numbers are reported as five-year moving averages:
Let us now add together everything we have learned so far about the interaction between government spending, GDP growth and tax revenue, and add one more twist to the tax-or-spending-cuts debate. Figure 6 reports a total of 262 quarterly observations of annual growth rates in all three variables, from 1954 to Q2 of 2019. The observations are not reported chronologically, but are instead organized by GDP growth, from high to low (blue).
Tax revenue correlates positively with GDP growth (black dashed), which is not surprising. What does stand out, however, is the turn upward of government spending growth (red dashed) when GDP growth falls below three percent per year. As GDP growth gets weaker, government spending accelerates:
We have now learned three important things about the government budget:
- As spending grows, GDP growth declines;
- As GDP growth declines, spending growth accelerates; and
- With declining GDP growth, tax revenue slacks off as well.
There is more to be said about the first two points; for now, let us note the conspicuous divergence between GDP and government spending toward the right end of Figure 6. That gap alone explains our structural budget deficit.
However, first, we need to add one last point about taxes. As Figure 6 tells us, tax revenue fluctuates with GDP growth, but the fluctuation is higher in tax revenue. This means, plainly, that tax revenue is a volatile source of revenue. Figure 7 extracts the equations defining the trend lines in Figure 6 and plots them strictly as analytical representations of how these two variables correlate:
The problem with Figure 7 is that the volatility in tax revenue has increased with each supply-side tax reform. This means, in turn, that tax revenue plunges more violently in recessions, but since the long-term growth trajectory for GDP – and therefore the tax base – is lower than it used to be, this volatility is not symmetrical. We don’t get enough of a compensating “Keynesian” surge in tax revenue at the peak of the business cycle.
In other words, we are left with a structural deficit.
But why, then, do we actually have this structural deficit? This question is of course essential to our discussion of structural spending reform. Figure 8 has the answer. It reports the share of the federal budget that is dedicated to entitlement spending, i.e., the welfare state. The blue function represents the welfare state’s share of the budget in 1964, when the War on Poverty began. Today, two thirds of all federal spending goes toward entitlements, from education to Social Security, from the Earned Income Tax Credit to Medicaid and Medicare:
To highlight, Figure 9 divides the 2019 federal budget by major program category. Notice the share that goes to national defense: in 1960 that share was 50 percent.
Spending on entitlement programs grows for reasons that are inherent to the programs themselves. This growth causes a depression in GDP growth, which in turn causes a structural budget deficit. The only way we can close the budget deficit is by reforming away the welfare state.
How? Please proceed to Part 2.
Click the Follow button to always get updates first!
 For a more detailed discussion of the ideological character of the American welfare state, see Larson (2018) and Larson (2020f).
In Part 1 I explained that fiscal conservatives no longer can rely on tax cuts to save us from big government. I noted specifically that libertarians who want to eliminate the income tax as part of such tax cuts, are missing the point entirely. Using state-level data I pointed out that states without an income tax show no sign of having smaller governments than states with an income tax.
In short: tax cuts no longer work as a means to contain government growth. They also do not help with balancing government finances. Government is simply too big.
Supply-side economics doesn’t work anymore. Only an ideologically principled, theoretically consistent and morally sound welfare-state reform effort can make the difference. There is compelling data to make this point, but first, let us take a look at the theory behind the demise of supply-side economics.
The blue, solid line in Figure 1 represents government spending, growing at a steady pace (hence the modest upward slope). Tax revenue is represented by the solid red line. A supply-side oriented tax cut initially depresses tax revenue, but as the economy starts growing faster under lower tax rates, revenue picks up at a faster pace. Eventually, revenue collection surpasses government spending and government runs a surplus:
Figure 1: The theory behind supply-side tax cuts
There is nothing wrong with the theory behind the red, solid function, quite the contrary. It has good empirical support from previous tax-cut reforms. The problem lies instead on the spending side: consider a slightly higher growth rate in government spending, as per the dashed blue line. When government grows faster, its depressing effect on government spending kicks in earlier than it otherwise would.
Specifically, there is the 40-percent threshold where four out of ten dollars in the economy runs through government. I discussed this point in my book Industrial Poverty, where I presented evidence by me as well as others on how this threshold works. Once government occupies more than 40 percent of GDP, there is a permanent slowdown in economic growth.
Once this happens, it becomes harder for the private sector to put a tax cut to good use. Bluntly, there will be less growth from every dollar’s worth of tax reductions. Hence the dashed red line.
Once the solid lines in Figure 1 become dashed, tax cuts no longer work. It is futile to spend political energy and efforts on those; we should still oppose tax hikes, but the reform efforts must be allocated to the spending side.
As a reinforcement of this point, consider Figure 2. It reports the growth in $100 worth of, respectively, total government spending and current-price GDP for the U.S. economy. For every $100 we spent through government in 1954, we spent more than $7,500 in 2019; over the same period of time, $100 worth of GDP grew into $5,000.
Government outpaced its own tax base by $1.50 to $1:
Figure 2: Growth in government spending relative GDP
The growth of government is stunning in itself, as are its causes. Consider Figure 3, where we also pinpoint how the size of government (relative GDP) has become increasingly immune to supply-side tax cuts. To highlight the relationship between federal tax cuts and the size of government, we now disregard states and local governments and focus solely on the spending that Congress has jurisdiction over:
Figure 3: Cycles in federal government spending
President Kennedy worked with Congress on the lowering of federal income taxes (1). It is hard to identify any clear downward trend, the reason being in part that defense spending at this time constituted almost 50 percent of the federal budget. That spending tends to be entirely immune to the ups and downs of the economy; at this time it was slowly being ramped up for the purposes of the Vietnam War.
Nevertheless, it is worth noting that the Kennedy tax cuts were indeed followed by a strong growth episode in the U.S. economy, one we would not see the like of until the 1990s. Unfortunately, the relatively modest size of the federal budget under JFK was replaced by a steady climb under President Johnson (2). Launching his War on Poverty, LBJ led the transformation of the American welfare state from socially conservative to redistributive socialist. New entitlement programs, built around a new, relative definition of poverty, permanently expanded the federal government. What had been a budget equal to 17-18 percent of GDP became a fiscal conglomerate equal to 22 percent and more.
It was not just the federal government that expanded. State spending grew even faster, as they became responsible for running a good part of the new programs that Congress put in place under the auspices of fighting poverty. With the rapidly expanding weight of government on the economy, growth slowed down and taxes depressed both entrepreneurship and career development.
In response, President Reagan spearheaded major tax reforms that rejuvenated the U.S. economy. Growth picked up and the private sector gained back some ground lost to government (3). The architect behind the supply-side strategy, Art Laffer, was proven correct on all points except one: the federal budget deficit did not vanish.
This was a sticking point that supply siders never quite addressed. It was not their theory in itself that was wrong; it was its omission of the spending side. Notably, it took a fiscally conservative Democrat in the White House to shed light on the importance of the spending side: working with fiscally conservative Republicans, President Clinton significantly tightened the belt on the federal budget, not to a point where he shrunk it, but by significantly reining in its growth (4).
With an economy growing in excess of four percent, Clinton was able to sign four budgets with a surplus. However, despite a reasonably good welfare-reform bill, known by its PRWORA acronym, he did not do much to turn the long-term tide of the welfare state. On the contrary, when he signed SCHIP into law he added a big spending program that later became a driver in Medicaid costs.
Once again, a Republican took the leadership on the tax side of the budget. With two tax cuts, one in 2001 and one in 2003, President Bush Jr. tried to counter the Millennium recession by repeating the Reagan supply-side success. It worked to some degree: while the economy revved back up again and tax revenue with it, non-military spending increased at about 6.5 percent per year. The welfare state almost outpaced tax revenue.
Not quite, though. If the economy had not gone into the Great Recession in late 2008, the federal budget would have been in balance by 2009. For sure, that was six years after the second Bush tax cut, but it was en route to happen.
Does this mean that supply-side economics worked under Bush? Modestly. It showed that it could still deliver good government finances under the best possible economic conditions. The problem is that last part: best possible conditions. A recession was all it took to throw the federal budget back in the hole again (5). For sure, President Obama and the Democrats recklessly increased government spending in the first couple of years of his presidency, but once the Republicans took back the House a fiscal standoff between Congress and the White House actually led to a de-facto practice of fiscal responsibility.
With Trump in the White House, Republicans tried for a third time to put supply-side theory to good use. Its positive effects, which were visible in the economy all the way up to the artificial economic shutdown in 2020, were too modest to bring about three percent annual economic growth. They also failed to make a dent in the budget deficit.
The reason is painfully obvious: government spending has weakened the transmission mechanisms that generate economic growth. The welfare state has eroded the incentives that drive employment, innovation, investments and entrepreneurship. It has not destroyed them, but it has worn them down to a point where we get much less growth out of every $100 worth of tax cuts than we did under Kennedy, or even Reagan.
Figures 2 and 3 tell us that the size of government is immune to tax cuts. What it does not tell us is how that size has remained comparatively stable since the 1970s thanks only to growing budget deficits.
A coming article will discuss tax hikes – and why they are a thoroughly bad idea. First, though, in Part 3 we look at what would have happened if we had tried to end the deficits by means of a Penny Plan.
As I explained in my latest op-ed for InsideSources, the U.S. economy is suffering from a government-debt explosion of a magnitude that
should rightfully send shivers through the country. This is a mounting national crisis that transcends party lines and ideological affiliations. Both parties in Congress have gone AWOL on this issue, and both Donald Trump and Joe Biden carefully ignore the problem.
Plainly, this is a problem that requires urgent attention – and a comprehensive, systemic solution. The first step toward that solution is to understand the problem, namely excessive entitlement spending. Two thirds of the federal budget goes to the redistribution of income, consumption and wealth:
Figure 1: Entitlement spending as share of the federal budget
Source of raw data: Office of Management and Budget
The column for 2020 is marked red, as it only represents a prediction. When we get the final numbers the entitlement share will probably exceed 70 percent for this year.
As of today, there are no clear signs that Congress is tapering off its spending binge. President Trump has postponed any talks about more Covid-19 stimulus bills until after the election, a sign that he may have started realizing just how precarious the situation is. However, for now the most reasonable assumption is that we will continue to forge ahead, and therefore continue to define the problem and point to the absolutely necessary solutions.
The essential component of that effort is, again, to direct the spotlight squarely at the core of the problem. Entitlement spending consists of two kinds of spending: doling out cash to people, and paying for services that are then given away to citizens that government has defined as entitled. In the first spending category we find, e.g., Social Security, the Earned Income Tax Credit and Temporary Assistance to Needy Families. The latter category consists of Medicaid, Medicare, public education and other programs through which government pays for services that some citizens benefit from.
It is the sum total of these programs, as share of all federal spending, that is reported in Figure 1. This is the figure – the spending – that Congress needs to rein in and reduce. Eventually, over the long term, it needs to eliminate all entitlement spending.
As of today – and probably for the foreseeable future – it is unrealistic to imagine any Congressional constellation that would dare to go all the way to the elimination of entitlements. However, while this long-term goal is ideologically desirable and fiscally and economically necessary, the urgent goal is to bring Congress to the starting point: reining in entitlement spending.
To do that, in turn, we first need to set our own focus on entitlement spending. That is easier said than done: as demonstrated by a quick sweep through the right-of-center think tank websites, a lot of the work being produced by libertarian and fiscally conservative organizations puts its emphasis on more or less irrelevant issues.
For starters, the Yankee Institute, a think tank in Connecticut, has published a study where they report that government employees in the state on average make 28 percent more than private-sector employees. The difference, they explain, lies primarily in the more generous benefits packages paid out to government employees.
This is an important factoid to bring to the public attention. I have myself published numerous articles about this statistic, part of if under the Government Employment Ratio that I originated back in 2011. However, the focus on employment and compensation ratios between the public and private sectors is ultimately a distraction. Yes, a government workforce costs taxpayers a lot of money, but the problem with that cost is not addressed in isolation. In fact, it is not even addressed as an independent issue. The only way to tackle it is to remove the reasons for having government employees in the first place.
Figure 2 explains what this means. It reports national numbers for the total cost of government, and the compensation of government employees, as share of private-sector employee compensation:
Figure 2: Government cost ratios
Source of raw data: Bureau of Economic Analysis
The red segment shows the non-employee cost of government. Before the 1970s employment compensation dominated government outlays; once the modern, economically redistributive welfare state had been created, spending on entitlements began taking over. In 2019 the entire government sector of the U.S. economy spent 28 percent more on non-employee outlays than on compensating its workforce.
In other words, if you want to bring government spending under control, you have to reform – and eventually reform away – entitlement programs. The Yankee Institute should follow up its current study with one that addresses this aspect of government spending, even if it is focused on their home state of Connecticut.
Other states make similarly good but more or side-track style contributions. The Cato Institute just published its latest gubernatorial fiscal report card. The guy in charge of it, Chris Edwards, is a solid fiscal policy analyst whose work always stands up to scrutiny. The problem, however, is that the report only addresses part of government spending, namely the General Fund. The motivation is that governors do not have jurisdiction over Other Funds, nor do they have control over the federal money that goes into state budgets.
From a strict technical viewpoint, this is a valid argument. The problem, however, is that Other Funds are often used by state governments to “conceal” spending from the general public, sometimes even from the legislature. My home state of Wyoming is a case in point: before I started writing about the true size of government here, many legislators believed that we only had 7,500 state employees. The real number is twice as high, but half of the state workforce is paid through something called “900 series” budget items. Therefore, they do not show up under the General Fund outlays.
It deserves to be noted that the Bureau of Labor Statistics reports the actual, total number of state employees, and therefore also allows for an account of the true cost of the government workforce. However, to get to that point one must first recognize the full size of government spending, namely add up General, Federal and Other Funds in the state budget.
It is worth noting that in 2019, according to the National Association of State Budget Officers, General Fund spending only accounted for 40.8 percent of total state outlays. This share has fluctuated over the years and varies a great deal across states, but the policy implication is clear: if we ever want to bring government spending under control we must first understand and account for all of it.
The Heritage Foundation has not published anything on government spending since September 18 and Dakota Wood’s piece promoting more defense spending. Before that, Rachel Greszler published a commentary on the deferment of Social Security taxes. In short, our nation’s dire fiscal situation does not seem to be a priority for this $85-million-a-year outfit.
Over at the American Enterprise Institute, which bills itself as an organization promoting a “freer and safer world” – whatever that means – continues to move away from its originally libertarian ideological domicile. Their latest contribution to our understanding of how costly government is, comes in the form of a case for increasing that cost. Angela Rachidi and two co-authors continue to make the case for a big, new federal entitlement program known as “paid family leave”. As I explained in my white paper on paid leave, this is a fiscally outright reckless idea that Congress should stay very far away from.
One of the more important ways to fight the growth of government is for government to retreat and give room for the private sector to grow and thrive. When that happens, more jobs are created and more people start businesses. However, in order to understand whether or not that is actually happening, we first need to know what metrics to use. The Foundation for Accountable Government makes a contribution to this effect, reporting in a new brochure that 1.7 million new businesses have started since June. This, they explain, is a record number with entrepreneurs starting new businesses “60 percent faster than ever before”.
Touting this as a major success for the American economic comeback, the FAG forgets to report how many businesses were destroyed as a result of the artificial economic shutdown. The omission of this number leaves the reader with the false impression that the U.S. economy is roaring back to growth and prosperity. It is coming back, and – as I have explained elsewhere – it is doing so in a V-shaped fashion like President Trump predicted. However, if we want to understand the comeback we have to report it with analytically accurate metrics.
Without an accurate approach to economic analysis, we leave our readers and our policy makers with inadequate information and a skewed, even false picture of the economic reality in which Main Street America lives. In this particular case, we get the impression that the U.S. economy is far stronger than it really is; although the FAG brochure is not intended to say so, it is easy to draw the conclusion that our private sector is impervious to the big cost of government. The only government spending item that the brochure really criticizes is the excessive unemployment bonus, the over-indulgence of which I examined in my Inside Sources op-ed.
There is a lot more to be said about our nation’s economic reality, and the scatter-brained approach of the libertarian movement in addressing the problems out there. For now, though, let us note that we will never save our country from its approaching fiscal disaster unless we first learn to correctly define the problem. That, in turn, will require that the practitioners of libertarianism and fiscal conservatism in the public-policy sphere put their intellectual indolence aside and start doing their homework.
In a couple of days we will enter the last quarter of this the strange year of 2020. Hopefully, 2021 will be a more normal year, and we can look back at this year as a weird anomaly.
As part of the review, we can start taking inventory of one of the most controversial aspects of government policy this year, namely the Covid-19 stimulus spending. As I have mentioned on my podcast, the combination of irresponsible spending by Congress and irresponsible funding by the Federal Reserve has put us in a precarious economic situation as a country.
Today I can report more numbers that beg some serious questions about the alleged economic necessity – let alone soundness – of the so-called stimulus spending.
The core argument for the CARES Act, the Families First Act (which included the elements of a paid-leave program) and the bills that are now being discussed, has been that the measures would save household finances and bring the economy back from the artificial shutdown. Emerging data suggests that the entire argument for the stimulus outlays has been hyperbolic to the point of reckless.
Let us make one point clear, before we move on: when government forces businesses to close and people out of work, government has a moral obligation to remedy the fallout of its actions. In line with this, it is perfectly reasonable that Congress temporarily raised the unemployment benefits. What is not reasonable is the rest of the stimulus spending going toward household finances.
Here is why. According to the Bureau of Economic Analysis, in the second quarter of 2018 (two years ago) total personal income – in other words all the money earned by individuals in America – was $4,437.6 billion, counted on a quarterly basis. In Q2 0f 2019, a year ago, that same personal income amounted to $4,620.2 billion.
This represents an increase of a bit over 6.1 percent in current prices.
So what’s the number in Q2 of 2020? $4,365.9 billion. Again, this is an annualized number counted quarterly – the Bureau of Economic Analysis does not publish straight quarterly numbers – but this number excludes any money coming from the coronavirus stimulus and from “other” stimulus money, i.e., the checks that all households got in the spring.
Now, let’s add those numbers. Defined similarly (annualized by quarter), the unemployment money added in $278.1 billion, which took total personal income up to $4,664 billion. This number is about one percent above where personal income was a year earlier.
Adding the stimulus checks – amounting to $456.3 billion on the annualized quarterly basis – we end up with $5,100.4 billion in personal income.
We are now 10.4 percent above where personal income was a year ago.
It is important to keep in mind that these are seasonally adjusted numbers, i.e., annual rates counted without regard to normal variations in economic activity due to calendar days, the tides of seasonally dependent industries, and so on. Therefore, they do not present the whole picture of the timing of the stimulus and unemployment spending. However, they do give us one important piece of information: the stimulus checks may have been a vast over-reaction from Congress.
Again, if we subtract the stimulus spending that was not funneled through the unemployment benefits system, we still have a personal income that tracked well with where it was a year earlier.
Statistics nerds will point out that the annual-rate component in these numbers disguise a massive drop in personal income, especially in the private sector. This is a fair point, one that we cannot control directly since the BEA does not publish raw, non-adjusted quarterly numbers for personal income. They do, however, provide that very type of data on government revenue; since the federal government as well as most states and many local governments levy income taxes, we can test for the shutdown effect by looking at raw data on income-tax revenue for the second quarter.
If the personal-income data disguise a major disruption in personal income in the second quarter, then we should see it mirrored in major losses of revenue from personal income taxes.
Starting with the federal government, in Q2 of 2018 they collected $389.7 billion in personal income taxes. In Q2 of 2019 that number had increased to $412.7 billion, an increase by 5.9 percent.
In Q2 of 2020, smack in the heart of the Covid-19 shutdown, the federal government collected $387 billion in personal-income taxes. That is a mere 6.2-percent drop over 2019 and almost exactly the same as in 2018.
These numbers reinforce the impression that the stimulus checks were entirely unnecessary.
State and local government revenue data point in the same direction. In the second quarter, they collected
$113.9 billion in 2018,
$129.8 billion in 2019, and
$123.9 billion in 2020.
In other words, states and local governments collected 8.8 percent more from personal-income taxes this year than two years ago, and only 4.5 percent less than last year. Since these are raw numbers, not adjusted seasonally and not adjusted annually, they give us an accurate image of what happened to personal income – in other words household earnings – during the thick of the shutdown.
Given these numbers and given that the funding came fresh from the money printer at the Federal Reserve, those checks were simply not defensible.
Congress is currently considering more stimulus spending, with some suggesting another round of checks. That would be highly irresponsible, to the point of fiscal and macroeconomic recklessness.