Saturday, September 09, 2006

Temporary Anomaly or End of a Trend?

Since George W. Bush, who in contrast to Congressman Ron Paul is anything but freedom-loving, came into office, the burden of the federal government in America have steadily risen. From 18.5% of GDP in fiscal year 2001 (Clinton's last budget) to probably (neither the final GDP or budget numbers are available yet) about 20.5% in fiscal year 2006 if current trends are maintained. And these numbers actually underestimate the degree of government expansion since lower interest rates have held down interest costs and since America have been at a cyclical peak (the burden of government tends to be countercyclical, all other things being equal).

At first, the spending boom was reflected in the Clinton surplus being turned into a larger and larger budget deficit. But for the last two years, the budget deficit have actually declined somewhat. The reason for that is a surge in tax revenues, which increased 14.6% in nominal terms in fiscal 2005 and which have continued to consistently increase more than 10% on a year to year basis every month during fiscal 2006. Until now, that is.

For according to the Congressional Budget Office preliminary report for the federal budget in August 2006 (final report from the Treasury Department is due next week, but the CBO's preliminary reports are usually basically correct, give or take a few billions of dollars), federal revenues actually declined even in nominal terms in August 2006 compared to August 2005.

To be sure, there were two special factors that temporarily distorted the year over year growth rate downwards. First, a correction of a previous accounting error regarding last year's revenues and secondly, the fact that August 2006 had one fewer Monday (the biggest withholding day) compared to August 2005. However, even adjusted for these special factors, revenue growth were much slower than in previous months.

At this point, it is premature to draw any final. definite conclusions about how to interpret this dramatic reduction in revenue growth. It could very well prove to be just a temporary anomaly. But it could also prove to be the end of the trend of surging tax revenues.

If so, it would be ominous for the fiscal health of the U.S. federal government. That is because spending growth have not slowed, and if revenue growth then slows significantly or even stagnates or declines, the federal deficit would once again surge, which would create big problems.


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