The Budget Binge that Never Was?

Tuesday, March 29, 2011
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Taylor Jones

New York Times columnist Paul Krugman wrote a recent column titled “Hey, Small Spender” in which the titular small spender is—sans deliberate irony—the federal government. He argued that accelerated federal spending was called for to reduce unemployment and feed economic growth—familiar turf for Krugman, who over the past couple of years has argued that the federal government should spend more, and run still larger deficits, than at present. But then he made the remarkable assertion that no spending expansion had yet taken place.

“The whole story is a myth. There never was a big expansion of government spending,” he wrote. Later he said, “Where’s all that spending we keep hearing about? It never happened.” Krugman repeated this “never happened” verdict twice more in the column. For good measure, he also wrote of a “widespread perception that government spending has surged, when it hasn’t.” This alleged misperception, he said, arose in part from a “disinformation campaign from the right, based on the usual combination of fact-free assertions and cooked numbers.”

spending balls

Before delving into the particulars of Krugman’s policy arguments, let’s eliminate the risk of fact-free assertions and examine the data pertinent to government spending levels. If there is a disinformation campaign, the conspiracy has grown quite wide, spreading to both the Congressional Budget Office and President Obama’s own Office of Management and Budget (OMB). It was the OMB that last year reported the history of federal spending levels shown in Figure 1.

As the chart shows, federal spending reached historic levels in 2009—to be surpassed again in 2010—a peak in relation to the overall economy not seen since World War II. In 2009, federal spending soared to 24.7 percent of GDP, a figure not even closely approached since 1946.

The New York Times columnist attacks reports of a spending boom as a “disinformation campaign from the right, based on the usual combination of fact-free assertions and cooked numbers.”

Moreover, as the chart shows equally clearly, these levels of spending were not solely the result of a gradual, inevitable evolution in the size of government, but instead represented a sudden surge in response to the recession. From 2008 to 2009, federal spending increased by 4 percent of GDP in a single year. The spending increase that Krugman says never happened was in fact the biggest single-year spending increase since 1952.

Lest anyone believe that the rise in government spending as a percentage of GDP was largely a function of a decline in GDP itself, it should be noted that the absolute size of the spending increase over 2008–9 was also of historic magnitude—exceeded since 1952 only by 1975 (a year in which rapid nominal spending growth was partially fueled by high price inflation).

This recent spending surge is the largest reason why the federal deficit has arisen from 3.2 percent of GDP in 2008 to roughly 10 percent in 2009 and 2010. Once again, it bears recollection that these are the highest levels for federal deficits since (sound familiar?) World War II.

Of what did this sudden spending increase consist? The OMB again supplies the data. Altogether, federal spending rose by roughly $535 billion from 2008 to 2009. But at the same time, annual federal interest costs on government bonds dropped by roughly $66 billion. Overall, then, the government engaged in more than $600 billion in additional non-interest spending in 2009 relative to 2008.

Figure 1.

figure 1 graph

To understand where all the new spending occurred, it may be helpful to rely upon the government’s methods for classifying spending. The federal budget is classified each year into different categories by function and subfunction. Figure 2 shows which functions had the biggest shares of the $600 billion increase.

By far the biggest single expenditure increase in 2009 (44 percent of the total) was in the budget function dubbed Commerce and Housing Credit, where outlays for the TARP financial stabilization program were categorized. Incredibly, the government projected to spend even more in 2010 than in 2009, despite the fact that TARP’s transactions turned around completely during the past year. The OMB actually projected a positive swing of more than $300 billion in TARP spending from 2009–10: from a $292 billion net outlay in 2009 to a $25 billion net savings in 2010. This fiscal improvement of more than $300 billion would be swamped, and then some, by still more spending increases currently in process.

Behind TARP, the spending category most responsible for the 2008–9 increase was Income Security (which includes unemployment compensation and other forms of relief), followed by Social Security, whose expenditures were swelled by a large 2009 cost-of-living adjustment as well as a recession-induced uptick in disability and early retirement benefit claims.

Figure 2.

figure 2 pie chart

Krugman acknowledged these spending increases: “To be fair,” he writes, “spending on safety-net programs, mainly unemployment insurance and Medicaid, has risen—because, in case you haven’t noticed, there has been a surge in the number of Americans without jobs and badly in need of help. And there were also substantial outlays to rescue troubled financial institutions, although it appears that the government will get most of its money back.” Despite this acknowledgment, however, much of his column was still devoted to arguing that this historic expansion of federal spending never occurred.

Some of the government’s deficit spending in 2009–10 occurred somewhat automatically because of cyclical effects, while some of it was a consequence of deliberate interventions. The recession itself depressed federal revenue collections and increased federal benefit claims, each of which adds to federal deficits. The depression of federal revenues will fix itself once the economy recovers. By 2013, under OMB projections, federal revenues will actually be higher than the historic average as a percentage of GDP.

Even without further legislation, therefore, government fiscal practices would have been countercyclical. Legislation such as TARP and the “Recovery Act” has only added further to the base of government-provided fiscal stimulus that would otherwise have occurred.

It is important to distinguish between the wisdom and the fact of these countercyclical relief and financial stabilization expenditures. Even if we agree that they were appropriate, this doesn’t mean that they never happened. All reasonable participants in the national discussion should acknowledge that the federal spending increase is the largest in recent history.

The spending increase that Krugman says never happened? It was in fact the biggest single-year spending increase since 1952.

Krugman staked his claim to the nonexistence of the spending binge primarily on redefining what constitutes relevant federal spending. “When people denounce big government,” he wrote, “they usually have in mind the creation of big bureaucracies and major new programs. And that just hasn’t taken place.” He then went on to cite the decline in the federal workforce as evidence for his general claim.

That is, to put it charitably, an innovative argument, considering the demonstrated and widely evident public unease with the current overcommitment of federal resources. It seems absurd to suggest that the tea party movement would never have materialized if only these ignorant demonstrators had appreciated that TARP and the auto bailout were being administered by existing government departments. Those who rightly worry about untenable federal spending commitments are not basing their concern on the number of federal employees required to administer them, but on the fiscal commitments themselves. A willingness to spend money within the existing federal bureaucracy does not a “small spender” make.

Let’s keep these facts in mind during the debate over the best direction for federal policy. Some advocates, like Krugman, call for additional stimulus spending. Fine; that’s a point to be debated. But we need to remember that the government is already engaging in historically unprecedented fiscal stimulus, to the tune of deficits equal to 10 percent of GDP, most of this fueled by increased spending.

No one can say with certainty when exactly this level of deficit spending begins to produce diminishing or negative returns, that is, when the cumulative effect of fiscal overextension begins to undermine even near-term stimulative effect. It is reasonable to debate whether, given the current state of the economy and the grim long-term budget picture, the government should be running deficits equal to 6 percent, 8 percent, 10 percent, or 12 percent of GDP. We cannot even have that discussion if we are unwilling to acknowledge the facts.