Tuesday, February 13, 2007


Compliments of our friend, Michael Darda, chief economist at MKM Partners

Treasury data for January released yesterday afternoon showed that tax receipts continue to roll in at a rapid rate, which has reduced the fiscal deficit to $191.9 billion or 1.4% of GDP, well below the 2.3% average since 1970. At the current pace, the budget could move back into balance as early as May 2008.

Key points:

During the last twelve months, tax receipts have grown by 11.5% while spending growth is up 5.5%. If the six percentage point gap between the two were to continue, the budget would move into surplus by June 2008;

Total tax receipts now are 18% ($375 billion) above their previous all-time peak, which was reached in April 2001. Since tax rates on capital (and labor) dropped retroactively in the spring of 2003, total tax receipts are up $686 billion;

Household net worth has risen by $13.2 trillion since the tax cuts were fully implemented. Even excluding the value of homes (but including the mortgage debt), household net worth has risen by $6.9 trillion to a record $33.5 trillion. With non-managerial wages averaging twice the rate of growth in real terms during this cycle compared to the first five years of the last expansion, it is hard to argue that only the very wealthy have benefited;

The fiscal balance as a fraction of GDP has born a strong, positive relationship with real yields in the Treasury market, the exact opposite of what neo-Keynesian demand theory (sometimes referred to as “Rubinonomics”) would hold. To wit: the 10-year TIPS yield, at 2.45%, is nearly 60 bps higher than it was when the fiscal deficit stood at 3.9% of GDP in April 2004. In other words, whatever the impact of deficits on interest rates (real or nominal), the effect is usually totally swamped by other factors such as global liquidity flows, the current and expected level of short rates, and economic growth expectations.

The NIPA data now shows that, on a quarterly annualized basis, tax receipts have risen to 18.9% of GDP, above the 18.6% average since 1970. In other words, with total receipts growing faster than GDP, the ratio of tax receipts to the overall economy is rising and likely will rise further given the interaction of a tight labor market with progressive tax rates.

Conclusion: Treasury data continues to show extraordinarily strong tax receipt growth while spending seems to be moderating somewhat. This has allowed the deficit to plunge to 1.4% of GDP, well below historical averages around 2.3%. We continue to believe the interaction of massive liquidity with a lower marginal tax wedge on capital and a super-tight labor market will continue to drive overall revenues higher (both in absolute terms as a fraction of GDP). With a little gridlock along the way, the budget could move back into balance by May 2008 with surpluses emerging during the second half of next year.