The Entrepreneurial View #451                                                               

Government Revenues and the Economy

by Raymond J. Keating

(The following column builds on remarks made at the September 17-19 policy conference co-hosted by the Small Business & Entrepreneurship Council and Women Impacting Public Policy.)

It's unclear which direction the U.S. economy is heading.  Optimists, pessimists and those on the fence have plenty of data to support their positions.

For example, under the negatives column, energy costs, housing and sub-prime lending problems, consumers being less confident, and some recent disappointing reports on retail sales and manufacturing production could be listed.

In contrast, the positives column includes household net worth still on the rise, increasing investment in nonresidential, or commercial, structures, and solid export growth.

And then there is the mixed column.  Regarding real GDP growth, the second quarter of 2007 was pretty good, but growth generally underperformed from late 2005 to early 2007.  Similarly, real gross private domestic investment was up in the second quarter, but that was after declining in the three previous quarters.  Finally, employment growth took a turn down in the latest month, but is up over the past year - in fact, up solidly over the past several years.

So, as we all struggle to figure out where things are headed, it always pays to keep in mind that when the economy does hit rough waters, it's usually because government has done something dumb on the policy front.  One item catching my attention has not been widely noted, but warrants close watching as we move forward.

Since World War II, each time total federal revenues as a share of GDP has exceeded 18.5 percent, the economy has suffered. It happened in 1952-54, in 1969-70, in 1979-82, and in 1996-2001. The only question is the lag time.  For example, the economy held up longest during the 1996-2000 period before a recession came. The pro-growth capital gains tax cut in 1997 no doubt helped considerably. In addition, each time individual income tax revenues have exceeded 8.5 percent, the economy has reacted negatively - again in 1969-70, the early 1980s, and 1998-2002. 

On August 23, the Congressional Budget Office released "The Budget and Economic Outlook: An Update."  CBO, unfortunately, offers the following estimates regarding federal revenues as a share of the economy.

Federal Revenues as a Share of GDP

                                                2007                2008                2009                2010

Total                                        18.8%              19.2%              18.9%              19.4%

Individual Income tax                 8.5%                9.0%                8.9%                8.9%

If these CBO estimates are in the ballpark, we are crossing into the danger zone regarding revenues as a share of GDP this year, and will remain there for the following three years.  And keep in mind that these figures do not reflect a huge looming tax increase in 2011 if the 2001 and 2003 tax relief packages are allowed to expire.

The economy clearly needs some substantive tax relief.  But that's not what Congress is talking about right now.  Instead, many are playing the wait-and-see game as the 2008 elections approach, and others are even talking about some tax hikes.  And with each passing day, that massive 2011 tax increase moves ever closer. 

It's time for our elected officials to wake up and realize that the federal government, once again, is sucking far too many resources away from the private sector, and that comes with a heavy price for the economy.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

This article may be reprinted with appropriate citation and credit.