The Budget's Missing $240 Billion

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By all accounts, Republicans—including President Bush—are going to start talking up the economy big time as a way of improving their chances of holding on to one or both houses of Congress. And there's a lot of meat to their argument, what with the Dow Jones industrial average climbing to new highs and unemployment at the lowest levels of the Bush presidency. But if there is one area that even die-hard Republicans kvetch about, it's spending. As budget expert Brian Riedl of the conservative Heritage Foundation points out, federal spending has jumped 45 percent since 2001, with defense and homeland security accounting for less than one third of the increase. Education has increased 137 percent, international spending 111 percent, and health research and regulation 78 percent.

Look at the most recent numbers. Michael Darda, chief economist at MKM Partners, notes in a report today that government spending rose 7.4 percent during the fiscal year ending in September, a pace well above the average of the past two decades. Yet since tax receipts surged 11.8 percent, also above historic norms, the deficit shrank to $248 billion from $318 billion in 2005. (All these numbers count Social Security surpluses.) Put another way, the ratio of the deficit to gross domestic product is now at a skimpy 1.9 percent, below the three-decade average of 2.4 percent.

But things could be so much better. Darda did the math, and he found that if spending growth had been held to the average rate of nominal GDP growth—around 7 percent during the past year—since the recovery began, the United States would have had a small surplus of $900 million as of September. If spending had compounded at a more conservative pace of 3.4 percent—the average under President Clinton and the GOP Congress from 1994 through 2000—the federal government would have a current fiscal surplus of $240 billion, even though tax rates on income and capital have fallen during the Bush years. Indeed, tax revenues as a percentage of GDP are a bit above the average level of the past 50 years, 18.3 percent vs. 18.1 percent, despite the cuts. As Darda concludes, "A guns-plus-butter approach to U.S. fiscal management has created red ink that would not otherwise be there even though tax rates have dropped."