Debt, Taxes and Politics
July 29, 2010
I continue to receive many email requests for links to my charts on federal debt, taxes, and politics. Here is the latest update, and I've added a permanent link to it the Favorites menu above.
My previous commentary on US Federal debt and personal tax rates highlighted the significant difference between nominal and real (inflation-adjusted) gross federal debt. I showed that the tax cuts in the early 1980s coincided with the beginning of an acceleration in real federal debt from a relatively consistent level over the previous three decades, evident in the first chart.
The second chart replaces real debt with the debt-to-GDP (Gross Domestic Product) ratio. Against the backdrop of US history, the contours of the first two-thirds of the chart are easy to understand. Debt-to-GDP soared with the US entry into World War I, as did the personal tax rates. After the war the ratio gradually dropped, this time against the backdrop of the "Roaring Twenties." The Crash of 1929 and Great Depression triggered a rise in the ratio to levels exceeding the peak in World War I. Logically enough, World War II brought about another rapid rise in Debt-to-GDP. War costs drove the ratio to a peak above 120% in 1946.
The ratio rapidly declined after WW II and bottomed out 28 years later in 1974, where it remained within a 3% range until 1982. Then, over a 14-year period the ratio more than doubled from 31.9% in 1981 to 67.1% in 1995. For the next six years the ratio improved, dropping to 56.5% in 2001. The ratio reversed again, this time in sync with several factors — the Tech Crash, 911, and wars in Afghanistan and Iraq. And then, of course, came a dramatic acceleration in the ratio triggered by the Financial Crisis and deepest market decline since the Great Depression.
Here's another view of the federal debt-to-GDP ratio, this time with major wars and the Great Depression highlighted:
Debt and Taxes
Does the Gross Federal Debt-to-GDP ratio chart change my view of the disconnect between tax brackets and gross federal debt? Not at all. There is a logic to the ratio increases within the historical context of two World Wars and the Great Depression. Likewise, the steadily decreasing ratio over the next 35 years enabled the tax cuts in 1964. In contrast, the Economic Recovery Tax Act of 1981 was followed by an 18-year secular bull market that began the following year and, paradoxically enough, by a reversal in the direction of the Debt-to-GDP ratio. Correlation does not imply causation. Federal tax revenues did decrease fractionally in 1982 and by a more significant 6% in 1983. But the recession from July 1981 to November 1982 (culminating in 10.8% unemployment) was a key factor in the revenue slippage. There were other epic factors that played roles in the reversal — among them the gradual transition from manufacturing to a service-based economy, the dawn of the Age of Information, and a gradual relaxation in both private and public concern about debt.
With the 2001 and 2003 tax cuts expiring this year, will the gross federal debt be a factor in determining the direction of future tax rates? Who knows? This is, after all, a congressional election year. Let's close with a snapshot of Debt-to-GDP and presidential politics:
Click for a larger image Source for U.S. federal debt data: Budget of the United States Government. Click on a fiscal year link, and then find the link near the bottom labeled Historical Tables. Table 7.1 presents the federal debt data since 1940 and includes six years of debt estimates. Treasury Direct is my source for the pre-1940 numbers.
Source for historic U.S. tax data: www.taxfoundation.org.
I've also drawn upon the excellent data resource at US Government Spending to crosscheck my work.
(c) Doug Short