Happy Valentine’s Day! It was a busy week for the markets as the January inflation reports were released for both consumers and producers (businesses). They both showed that prices increased slightly more than expected last month. For consumers, prices rose 0.5% in January versus an expected 0.3% rise, and the annual inflation rate was 3.0% versus an expected 2.9%.
While the Fed continues to target 2.0%, the inflation rate remains stubbornly stuck around 3.0%. We still believe achieving 2.0% inflation is almost impossible without triggering a recession, and, therefore, the Fed is likely to eventually move the goalposts to a higher target, possibly 2.5% – 3.0%.
Markets initially reacted negatively to the inflation news until analysts dug into the numbers and determined the news wasn’t really as bad as previously thought. As of Friday morning, stocks looked to finish positive on the week as investors chose to focus on healthy economic growth forecasts for the 1st quarter from both the Atlanta Fed (2.9%) and the New York Fed (3.1%).
https://www.atlantafed.org/cqer/research/gdpnow.aspx
https://www.newyorkfed.org/research/policy/nowcast#/nowcast
There’s been a lot of controversy around the actions of the Trump administration to make significant changes to the federal government to reduce government spending. It has been very divisive and I just want to highlight some key facts we can consider in when evaluating the news reports.
First of all, the US government has averaged a 3% annual budget deficit for a long time and that’s OK. On average, the government has spent 3% more than it collects each year because federal revenue (tax collections) has averaged 17.4% of GDP and spending has averaged 20.3% of GDP.
Source: Congressional Budget Office
This has been fine because our economy (GDP) has grown roughly 3% per year. It’s sort of like getting a 3% raise every year while your mortgage payment goes up 3% annually. It’s a long-term sustainable situation.
But as you can see from the chart, government spending spiked during Covid and that makes sense – the government should spend more during a crisis and spend less when times are good. But something happened as spending was returning towards the long-term average of 20% of GDP. It never made it back and now our 3% deficit target is closer to 6.3%. In 2024 the government took in $4.92 trillion, spent $6.75 trillion, and borrowed $1.83 trillion. Left unchecked, increased borrowing at these higher interest rates will accelerate the spreading of this gap going forward, putting our country in a dangerous debt spiral.
Tax hikes and tax cuts over the years have resulted in tax collections fluctuating between 15% and 20% of GDP over time, but averaging 17.4%. Increasing tax revenues can certainly be part of the solution to close the deficit gap, but higher taxes alone cannot get us back to 3%. Here are some 2024 tax revenue figures to consider.
In 2024 the federal government took in $4.92 trillion. We need about $1 trillion more to get to a 3% deficit at current spending levels.
- $2.43T individual income taxes
- $1.71T social insurance & retirement
- $0.53T corporate income taxes
- $0.18T excise taxes, customs duties, tariffs
- $0.03T estate and gift taxes
From this we can see that tariffs will never replace personal income taxes, but may be good for other purposes. Also, while drastically raising estate taxes may be done in the interest of fairness, they aren’t a major source of government income.
Now let’s look at 2024 spending according to the Center on Budget and Policy Priorities – https://www.cbpp.org/research/federal-budget/where-do-our-federal-tax-dollars-go
In 2024 the federal government spent $6.75 trillion. We need to cut about $1 trillion to get to a 3% deficit with current revenue levels.
- $1.7T healthcare, or 24% of the budget
- $1.5T Social Security, or 21% of the budget
- $0.89T interest on current national debt, or 13% of the budget
- $0.53T benefits for veterans & federal retirees, or 8% of the budget
- $0.48T economic security programs, or 7% of the budget
The items above represent $5.1T, or 76% of the budget, and this is considered to be the non-discretionary portion of the budget. Here’s the discretionary portion of the budget, which totals about $1.65T.
- $0.87T defense, or 13% of the budget
- $0.72T government agencies, or 11%
- $0.06T international aid & US embassies, or less than 1% of the budget
I wanted to summarize, as briefly as I could, the current federal budget situation so we can all operate from the same facts when considering taxing and spending priorities. I hope this helps.
Have a great weekend.
Jack C. Harmon II, CFP®, CIMA
Principal, Harmon Financial Advisors
Registered Principal, Raymond James Financial Services
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