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There
has been much speculation and many theories about what led to the
Before
beginning the analysis, an understanding of the Gross Domestic Product (GDP) is
required. There are references on
the website to begin to explain GDP. The
importance of understanding GDP is because, based on conversations with people,
there often appears to be a misunderstanding that GDP is somehow correlated to
“value.” The Income
Approach to GDP has several components, the largest of which is Salaries and
Wages or also referenced as Compensation of Employees. The component is the actual wages and
salaries paid. Because GDP is not
based on “value,” it is possible to increase the GDP by simply
paying someone to do nothing. In
addition, worker productivity will be increased if a person is paid the entire
compensation in one hour versus two hours, regardless of the eventual market
value of the work performed. Therefore,
when you see a GDP line, remember, it is not intended to be an indication of
“value” being generated in the economy.
The
next step before looking at any of the following analysis is to read the
original CBO Budget and Economic Outlook:
Fiscal Years 2002-2011. The
document is 190 pages and supports the summary figure of a $5.6 trillion budget
surplus projection by 2011. Only a
light reading will reveal the extensive qualifiers and concerns surrounding the
$5.6 trillion budget surplus projection.
For example, the CBO includes a section
only on the uncertainties in the projection. I suggest reading the original document,
as I did, and then proceed to my
review notes for each section.
The uncertainties stated by the CBO were used by me to select the areas
to evaluate. I do not attempt to
evaluate all of the points made by the CBO in the Budget and Economic Outlook
issued in January 2001.
After
you have obtained the necessary background directly from the CBO report, you
will be ready to proceed to the analytical review section. When you read the analysis you will see
most of the presentation is text and graphs, with graphs being identified as
Figures. Not included at this time
are the Regression Analysis results
that calculate the correlations between a dependent and independent
variable.
The
analytical review also includes the use of Trend
lines. An example demonstrating the use of trend lines versus other options
is presented with the first graph using a trend line.
The
analytical review begins with a figure on the annual budget results. The analysis then proceeds to the
activity in the major components, outlays (government spending) and revenues
(tax revenues), in the budget.
Often times the GDP trend line is included to evaluate the activity
relative to the GDP. After the
major components of the budget are identified, the details supporting the major
components are evaluated. For
outlays, the sub-categories are Discretionary and Non-Discretionary spending. For revenues, there are many sources
including individual, corporate, estate and social security taxes. Because revenue is more difficult to
evaluate than outlays, an analysis is performed to begin to understand the
anomalies in the revenue trend lines.
The analysis includes the potential for Capital Gains taxes, the sources
for any salaries and wage gains and the changes on Adjusted Gross Income (AGI)
for taxpayers. The analysis also
includes the sources of funds for the increases in AGI experienced leading up
to 2000. The revenue analysis then
looks at corporate book profits and corporate income taxes. Each major section of the analysis
concludes with how the results of the economic activity in 2000 then led to a
“budget projection”, as opposed to a “budget
prediction,” of $5.6 trillion surplus by the year 2011. A “prediction” would require
a probability of occurrence in excess of 50%.
As
a final note, the CBO was perfectly clear in the Budget and Economic Outlook
document, highlighting there were considerable uncertainties
surrounding the results. Therefore,
I believe the CBO acted responsibly in their presentation. Under no circumstances is any of the
following presentation to be considered an evaluation of the CBO’s budgeting techniques. The CBO states the document is a baseline budgeting tools and is not a
prediction of future results.
Based
on the definition of baseline budgeting, the final budget is the projection of
current year results into the future based on a series of assumptions. When you look at the analysis remember
the basis of the 10 year projection of a $5.6 trillion surplus by 2011 is based
on the results of the year 2000. To
understand the CBO’s constraints and qualifiers
surrounding a $5.6 trillion dollar budget projection requires a reader to get
beyond the second sentence of the
introductory Summary section of a 190 page document.
To
attempt to understand the budget and economic activity of the 1990s and 2000s a
series of graphs and comments will be presented.
The
following graph is the actual surplus/(deficit) from
1962 to 2006.
Figure
1
Looking
at Figure 1, the deficit worsened in 1975 and declined through 1992. Starting in 1993 the deficit lessened
resulting in near budget balance in 1997 and surplus in 1998 through 2001. The maximum budget surplus was $236
billion in 2000. The budget deficit
returned in 2002 and bottomed in 2004 at ($412) billion.
Because
the budgeting process includes On-budget as well as Off-budget items, Figure 2
is Debt Held by the Public (DHBP) compared to the accumulation of annual
surpluses and deficits. DHBP does
not include any debt or surplus associated with the Social Security Trust Fund.
Figure
2
The
DHBP in Figure 2 is a close accumulation of the annual budget surpluses or
deficits reflected in Figure 1.
Some separation began in 1998 and expanded until 2001.
Because the annual budget deficit or surplus is the net of
revenues less outlays, Figure 3 shows the actual revenues versus outlays.
Figure
3
Looking
at Figure 3 reveals the surpluses of the late 1990s were a combination of
revenue increases and a reduction in outlays.
To
add additional insight, the Nominal Gross Domestic Product (GDP-N) trend line
is inserted in Figure 4.
Figure
4
As
stated in the introduction, the GDP-N Trend line can only be used to evaluate
the direction of movement in the line and the amount of movement relative to
only the trend line. The actual
data for Figure 4 above is presented in Figure 5.
Figure
5
Figure
5 demonstrates the significant difference between GDP-N and outlays and
revenues. However, Figure 5 does
not demonstrate that Outlays and Revenues have historically been in the 16% to
20% range of GDP-N. The next figure
is another example on how trend data can be graphed. You will see in Figure 6 how the
logarithmic presentation (the y-axis increases geometrically [each horizontal
scale is 10 times the previous line] as opposed to linearly) of the data
presented in Figure 5 shows the correlation between GDPN, outlays and
revenues. With Figure 6 you will
see the correlation between GDP-N and revenues and outlays that is not obvious
in Figure 5. (The background colors
are different because this is the only logarithmic graph in the analysis.)
Figure
6
The
logarithmic graph in Figure 6 demonstrates the correlation between GDP-N,
outlays and revenues. For the
remainder of the analysis, trend lines are used versus a logarithmic
presentation. Figure 4, Figure 5
and Figure 6 should clarify how trend lines should be viewed throughout the
remaining analysis.
Returning
to the analysis, the next graph focuses on the GDP-N trend, revenues and
outlays for 1992 through 2001.
Figure
7
The
conclusion of Figure 7 is the budget surpluses experienced in the late 1990s
and early 2000s were a combination of increased revenues as a percentage of
GDP-N and reduced outlays as a percentage of GDP-N. To understand the
budget surpluses of the 1990s and early 2000s, an understanding of how the
revenues increased as a percentage of GDP and how outlays as a percentage of
GDP were reduced. Because
the explanation of outlays is easier to understand, i.e. what outlays were cut
in relation to the historical GDP, changes in outlays will be presented first.
The
outlays budget is comprised of Discretionary and Non-Discretionary
expenditures. For details on the components in each category there is
extensive information available at the CBO including comments in the 2001
report included in another location in this website.
Figure
8
The observation from Figure 8 is Discretionary spending was
nearly flat during the 1990s and the rate of Discretionary spending increased
starting in 2002. The next graph will include the GDP-N
trend line.
Figure
9
The
conclusion from Figure 9 is the increases in Mandatory spending were being
offset by decreases in Discretionary spending. Another observation is there was a
dramatic leveling in Discretionary spending starting about 1993. The next step is to analyze the
components of Discretionary spending.
For budgeting purposes Discretionary spending is divided
into Defense, International and Domestic.
The following figure discloses the components of Discretionary spending
to determine the effect each component had on the reduction of Discretionary
spending.
Figure
10
Based
on Figure 10, Defense spending, as a percentage of GDP-N, was reduced beginning
in 1993 and continued until 2001.
Therefore, the primary source for the reduction of Discretionary
spending from 1993 to 2001 was Defense.
During some years in the late 1990s there were declines in actual
defense spending, without taking into account inflation or growth in the
GDP-N. Figure 11 focuses on
the years 1991 to 2003.
Figure
11
Based
on Figure 9, Figure 10 and Figure 11, from 1993 through 2001 there was a
reduction in Discretionary spending as a percentage of GDP-N. Within the Discretionary spending
classification, the figure reveals Defense spending was the largest source for
spending reductions.
With
reference to the CBO report issued in January 2001, the CBO states that expenditures are projected based on
current rates, current legislation and legislative restrictions. Based on the CBO projection process as
detailed in the report, the CBO projected the Discretionary spending rates for
the next 10 years. The following
schedule compares the Projection rates versus Actual rates.
As a percentage of GDP
CBO Budget Projection versus Actual
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Discretionary Spending |
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As a Percentage of GDP |
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2000 |
6.3 |
6.3 |
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2001 |
6.3 |
6.5 |
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2002 |
6.3 |
7.1 |
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2003 |
6.2 |
7.6 |
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2004 |
6.0 |
7.7 |
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2005 |
5.9 |
7.9 |
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2006 |
5.8 |
7.8 |
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2007 |
5.6 |
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2008 |
5.5 |
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2009 |
5.4 |
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2010 |
5.2 |
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2011 |
5.1 |
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Based
on the results of declining Discretionary spending in the 1990s, the CBO
forecasted the declines to continue as detailed in the percentages cited
above. As stated in the 2001
report, the CBO is required to base projections on current year activity. Therefore, a component of the CBO’s $5.6 trillion budget surplus projection was the
forecast of future Discretionary spending reductions based on the 40 year
historically low Discretionary spending as a percentage of GDP incurred in 2000
and the downward trends of the 1990s as displayed in Figure 11.
Non-Discretionary
spending, because of the lack of volatility (see Figure 9), will be evaluated when
time and demand exist.
As
stated in the January 2001 CBO report, the CBO stated outlays are easier to
forecast than revenues. Also stated
in the CBO report, revenue fluctuation
normally correlates to the GDP and legislation. The CBO further stated the increased tax
revenues of 2000 were not projected
and not entirely understood.
Therefore, with the benefit of available historical data and the
comments of the CBO describing the difficulty in understanding the source of
revenues, the following provides correlation detail on sources of revenues.
Figure
12 shows the revenue and GDP-N trend lines for 1962 to 2006. The graph includes Social Security
receipts as tax revenue.
Figure
12
For
reference purposes only, the Social Security surplus as a percentage of net
revenues peaked in 2003.
Figure
13
Returning
to the analysis, Figure 14 adjusts the revenue amount to include only the
Social Security surplus as tax revenue.
From 1962 to 1995 there is a high correlation between revenues and the
GDP-N trend line.
Figure
14
As
can be observed from Figure 14, the tax revenues including the Social Security
surplus are equal to the GDP trend line in 1997. Before 2000, the widest negative margin
between the GDP-N and revenue line occurred in 1993 and revenues to GDP
increased until 2000. In 2000 there
was the widest positive margin between the GDP-N trend line and revenues. The revenue line declines beginning in
2001 until it is at the widest negative margin in 2003. As can be seen in Figure 14, an
explanation as to what happened from 1995 to 2000 is required to understand the
unprecedented high revenue as a percentage of GDP in 2000. In addition, an understanding as to what
happened from 2001 to 2005 is required to understand how revenues as a
percentage of GDP fell precipitously until 2003 and then recovered to near
historical norms in 2006. In
addition, a close observation of the GDP trend line for 1995 to 2005 reveals
the biggest decline occurred in 2001.
Figure
15
Referencing
the CBO’s 2001 report, the CBO stated revenue fluctuations can normally be tied to
economic or tax legislation; however, the CBO stated in the same report the
economic phenomena occurring
in 2000 was not completely understood.
The CBO also stated in the report there are at least two factors at work
to explain the increase in revenue.
One factor was Capital Gains tax realization. Because Capital Gains taxes are not contingent upon
GDP, fluctuations in Capital Gains taxes can occur without any correlation
to GDP. The second factor cited in
the CBO report was an increasing percentage of a more highly taxed component in GDP (wages
and salaries). Specifically,
according to the CBO, wages and salaries are the most highly taxed component of
GDP and, therefore, when wages and salaries are a larger component of GDP, more
tax revenue as a percentage of GDP will be generated.
The
analysis for tax revenues will begin with the potential of Capital Gains tax
revenue.
There are many sources for Capital Gains tax revenues;
however, as referenced in the CBO 2001 report, there was considerable activity in the stock market
during the Dot-Com boom from 1995-2000.
(The stock market being one of the sources for Capital Gains tax
revenues.) Figure 16 shows the
maximum NASDAQ closing price from January 1985 to January 2006. The index started the most dramatic
increase in 1995, peaked in March 2000 and declined until it reached a bottom
in late 2002. Capital Gains tax
recognition occurs during a rising stock market and, to a lesser degree, in a
falling Stock Market.
Is there also a
correlation between the stock market activities and wages and salaries? That question will be analyzed
later. Figure 16 is the Maximum
NASDAQ Index Close.
Figure
16
Price fluctuation is only one factor associated with Capital
Gains tax recognition. Another
factor is volume. Figure 17
reflects the NASDAQ volume.
Figure
17
Figure
17 indicates the volume began to increase in 1995 and peaked in 2000. Volume has remained essentially at 2000
levels through 2006. The increase
in NASDAQ volume corresponds to the increase in the NASDAQ index as observed in
Figure 16.
As
stated earlier, price fluctuations and volume are the two primary stock market
factors in calculating the potential for Capital Gains taxes. Figure 18 displays a NASDAQ factor which
is the result of multiplying the NASDAQ Index times the volume. The potential for Capital Gains taxes,
based on the previously described factor, appears in the following graph.
Figure
18
Figure
18 shows the peak potential for Capital Gains taxes based on price and volume
occurred in 2000. As stated in the
CBO report, Capital Gains taxes appear in Individual, Corporate and Estate
taxes. Therefore,
to evaluate the possible correlation of the NASDAQ activity to the fluctuations
in tax revenue, Figure 19 has the NASDAQ factor, the tax revenue categories
that contain Capital Gains taxes (Individual, Corporation, Estate), and the
GDP-N trend line. See Appendix II for examples of individual stocks.
Figure
19
Figure
19 indicates the tax revenue for those categories containing Capital Gains were
moving in the same direction as the NASDAQ factor from 1995 through 2004.
Therefore, Figure 19 indicates there is a correlation between the NASDAQ factor and the Individual,
Corporate and Estate taxes for 1995 to 2004. The correlation, as just stated, exists
during the revenue downturn. Figure
19 also indicates there is a close correlation between tax revenues and GDP for
the time period between 1985 and 1995.
After 1995, the tax revenues appear to be a function of both GDP and the
NASDAQ factor.
Why
does the tax revenue line fall below the GDP trend line in 2003 and continue to
follow the NASDAQ decline? One
reason could be the correlation between business spending and wage activity was
based on the sentiment caused by the stock market. There are certainly other factors at
work but another factor is the obvious tax consideration of Capital Losses
being limited to $3,000 per year with the additional losses being carried
forward to future years. To some
degree, the effect of having the extensive Capital Losses associated with the
dramatic stock market decline beginning in March of 2000 had some effect on
future years Capital Gains tax revenue because the losses incurred during the
decline of 2000 and 2001 were offsetting Capital Gains taxes in subsequent
years..
The
next step is to analyze wages and salaries.
Another
factor cited in the CBO 2001 report was the higher
marginal rates of salaries and wages component in GDP. The largest single component in GDP is
salaries and wages. Therefore, an
increase in salaries and wages increases GDP and further increases the highest
taxable factor in the GDP. In
conclusion, the higher the percentage of salaries and wages in the GDP, the
higher the tax revenue will be, relative to GDP. The CBO in 2001 cites the higher wages and
salaries was the biggest reason for the surge in tax revenues. The following figure shows the
percentage of salaries and wages to GDP.
Figure
20
(In a global economy with workers
around the world willing to work at a small fraction of the cost of American
workers, is it reasonable to believe an American economy, which competes by
attracting massive capital investment, can sustain itself where wages and
salaries as a percentage of GDP are increasing? The 1990 to 2005 peak occurred in
2000. Also, people should beware of
any political references to 1970 when salaries and wages as a percentage of GDP
are discussed.)
Figure
20 shows a steady decline in the wages and salaries percentage of GDP from 1970
until 1994, and then in 1995 the percentage increased and peaked in 2000. The year 2000 was also the year when the
NASDAQ factor peaked. Are the two
simultaneous peaks of the NASDAQ and wages and salaries as a percentage of GDP
a coincidence? The wages and
salaries percentage then declined from 2000 until 2005. Is there a correlation between the wages
and salaries percentage to GDP and tax revenues from 1996 to 2003? Figure 21 addresses the correlation.
Figure
21
Based
on the increases in both tax revenues and the percentage of wages and salaries
to GDP-N from 1996 to 2000, Figure 21 indicates there is a correlation between
wages and salaries as a percentage of GDP-N and tax revenues for
1996-2000. This reverses a trend
that had been occurring since the 1970s where GDP-N was increasing as wages and
salaries as a percentage of GDP-N was falling (refer to Figure 12 for the GDP-N trend
line). At this point it is critical
to understand the components of GDP-N.
With wages and salaries being a component of GDP-N, an increase in wages
and salaries will increase GDP-N, regardless of the overall value or benefit to
the future economy. This is
especially true if the wages and salaries are capitalized as an asset to be
depreciated or written-off in a future year.
Figure
19 indicated there is a correlation between the NASDAQ Factor and the tax
revenue based on the generation of Capital Gains taxes.
Figure 20 and Figure 21 indicates there is a correlation between the wages and salaries as a percentage of GDP and tax revenues from 1995 to 2000, as a result of higher tax rates on wages and salaries. Therefore, Figure 21 supports the CBO’s assumption that a higher percentage of wages and salaries in GDP will generate higher tax revenues. (See Appendix IV - National Average Wage Index from Social Security Administration .)