Sunday, November 21, 2010

Government Spending as Percent of Full-Employment GDP

One of the categories in measuring the economy is government spending. We add spending by households along with investment spending by business and subtract our trade deficit to get GDP. Since GDP rises and falls in response to changes in the business cycle, this graph shows government spending as a percent of potential GDP which assumes full-employment and negates the effect of business cycles on GDP.

We only count government spending on the delivery of government services as part of GDP. The red line shows that discretionary government spending as a % of potential GDP has declined since the sixties. The green line shows mandatory government spending on transfer payments. This includes entitlements such as Medicare, Medicaid, Social Security, Veterans Health Care etc. This line shows that most of the growth in government spending has been mandatory spending and that discretionary spending, which is controlled by Congress, has been shrinking as a percent of GDP. The blue line shows what current government expenditures would look like as a percent of GDP over time. Current government expenditures as a percent of GDP are slightly elevated by transfer payments and about the same as they were in the 80's under the conservative icon Ronald Reagan. Our current budget deficits are primarily due to rising transfer payments, lower tax revenues from the Bush tax cuts and from the recession. They are not the result of large increases in discretionary spending.

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