Economic Monitor – Weekly Commentary
by Eugenio Alemán

It would be relatively easy to fix our fiscal mess: In search of political leadership

October 25, 2024

Talking and exchanging communication with advisors and clients over the last several years has shown that many of them are concerned about the fiscal path of this country and the consequences it is having on our debt. Most of these advisors and clients are concerned that not acting is bad for their investments and they are probably correct. At some point, the tables will turn and when they do, it will be game over. We have written a whitepaper about the U.S. debt, a white paper that we recently updated and republished.

As we argued in that paper, the decision to get our house in order is fundamentally a political decision. Furthermore, the effort to stabilize the growth in the debt should not be that difficult if anybody involved is willing to sit down and look at the problem and its potential solution.

The fact that interest rate payments on the U.S. debt have increased so much since the burst in inflation after the pandemic recession should have put more pressure on the political system, i.e., the Republicans and the Democrats, to grab the bull by the horns. However, have you heard any political party or any one of the politicians at the top of the ticket talking about how to solve the issue? We have not. We sometimes hear some talk in the U.S. Congress, but it sounds more like lip singing than serious talk. The only thing that we hear is how much they are either going to reduce taxes or eliminate taxes for some sectors, on one side and, on the other, increase spending for a plethora of new programs.

We understand that politicians are, in some sense, similar to salespeople: they just have to package whatever they are selling in order for consumers (voters) to vote for them. We also understand that increasing taxes and/or reducing spending or even slowing down spending growth, is not in their best interest of ‘buying votes.’

But the effort we would have to make to stabilize the growth of the U.S. debt is not that ‘taxing’ in terms of either higher taxes or lower spending, and or a combination of both. Furthermore, the fact that we have a two-party system should ease the way to finding common ground to achieve the objective. We know that, in principle, Republicans don’t want to increase taxes. In fact, Republicans not only don’t want to increase taxes but what they want is to decrease taxes further, but nothing is said about expenditures. Meanwhile, the opposite is true for the Democrats, they want to increase taxes and increase expenditures.

The problem is that both Republicans and Democrats know that if they do the opposite of what they are looking for or try to agree on a negotiated middle they will probably lose voters because the economy is probably going to slow down. So, they don’t do anything and continue with the status quo.

But if we have leaders willing to negotiate in good faith, the negotiations should be very easy, and because it is a negotiation, both are going to have to give up on their demands, and the public, i.e., the voters, will probably blame both parties for a negotiated solution and thus they can move forward with their political lives.

Furthermore, although U.S. taxes as well as tax receipts have gone up and down over the decades, federal tax receipts as a percentage of GDP have remained relatively stable but with a hint of a downward trajectory as shown by the graph below.

At the same time, it is important to point out that these federal government tax receipts as a percentage of GDP include social security taxes, which have hovered around at about 6% of GDP. Thus, federal government tax receipts as a percentage of GDP have been about 10% to 12%.

Another approximately 10% of GDP represents local and state taxes for total tax receipts as a percentage of GDP of about 26% to 27%. On the other hand, federal government expenditures and gross investment as a percentage of GDP have been close to 6% of GDP, from a high of about 18% of GDP in the aftermath of the Second World War. Of course, taxes as a percentage of GDP are not enough to cover all government needs and thus we need to figure out the path forward, which will probably include some cuts or a slowing down of expenditures plus higher taxes.

Meanwhile, state government tax revenues are not enough to cover state government expenditures, and thus the federal government must transfer resources to the states. According to the Federal Budget in Pictures1, federal transfers to state and local government represented about $1.1 trillion in 2023, down from about $1.2 trillion the previous year.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those Raymond James and are subject to change without notice the information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies. Currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of ten seasonally adjusted components. It provides a indication of the health of small businesses in the U.S., which account of roughly 50% of the nation's private workforce.

The producer price index is a price index that measures the average changes in prices received by domestic producers for their output. Its importance is being undermined by the steady decline in manufactured goods as a share of spending.

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