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  • richoncat richoncat Dec 28, 2012 11:09 PM Flag

    Understanding How We Got to the Fiscal Cliff

    Great Article from Zacks Investment Management

    How did we get here?

    To begin to answer this question, we first need to discuss U.S. real GDP growth.

    GDP Growth

    Real GDP growth analysis takes out price inflation and focuses on actual concrete increases in income and wealth. In other words, it measures increases in concrete items like homes, food, and clothes. Real GDP allows us to compare GDP numbers over time. Any real economic growth we see comes with a real increase in income and wealth.

    Since 2000, U.S. real GDP has gone up 20% to 25%. Over the last 12.5 years, the real U.S. economy grew from $11 trillion to $13.5 trillion. This amounts to a 1.8% to 2.0% real growth rate each year. However, from 2000 to 2007, the U.S. economy delivered 21% of the 23% total growth. In other words, for the first seven years we saw 3% growth rates; then the U.S. economy failed to grow at all. Over the last five years, the U.S. garnered very little added real income or wealth.

    How can we judge this number? In short, this economy can achieve 2% growth and see prosperity remain.

    So why with this 2% U.S. GDP growth rate are we faced with the fiscal cliff? This brings us to the second part of the fiscal cliff equation, tax revenue.

    Taxes

    In the U.S., the 2% growth in GDP has been accompanied by a 3% growth in taxes.

    Real tax receipts in the U.S., before Social Security and other taxes were added, went up from $2.1 trillion in 2000 to $3.1 trillion in 2012. Income taxes have followed the U.S. economy up over the last 12.5 years. This amounted to a 20% to 25% tax burden rising to a 25% to 30% tax burden. In other words, we saw our tax burden go up at a 3% annual growth rate.

    In the first seven years of the past decade, real GDP grew at a 3% rate and taxes grew at 3%. The collapse of the housing and borrowing bubble altered this dynamic. From 2007 onwards, our GDP numbers went nowhere, yet our tax growth kept growing 3% annually.

    As you increase taxes, what are the effects? The left view is tax increases lead to better investment in education and health. The right view is higher taxes lead to lower spending, less room for business, and lower growth in jobs and incomes. 2000 to 2008 was the era of a right view. 2008 to the present 2013 was the era of a left view. And despite which party was in power, taxes grew faster than the economy.

    This brings us to the most crucial part of the fiscal cliff equation: spending.

    Spending

    We saw a major spending surge from 2000 to 2012 over three different U.S. governments. U.S. Federal government spending consistently increased year-after-year. In total, it amounted to an 8% growth in spending per year.

    Spending growth came from Social Security and Medicare/Medicaid increases, an aging population dynamic. A Baby Boom cohort that started with high birth rates around 1950 reached 60 years old in 2010. This is the basic U.S. spending problem going forward.

    From 2000 to 2010, the U.S Federal government racked up 9% to 10% annual spending growth rates. Flat spending growth rates hail from 2010 to 2012. You don’t need to be a rocket scientist to realize this rate of annual spending growth led to a huge Federal deficit.

    Putting It All Together

    Each year, for 12 years, we have recorded 2.0% GDP growth, 3.0% tax growth, and 8.0% spending growth. The result is huge deficits. The annual Federal deficit has gone from no deficit in 2000, up to a $1.4 trillion at the base of our recession, and now sits around $1 trillion. The U.S. has gotten as much as 10% of its annual GDP growth over the last 12 years by borrowing from the future.

    It is a positive development that we are addressing this massive deficit issue before the market forces a higher interest rate on the U.S., like the situation in Spain and Greece. We are addressing these problems before a crisis.

    To learn more about how I am allocating my private clients, please contact us at 800-245-2934.

    -Mitch Zacks

    Sentiment: Hold

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