With President Obama’s deficit-reduction plan now on the table, the political left, right and center are ready to rumble over how to assure long-term fiscal stability. The big questions are where to slash and by how much, but over the next year or two, the most important question for the economy might well be how quickly the cutting should begin. Households have become unusually dependent on the government for income support and removing that prop too fast could put the recovery at risk.
For the first time since the Great Depression, households are receiving more income from the government than they are paying the government in taxes. The combination of more cash from various programs, called transfer payments, and lower taxes has been a double-barreled boost to consumers’ buying power, while also blowing a hole in the deficit. The 1930s offer a cautionary tale: The only other time government income support exceeded taxes paid was from 1931 to 1936. That trend reversed in 1936, after a recovery was underway, and the economy fell back into a second leg of recession during 1937 and 1938.
As then, the pattern now reflects two factors: the severe depth of the 2007-09 recession and the massive fiscal policy response to it. The recession cut deeply into tax payments as more people lost their jobs, and it boosted payments for so-called automatic stabilizers, such as unemployment insurance, that ramp up payments as the economy turns down. Plus, policy actions, including the Recovery Act, boosted payments to households by expanding and extending jobless benefits and creating other income subsidies while extending the Bush-era tax cuts and adding new reductions in income and payroll taxes.
Government transfers of income to households started to overtake personal taxes at the start of 2008, and the gap has been widening. In February, households received more than $2.3 trillion in income support from unemployment benefits, Social Security, disability insurance, Medicare, Medicaid, veterans’ benefits, education assistance and other cash transfers of government funds to individuals. In the same month, households paid $2.2 trillion in income, payroll, and other taxes. The difference was about $150 billion, equivalent to more than 1 percentage point of overall personal income and about four times the amount Republicans and Democrats agreed to cut from government spending through Sept. 30.