CONTRIBUTORS
Andrew Bogle
Associate Portfolio Manager & Senior Research Analyst,
Brandywine Global
United States
Fiscal thrust. Fiscal drag. Fiscal impulse. Fiscal headwinds. A lot of nomenclature gets thrown around when discussing how government spending is impacting economic activity. Different measures and methodologies can sometimes lead to conflicting conclusions about how tax dollars are flowing through the broader macroeconomic landscape. US fiscal policy over the last three years undoubtedly had a massive impact on the economy’s response to the global pandemic, but we now find ourselves in a situation where the impact of future government spending is less clear. Furthermore, the government recently reported that the deficit surged to $1.7 trillion for the year ended September 30, 2023, a concerning number. We will walk through a few common ways of measuring fiscal policy as it relates to the economy and discuss some of the underlying details that are important for investors to consider.
The deficit
The US has been running a budget deficit for most of the twenty-first century (see Exhibit 1).
Exhibit 1: Annual US Budget Deficit
Percent of Gross Domestic Product (GDP), as of June 1, 2023.
Source: Macrobond (© 2023).
A simple way to consider how much government policy is flowing through to the economy is to consider the year-on-year change of the government deficit (see Exhibit 2).
Exhibit 2: Change to US Fiscal Deficit
Percent, Year-over-year Change, as of June 1, 2023.
Source: Macrobond (© 2023).
The current budget deficit as a percentage of gross domestic product (GDP) is roughly 4% higher than it was a year ago. Some will point to this chart as ‘fiscal thrust’ and infer that current fiscal policy should be positively contributing to economic growth. However, we think a deeper dive is warranted to really understand what is happening. It is important to remember that the deficit has two sides to the equation: spending and revenue (see Exhibit 3).
Exhibit 3: Annual US Budget Deficit: Outlays and Receipts
Percent of GDP, Seasonally Adjusted, as of June 1, 2023.
Source: Macrobond (© 2023).
When deconstructing the annual deficit into its two respective components, it is interesting to note that the larger contributor to the current change is actually a decrease in government tax receipts. We believe there are two primary drivers for this decline in revenue. First, after an abysmal 2022 calendar year for both stocks and bonds, capital gains taxes collected in 2023 declined sharply. Second, several states, including California, Alabama, and Georgia, were granted tax waivers due to natural disasters, delaying the deadline to file federal tax payments, according to the IRS website. The important takeaway here is that it is hard to imagine a decrease in government tax receipts as being supportive to US economic activity. On the spending side, government spending has ticked back into a positive year-on-year print, but again we think it is worth looking into the details (see Exhibit 4).
Exhibit 4: US Government Outlays by Category
Percent, Year-over-year Change, as of June 1, 2023.
Source: Macrobond (© 2023).
Breaking down the underlying components of government outlays shows that the recent uptick is driven almost entirely from increased interest expense due to the increased Federal Reserve policy rates. We consider this another example of data contributing to fiscal thrust that in reality is in no way stimulative to economic growth.
GDP
The growth in the US economy is generally attributed to four major components: consumption, investment, government spending, and net exports. We think an evaluation of how the contribution to GDP from these four categories changes on an annual basis tells an interesting story of the government’s response to the COVID-19 pandemic (see Exhibit 5).
Exhibit 5: Contributions to US Gross Domestic Product by Category
Percent, Year-over-year Change, Seasonally Adjusted, as of April 1, 2023.
Source: Macrobond (© 2023).
We can see from the chart that the government contribution to GDP grew rapidly for a few quarters during and post-COVID. However, in 2021 to 2022, this trend reversed as the government GDP contribution normalized. Meanwhile, the consumer component became a larger share of total GDP as consumers spent their excess savings accumulated during the pandemic, the result of fiscal stimulus and pent-up demand. With this particular fiscal support waning, year to date both of these categories have remained stable while gains in net exports have been offset by investment.
While this narrative generally aligns with our views on how the economy has evolved over the past few years, we think it may not accurately reflect the total role fiscal policy has played for two primary reasons. First, there is the issue of transfer payments. While the chart above reflects robust consumption in 2021, we believe this activity was primarily driven by the transfer of payments made to consumers from the government through various fiscal policies, which allowed those consumers to spend at elevated levels for an extended period of time. Second, multiplier effects may be underrepresented. Direct government spending is captured above, but the impact to the supporting economies and infrastructures may be captured elsewhere, resulting in a more muted picture of overall government impact.
Another area where fiscal policy impacts may not be fully reflected is private sector spending, where there is an expectation of future fiscal support.
Exhibit 6: US Private Sector Nonresidential Manufacturing
USD Billions, as of August 1, 2023.
Source: Macrobond (© 2023).
There has been an incredible spike in nominal nonresidential manufacturing spending from the private sector (see Exhibit 6). This increase mainly has been driven by investments in technology as large semiconductor companies begin construction on multibillion dollar fabrication plants in several states. These investments are being supported by the US government’s commitments to reshoring critical technology infrastructure. While these activities are not considered direct spending by the US government, they certainly represent observable economic development supported by fiscal policy.
Government acts
While some top-down approaches to monitoring and quantifying fiscal support may present some drawbacks, it is also worthwhile to look bottom-up at the actual legislation that has passed through Congress. We note three major legislations that are worth discussing when constructing a holistic fiscal policy framework: the Infrastructure Investment and Jobs Act (IIJA), Inflation Reduction Act (IRA), and CHIPS and Science Act (CHIPS Act). Each of these acts, individually, is projected to spend hundreds of billions of dollars over the next few years to support various political ambitions under the current administration.
The CHIPS Act, the smallest of the three, with roughly $250bn of projected spending (approximately 1% of nominal GDP*), is what we see as the main driver of the technology manufacturing chart above (see Exhibit 6).1 Future tax incentives offered by the government are encouraging corporations to act now. The IRA is maybe the most uncertain of the three acts, with projections of anywhere from $400bn to $1.2tn of spending (2-5% of nominal GDP*).2 This legislation is prompting the energy sector to start serious investments in more green-friendly technology. The IIJA, at $1.2tn of projected spending (5% nominal GDP*), is one of the largest legislative spending acts ever passed and will be used for a broad array of federal, state, and local infrastructure improvements.3 One common theme among the three programs: the anticipated spending will take years to fully play out. These programs all have 3 to 7-year investment horizons to deploy the trillions in total spending that has been allocated. In other words, while there is a significant amount of fiscal stimulus already working through the system, there is more that has been pledged but not spent, so the full future impact is unknown. While government websites provide specific sources and uses for these programs, which highlight limited to no additional funding needs through the Treasury market, we are somewhat skeptical that these programs can be wholly self-financed to the completion of their investment life cycles.
Conclusion
It is hard to find one-time series or data release that accurately reflects the state of fiscal policy and how it feeds into the broader economy. Despite the difficulties in gauging the potential magnitude and impact of fiscal policy, we think it is important to consider a wide range of variables, both macro and micro, to make an assessment about what is really happening at the federal spending level. The resumption of student loan repayments and spending caps imposed as part of the debt-ceiling agreement may dampen fiscal stimulus effects, but there remains a fair amount of outstanding policy, the impact of which has yet to be realized. Furthermore, while the situation at the present time is not as clear cut as it may seem, one thing in which we are confident: During a presidential election year, incumbents are rarely inclined to demonstrate fiscal restraint. Without material changes in spending or revenues, the US deficit is expected to continue to increase, posing a risk to the Treasury market and the country’s credit rating.
Definitions:
Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
Nominal gross domestic product (GDP) is a GDP figure that has not been adjusted for inflation.
Endnotes:
- Source: The CHIPS and Science Act: Here’s what’s in it, McKinsey & Company, October 4, 2022.
- Source: Bistline, J., Mehrotra, N., and Wolfram, C. Economic Implications of the Climate Provisions of the Inflation Reduction Act, Brookings Institution, March 30-31, 2023.
- Source: Infrastructure Investment and Jobs Act (IIJA) Implementation Resources, Government Finance Officers Association (website).
*Brandywine Global calculations using publicly available current economic data.
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