Taming The Twins

The trade deficit and fiscal (federal budget) deficits are sometimes referred to as the "twin deficits." They are linked by the identity: NX + NFP + Tr = NS - I; where NX is net exports (if negative, a trade deficit), NFP is net income from abroad and Tr is international transfers. Together, they are the current account, of which NX is by far the largest part - i.e. the US trade deficit drives the US current account deficit. The other side is national savings (NS) less investment (I), where national savings is private savings and government savings. The fiscal deficit is negative government savings; NS can therefore be thought of as the savings left after subtracting the part borrowed by the government. So, ceteris paribus, the trade deficit (-NX) and the fiscal deficit (which reduces NS) move together - hence the "twin deficits."

Last week brought news that both of deficits are shrinking. The CBO reported preliminary estimates that the federal deficit decreased to $161 billion in fiscal year 2007, from $248 billion the year before (the federal fiscal year ends in September). The biggest change in the spending side was a $65 billion decrease in "other programs and activities" (i.e. not defense or entitlement programs), which the CBO attributes to some one-time-only events:

The decrease in outlays for "other programs" was mainly due to unusually high spending in 2006 for activities related to the 2005 Gulf Coast hurricanes and for the subsidy costs recorded for student loans. Payments received in 2007 for licenses auctioned in 2006 for use of the electromagnetic spectrum further reduced net outlays. Excluding those three activities, spending for this category rose by about 1 percent.

On the revenue side, income tax revenue surged by $118 billion - partly this is the "automatic stabilizer" effect (taxes rise as incomes rise). A large part of the increase came from "nonwithheld income":

Nonwithheld income and payroll tax receipts gained about $55 billion (or 13 percent) in 2007. The two main components, quarterly estimated payments and final payments with tax returns, both grew at about that same rate. Nonwithheld receipts grew more slowly than the 19 percent rate recorded in 2006. The double-digit growth in 2007 probably reflects continued strong growth in income from sources other than wages and salaries.

Presumably, that would mostly be "capital income" like dividends, interest income and capital gains - growth in this type of income is consistent with the rising inequality reported by the IRS (see previous post).

As for the trade deficit - the BEA and Census Bureau reported exports of $138.3 billion and imports of $195.9 for a deficit of $57.6 billion for the month of August. That's $1.4 billion less than July and $10 billion less than August, 2006. This may, in part, reflect the continuing decline the in the value of the dollar, which makes US products cheaper to foreigners (increasing exports) and makes foreign products more expensive to Americans (decreasing imports). By country/region, the largest deficits were with China ($22.5 billion), OPEC ($11.4 billion) and Europe ($11.1 billion). Here's the NY Times story.