The financial crisis and the resulting recession have coincided with a rapid run-up in American -- and global -- government debt. A lot of people, understandably enough, assume that this is the product of government spending. The stimulus was expensive, and the bank rescues seemed expensive, and we just passed a health-care reform plan, and that must be why the deficit blew up.
The IMF, in a new report (pdf), explains that that's not the case. "Of the almost 39 percentage points of GDP increase in the debt ratio, about two-thirds is explained by revenue weakness and the fall in GDP during 2008-09," they write. Check out the graph atop this post: New spending isn't nearly as large a contributor to the increase in debt as reduced revenue is.
The mechanism here is simple enough. As Paul Krugman explains it, "the financial crisis has made us permanently poorer, which among other things reduces revenue." Recessions reduce income, reducing income reduces taxable income, and that in turn reduces the revenue that normally keeps governments out of debt.This isn't just an interesting explanatory point, though. It's a reminder that the most important thing we can do to reduce the deficit in the long run is to do whatever it takes to get economic growth back up to speed. The more willing we are to accept permanently higher unemployment and permanently lower growth, the harder it's going to be to get our debt under control.