In my August 26 post, “U.S. Federal Budget Cuts in the 1990s,” I pointed out that U.S. government spending fell from 21.8 percent of GDP in 1990 to 18.4 percent of GDP in 2000, a 3.4-percentage-point drop. I focused on the numerator–government spending–but I did point out that the denominator, GDP, had done nicely too.

One commenter argued that my reasoning was misleading because of the boom in the last half of the 1990s. Presumably, his point was that the boom boosted GDP. I’m guessing that he’s right. But I don’t think it boosted GDP as much as many people think. And the reason has to do with the nature of GDP.

The major effect of the boom was to boost capital gains. How do capital gains show up in GDP? They don’t. GDP = C + I + G, where C = spending on consumption, I = spending on investment, and G = government spending on goods and services. Do you see capital gains in there? I don’t either. GDP does not include capital gains.

Of course, one can argue that capital gains made people wealthier and that they used that wealth both to invest in real plant and equipment (thus boosting I) and to buy consumer goods and services (thus boosting C.) But that has to be the argument. Capital gains per se are irrelevant.