More Dismal Prospects for the Federal Budget: It’s All Greek to Me
Bill Gale and Alan Auerbach are once again ruining another beautiful spring day. Bill, the Tax Policy Center’s co-director, and Alan, a highly-respected economics professor at Berkeley, have updated their federal budget outlook. And their projections—based on realistic assumptions of what may happen to tax and spending—are truly frightening.
In the short run, Bill and Alan figure that today’s deficit—roughly 10 percent of Gross Domestic Product—will ease somewhat as the economy improves. It will bottom at 2.3 percent of GDP in 2014, but after that, it is off to the races.
Without big policy changes, they project the deficit will be back to nearly 7 percent of GDP by the end of the decade, more than twice the Congressional Budget Office’s official forecast. At that pace, we will accumulate another $11 trillion in deficits through 2020. And by mid-century, the red ink will be 8 percent of GDP and rising. They see a permanent budget gap of 9 percent of GDP.
Matters would be slightly better under President Obama’s budget, but not very much. For instance, Obama would add a mere $9 trillion to deficits over the coming decade.
What could deficits like these mean? In another new article, Len Burman lays out one terrifying–but hardly improbable–scenario.
The bottom line: If Congress keeps doing what it has been doing, which is to say both spending and cutting taxes as if there were no deficit, be very afraid. If current policy does not change, Bill and Alan figure revenues will hover around 18 percent of GDP—where they’ve been for much of the past few decades. Spending, now about 23 percent of GDP, will fall to about 20 percent over the next few years, but then head rapidly north. By mid-century, the federal government will be spending about 26 percent of GDP.
The dollars may be incomprehensible but the math isn’t so hard. If Washington spends 26 percent of our economic output, but collects only about 18 percent in taxes, we’ve got a problem. We may not be Greece, where the deficit is now estimated to be about 13.6 percent of GDP, but we are not in a good place. Plus the weather isn’t as nice.
How do Bill and Alan come up with their numbers? They start with CBO’s budget baseline, which assumes current law. That is, the Bush tax cuts all expire at the end of the year, millions of middle-class households get hit by the Alternative Minimum Tax and the like. They then adjust the forecast to reflect what would happen if Congress, instead, continues current policy into the future. Thus, the Bush tax cuts would be extended, the middle-class would continue to get relief from the AMT, and dividend and capital gains rates would remain at 15 percent. On the spending side, they figure Medicare physician payment rates remain frozen at current levels but not cut, defense spending falls modestly, and non-defense discretionary spending (that is, government operations except for Medicare, Medicaid, and Social Security benefits) increase only to keep up with inflation and population growth.
My own best guess is that Washington will make some changes to current policy. For instance, I suspect Congress will raise tax rates for top bracket taxpayers, but will also give Medicare docs a raise. Add it up, and the bottom line won’t change much.
The point is, Alan and Bill have again added their voices to those warning that we are living Stein’s Law here. Herb Stein—who was top economic advisor to President Nixon and father to comic Ben Stein—used to have a well-known aphorism that went something like this, “If present trends can’t continue…they won’t.”
And to that, I propose we all stand and toast. Somebody pass the Retsina.
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People thought the same thing in 1993 when deficit projections hit $500 Billion. The introduction of the 36% and 39.6% were not supposed to balance the budget, but merely cut it in half. I suspect that current estimates of the reemergence of these rates at the end of the year are also low, as are the impact of health care reform tax enhancements at the upper income levels. As long as the Bush high end taxes are allowed to expire, I think we will do better than planned, although a VAT fully funding Medicare growth would certainly help as well, given that the benefits are broad based as well. Both would deflate rather than pop the bubble. The only way I see the bubble popping is for the White House to agree to extend the Bush Tax cuts for another two years in the face of either Republican opposition to extending the lower rate cuts or economic fears that allowing taxes to go up may hurt the recovery. It would not. Taking money out of speculation by the wealthy and putting it in government spending and consumer borrowing (by decreasing the crowding out effect) will help the recovery – and should have been undertaken a year ago.
The one thing that will spook Asia is the concept that taxes on the wealthy will never increase, since it makes very real the fear of permanent deficits. Tax increases on the wealthy and the eventual withdrawl of American troops from Iraq and Afghanistan will end these fears.
As a practical matter, the crisis is inevitable. As with any bubble, the bigger it gets the greater the pain when it bursts. We would be better off, with more and better options to react and with less shredding of the safety net, if the bubble bursts this year rather than in 2020.
Spendthrift policies might be just what it takes to burst the bubble now. This is the aspect I like most about the new health care law. Abject failure of the deficit reduction commission will help too.
My guess is more rosey, although the doomsday scenarios help sell the reforms I advocate:
1. Drastic defense reductions as the wars in the middle east and Korea are negotiated to a close, with some shift of defense procurement to civilian space technology – but deep cuts by and large.
Consolidate taxes for entitlement spending, health spending and redistribution to families into a business income tax and possibly to a personal account for social security with contributions from employers to employer stock without a government middle man. Redistribution for FICA comes through the revenue side, with all employees getting the same employer contribution based on all value added, not just capped payroll.
A VAT to fund domestic military and civil spending with a balance requirement and sequestration.
A high income surtax to fund overseas and sea deployments, net interest, military retirement and debt repayment. Authorize borrowing only in wartime or when Business Income Tax cannot meet obligations.
Since debt repayment will clearly be only a high income thing, most people will settle on a higher tax rate in order to spare their children from paying this later.