What the Fiscal Cliff Deal Really Means for Taxes and Spending

By :: January 3rd, 2013

Everyone trying to sort out the fiscal cliff deal is getting hopelessly tangled in budget baselines.  Are taxes going up? Or are they going down?  There is an easier way: Forget the multiple baselines. Just look at what is happening to total spending and total revenues.

My Tax Policy Center colleagues ran the numbers and they tell two important stories—one about budget policy and the other about budget politics.

The policy story is simple: The cliff deal (plus expected economic growth) does begin to reduce the deficit to levels approaching sustainability, though the red ink begins to flow faster after about five years.  And since TPC’s projections include some optimistic assumptions about both spending and tax revenue, deficits could be even higher than the estimates.

The political picture is even more challenging.  Under the agreement, revenues in 10 years will reach about 19.4 percent of Gross Domestic Product, and that is at the very high end of what most Republicans say is tolerable. Spending will exceed 22 percent, at the low end of what many Democrats think is acceptable given the aging of the population.  Looking at taxes and spending as a share of GDP shows just how tough it will be for the parties to reach a fiscal compromise.

Fiscal cliff GDP 1-3-13Under the agreement, in 2013 the federal government is projected to spend about 22.7 percent of GDP, and it will collect about 16.6 percent of GDP in taxes and other revenues. That spending level is not very different from what the Congressional Budget office figured in its most likely fiscal scenario back in August, but taxes are about 0.3 percent of GDP higher.

The deficit in 2013 under the cliff deal: A steep 6.1 percent of GDP.

But the picture changes after the first year.  Revenue rises and spending falls, in part because CBO figures the economy is improving. Under the cliff agreement, in 2017 spending falls to 21.5 percent of GDP, while revenues rise to about 19 percent for a deficit of about 2.5 percent of GDP, which is not too bad. Spending is about 1 percentage point lower and taxes about 0.7 percent higher than under CBO’s fiscal projection.

By 2022, spending will rise to about 22.3 percent of GDP and revenues to about 19.4 percent, and the deficit will be back up to 2.9 percent of GDP.  However, spending will be about 1.8 percent lower than under CBO’s most likely scenario, and revenues about 0.8 percent higher.

Both spending and taxes will be lower under the cliff deal than under President Obama’s 2013 budget.

Some important technical points:  These estimates exclude interest. They also assume that the temporary tax provisions (the so-called extenders) and the temporary Medicare physician payment adjustment (the doc fix) expire in a year as the law states. If not, or if they are not paid for some other way, long-term revenues would be lower and spending quite a bit higher. Similarly, if the automatic spending cuts known as the sequester are repeatedly postponed and not replaced with other spending reductions, the deficit would also balloon.

There are lots of ways to look at this agreement but this one—spending and revenues as a share of the economy—can clarify a lot that is hidden under all those baselines.

 

 

8Comments

  1. SteveinCH  ::  5:16 pm on January 3rd, 2013:

    Wow. You show a chart labeled “deficit as a percent of GDP” and then later on mention that “[t]hese estimates exclude interest?”

    Have you discovered some form of magic that means we don’t have to pay interest anymore?

    This approach is particularly disingenuous because it, in effect, ignores the impact of rising interest rates (almost certain under the growth forecasts that are used) on the deficit.

    And then you assume the doc fix goes away and the sequester happens. I wonder how much closer the line moves toward the alternative scenario if you make more reasonable assumptions….

    I’d expect more from the TPC

  2. JC  ::  8:29 pm on January 3rd, 2013:

    Ditto.

  3. Michael Bindner  ::  9:23 pm on January 3rd, 2013:

    For now, this looks good. We really have no idea what will happen to the stocks of health insurance providers. I expect that the entitlement challenges, such as the doc fix and spending levels will be dwarfed by what is coming in 2014.

  4. Tax Roundup, 1/4/2013: How many seconds of federal spending do you cover? And more debris from the bottom of the Fiscal Cliff. « Roth & Company, P.C  ::  9:45 am on January 4th, 2013:

    […] Howard Gleckman,  What the Fiscal Cliff Deal Really Means for Taxes and Spending […]

  5. Vivian Darkbloom  ::  11:04 am on January 4th, 2013:

    Good point. Any reasonable discussion about the deficit, the debt and spending should include interest expense and other reasonable assumptions. That said, I’m confused about Howard’s presentation of the data.

    Gleckman presents two sets of numbers. The first is presumably an extension of the CBO’s “baseline scenario” or “current law scenario” taking into account changes brought about by the fiscal cliff bill (HR 8). The second presumably represents the extended alternative fiscal scenario, again, presumably after adjustments for the effect of HR 8. The main difference between the pre- and post- HR 8 “baseline scenario” and the pre- and post- HR 8 “alternative scenario” on the spending side is primarily the assumption that spending under certain laws (such as the mandatory cuts to Medicare reimbursements and the sequester) would be adhered to. The alternative scenario represents reality—Congress will override those laws. Clearly, these spending assumptions make an important difference. I agree that the alternative scenario is the most realistic and the one we should focus on, but HR 8 didn’t really affect that spending distinction much.

    But, what about interest on the debt? In principle, there should be no distinction between the baseline scenario and the alternative scenario on this score, except for the fact that if interest is included in the numbers, the additional primary debt under the alternative scenario should also drive up proportionately the interest expense.

    A main issue you raise is whether these sets of numbers regarding spending as a percentage of GDP include or exclude interest on the debt. Howard says “these estimates” don’t. He also says “these estimates” don’t take into account the alternative assumptions on spending; however, clearly some (what Howard refers to as CBO’s “most likely” scenario) do. The use of the term “these” suggests it applies to all the numbers, but that seems unlikely.

    I consulted the CBO August 2012 update (Table 1-1). Their baseline projection at that time was that spending *including* net interest of 2.3 percent of GDP would be 22.3 percent of GDP in 2022 (the breakdown was 14.4 percent mandatory, 5.6 percent discretionary and 2.3 percent net interest). I don’t think the fiscal cliff bill moved the needle on spending that much. It appears that the increase in spending contained in that bill more or less offset the slightly reduced interest expense due to higher revenues.

    Compare that with the following (unnecessarily confusing) quote from Gleckman’s post:

    “By 2022, spending will rise to about 22.3 percent of GDP and revenues to about 19.4 percent, and the deficit will be back up to 2.9 percent of GDP. However, spending will be about 1.8 percent lower than under CBO’s most likely scenario, and revenues about 0.8 percent higher.”

    This begs for a plain English translation, such as:

    “Under the most reasonable assumptions (the so-called alternative fiscal scenario) spending will steadily increase to 24.3 percent of GDP by 2022 and revenues will also increase to 18.6 percent of GDP. Under less reasonable assumptions that current laws requiring spending cuts and the sunset of certain tax benefits will be adhered to, spending will increase to only 22.3 percent of GDP and revenues to 19.4 percent of GDP”

    But, the question remains: do these sets of numbers on spending include net interest expense? Howards says “no”.

    The above number (24.3 percent of GDP on spending) seems consistent with the CBO’s June 2012 Long-Term Budget (Alternative Fiscal Scenario) on federal outlays, which *includes net interest*. That report says that under the alternative scenario (including spending for the doc fix, etc) the spending rises to 24.3 percent of GDP.

    Based on the above, my guess is that Howard’s numbers *do* include net interest expense on the debt.

    The data from the referenced reports can be accessed at the CBO’s website.

  6. Somebody find the GOP a carrot | Reihan Salam  ::  4:52 pm on January 11th, 2013:

    […] that it was powerless to stop tax increases on high earners, the GOP finds itself in a bind. Federal taxes are expected to rise to 19.4 percent of GDP, a level that is well above the 17.8 percent of GDP that had been the average federal tax take from […]

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