Deficits After ATRA

By :: January 31st, 2013

The American Taxpayer Relief Act (ATRA), the New Year’s legislation that effectively forestalled the bulk of the January 2013 fiscal cliff, probably staved off a recession. But compared to doing nothing, Congress made the deficit worse by passing ATRA. New Tax Policy Center calculations show how much more deficit reduction Congress will need to approve to fill in the hole created by ATRA.

Had Congress not acted, nearly everyone would have paid more tax in 2013 than in 2012, military spending would have been slashed by about 9 percent, and non-entitlement domestic spending would have been cut by more than 8 percent. Instead, Congress delayed those automatic spending cuts for a couple of months, allowed most 2001-2009 tax cuts to expire only for the highest-income households, and let the 2010 payroll tax cut die.

By adopting ATRA, Congress shifted the deficit path scheduled under current law by extending most tax cuts not just for a few years but permanently. ATRA singlehandedly moved the deficit outlook under current law from one that achieved primary budget balance (where tax revenues equal non-interest spending, roughly the level needed to hold debt constant as a share of the economy) to a budget outlook that has deficits approaching 3 percent of Gross Domestic Product by the end of the decade (see chart 1). Differences in the projected deficit paths pre- and post-ATRA are shown below in chart 1.

Chart1

Congress clearly is not finished with its deficit negotiations. It may have postponed certain decisions, but the country still faces hundreds of billions in cuts to discretionary spending, steep cuts in Medicare physician payments, and popular but temporary tax cuts scheduled to expire in coming years. My colleagues and I estimate that under a budget policy that extends current practices, deficits will exceed 5 percent of GDP in the later part of the decade (see chart 1). This scenario—denoted “Post-ATRA Plus Likely Policies”—assumes that Congress not only extends the “likely” policies just listed but also ignores the cuts mandated in the Budget Control Act and maintains discretionary spending at or above historical lows for the past few decades.

Congress will need to approve additional sizeable, but not insurmountable, deficit reduction to bring the economy into primary balance. A combination of tax increases and/or spending cuts totaling $150 billion per year from 2015 to 2017, followed by annual cuts of $300 billion, would stabilize the debt in the future(see chart 2).

Chart2

One lesson of the past four years is that fiscal policy is a critical tool for macroeconomic stabilization. In the absence of the Recovery Act, economic growth would have been much worse, perhaps even negative in the near term. But a cost of using government spending to boost a weak economy, however, is a greater need for austerity during growth years. Running persistently high deficits once an economy recovers makes it much harder to provide effective stimulus the next time a recession hits. On Tuesday, the Congressional Budget Office will release updated economic and budget projections. The new estimates may show slightly different deficits than those shown above, but the song will remain the same: there is more work to be done.

4Comments

  1. AMTbuff  ::  5:37 pm on January 31st, 2013:

    More pining for the lost fantasy of a “current law” revenue baseline. Enough already. That projected revenue was never real because Congress would never allow all the tax rates and AMT relief to happen. The initially “temporary” 2003 tax rates have lasted longer than most “permanent” tax rates.

    As much as people who own real estate inside the beltway would like revenues to increase to 25% or more of GDP, that’s not going to happen. One party in particular is doing the country no favors by dragging its feet on reform of entitlement spending. Not to mention enacting a major new entitlement program which was claimed to safe money but which will exceed all cost projections in the same way Medicare did.

    Promised future benefits need to be scaled way back. Effective dates can be staggered so as not to harm the economy in the next year or two. On the contrary, I believe that a firm decision of this nature would boost the economy tremendously. Only myopic partisans of the left oppose rationalizing government promises. They fear a small tactical retreat even though it’s the only hope to prevent annihilation of the welfare state.

  2. Fiscal Policy After ATRA | The Government We Deserve  ::  8:12 am on February 1st, 2013:

    […] Harris over at TaxVox has […]

  3. Tax Roundup, 2/1/2013: What’s Iowa’s 2012 tax law? And you thought 50 years was bad? How about 351? « Roth & Company, P.C  ::  9:16 am on February 1st, 2013:

    […] Account Ostriches. David Cay Johnston, Tax To Defend a Tax Haven (Tax.com) Ben Harris,  Deficits After ATRA (TaxVox) Patrick Temple-West,  U.S. is preparing more tax-evasion cases, and more.  Bad news […]

  4. Michael Bindner  ::  12:36 pm on February 1st, 2013:

    I expect that we will see a Peace Dividend again as the new SecDef follows up on some of the recommendations of the Fiscal Commission. The Pentagon bureaucracy is fat and it is better to cut there than in force structure.

    Health care has to be considered as in flux until we know if the current uninsured or badly insured will sign up for insurance when the subsidies kick in or simply wait until someone gets sick. Frankly, without sick leave reform, many families will still be in the emergency room late at night seeking treatment for sick kids. Either way, if the stock market sees bad things in 2014, it may devalue health insurance stocks and drive them into a bailout. This will either take the form of a subsidized public option (either state by state or national) or a single-payer system. Either way, the additional broad based taxes needed to fund reform will make fixing Medicare and Medicaid look like chump change.

    On the other hand, optimists in the White House may believe that the changes in the ACA will work better than expected, so that with further defense cuts, savings from reform will soon be booked against the ATRA cuts.