The Causes of the Budget Deficit: A Reckoning

In case you missed it yesterday:

There seems to be some disagreement about the true cause of the US’s current budget woes. Conservatives blame it on federal spending, which they claim has risen too fast. The Bush administration, on the other hand, blames the state of the economy for the budget deficit. Refuting both arguments, the Center for Budget Policy and Priorities argues that lower tax revenues are to blame. Who’s right?

I’ve agreed to be the arbiter between these three claims. My job here is to gauge the relative importance of these three factors (spending increases, tax cuts, and the economy) on the budget deficit through the end of the decade, using the most concrete dollar figures available.

First, we need to precisely estimate the budgetary effects of the tax cuts. To do so, we can turn to the CBO. They provide periodic estimates of the effects of all specific changes in tax or spending policy on the federal budget. Looking through CBO publications over the past few years it is possible to piece together the specific revenue costs associated with the various Bush tax cuts. Assuming that Congress approves Bush’s request to extend the tax cuts that are currently scheduled to expire, the total cost of his tax cuts was about $83bn in 2002 and will grow to about $470bn in 2010. Note that both Republicans and Democrats in Congress use the CBO’s estimates as a neutral, non-partisan prediction.

Next, consider the spending increases. Congress and the President have no direct control over mandatory spending, so assume that those spending levels remain at the levels estimated by the CBO through 2010. For discretionary spending, however, let’s suppose that spending on everything that was not related to 9/11 (i.e. reconstruction costs, additional homeland security, and the war in Afghanistan) had grown at just the rate of inflation, instead of growing at the rate that we’ve actually seen. If discretionary federal spending had been restrained to grow at the rate of inflation, it would have been $38bn lower in 2002, and about $200bn lower in 2010 than currently projected.

The following graph shows the combined effects of the two. The blue line shows the CBO’s projection of the deficit through 2010, assuming that the expiring tax cuts are indeed made permanent. This will be Bush’s budget legacy, if he gets his way. The green line shows what it would have been without the tax cuts or faster-than-inflation increases in discretionary spending. One can think of the green line as what the deficit would have been were Bill Clinton still President.

The result is clear. Yes, the state of the economy has contributed somewhat to the US’s budget woes – even without tax cuts or unusual spending increases, the budget would have been in deficit from 2002 to 2004. The economy’s effect on the budget balance looks like a neat bite taken out of the green line from 2002 to 2005. The size of that bite, and thus a rough estimate of the 10-year budgetary costs of the recession and 9/11, is about $0.8 trillion. So the White House is slightly right — the economy has indeed had a negative effect on the budget. However, it’s also clear that the large and persistent deficits that the US is facing over the next decade are by and large NOT due to the state of the economy. By next year, the budget would once again be in surplus if it weren’t for the tax cuts and unusual spending increases. The majority of the budget deficit is due to deliberate, discretionary policy choices.

Of the two remaining possibilities, which is more responsible for the remaining budget shortfall – tax cuts or spending increases? The next graph shows the shares of the budget shortfall due to each.

Those who argue that the budget deficit is the result of spending growth are about 30% right. A bit under one-third of the avoidable budget shortfall between 2002 and 2010 – roughly $1.4 trillion – is due to discretionary spending (other than spending related to 9/11) that has grown unusually fast. But they are also about 70% wrong, because the other 70% of the remaining budget shortfall is due to the Bush tax cuts. The cost of the tax cuts will be about $3.1 trillion over the decade.

We can think of the implications of this in two ways. First, if discretionary spending had somehow remained restrained to just the rate of inflation, the budget would STILL be in deficit as far as the eye can see (about $200bn by 2010). Keeping spending growth down would not have balanced the budget. Put another way, if spending was at current (supposedly high) levels but the tax cuts had never happened, then the budget would STILL return to surplus by 2006, and remain in surplus thereafter.

To sum up, here’s the definitive reckoning:

• Recession + 9/11: 10-year budgetary effect = $0.8 trillion, or about 15% of the total shortfall.
  
• “High” spending growth: 10-year budgetary effect = $1.4 trillion, or 25% of the total shortfall.
  
• Tax cuts: 10-year budgetary effect = $3.1 trillion, or 60% of the total shortfall.

The conclusion is straightforward. Our current budget problems can largely be blamed on the tax cuts, not the state of the economy or spending increases. Reverse the tax cuts, and keep everything else the same, and our budget problems would be gone.

Kash

———–

Sources: Budgetary effects of the tax cuts is given by the CBO as “legislative changes to revenue,” and is taken from the CBO’s “Budget Updates” of January 2002, August 2002, January 2003, August 2003, and January 2004. Spending increases related to 9/11 are given by the CBO in “Letters” to John Spratt and Pete Domenici. CBO documents available here.