TaxVox Taxes and Spending Return To “Normal”-- But Not For Long
Howard Gleckman
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Yesterday, the Treasury Department reported that the deficit for Fiscal Year 2014, which ended on Sept. 30, fell to $483 billion, or about 2.8 percent of Gross Domestic Product. This being Washington, the report was hailed as either an enormous success or dismissed as meaningless.  Who is right? Is it good news or bad news? Well, it is good news, at least in the short run. But the news isn’t that good. We have, in effect, climbed out of a very deep hole and returned to something like fiscal normalcy. At least for now. To better sort through this, it helps to understand why the deficit has been falling. The main reason: The improving economy and expiration of some big tax cuts have generated significantly more tax revenue than in recent years. In 2014, federal tax receipts reached 17.5 percent of GDP, a level unseen since 2007, just before the economy cratered. That’s only slightly higher than the 40-year average of about 17.4 percent of GDP. It should be no surprise, given decent economic growth since the economy bottomed out in 2009. That year, tax revenues plunged to 14.6 percent of GDP, a level unseen since 1950. But it wasn’t just a better economy. Revenues also rose because a growing share of income went to the rich, who pay higher tax rates. Policy changes have had an effect on medium-term revenues as well. For example some Bush-era tax cuts for high-income households expired in 2012. The big payroll tax cut of 2011-2012 expired in 2013. The story is similar on the spending side. In 2009, federal outlays topped out at 24.4 percent of GDP. By the fiscal year just ended, they had declined to 20.3 percent, a shade below the 40-year spending average of 20.5 percent. [[{"type":"media","view_mode":"default","fid":"128391","attributes":{"class":"media-image aligncenter size-full wp-image-7168","typeof":"foaf:Image","style":"","width":"600","height":"400","alt":"CBO baselines 1974-2024"}}]] By those standards, both spending and revenues have returned to “normal,” at least by one definition. And many budget experts would argue an annual deficit of around 3 percent of GDP (the difference between 20.5 percent spending and 17.4 in taxes) is manageable given the current state of the economy. It might be too small for a weak economy and too big for a strong one but, for now, it probably is fine. Here is an interesting discussion of the "right" level of deficits But here’s the problem: It is unlikely that Congress and the President will be able to maintain this steady fiscal state. On the spending side, increasing health and long-term care costs of an aging population have been well documented. Even if you believe that the recent deceleration of the growth of per capita Medicare costs is the beginning of a new normal (a theory upon which healthcare economists vigorously disagree), the aging of the 77-million strong Baby Boom generation will mean more seniors will be receiving Medicare than ever before. And as they begin to reach their 80s, their demands for Medicare and Medicaid (which finances half of all paid long-term care services) will only grow. CBO figures that between now and 2039, health care spending will double to about 8 percent of GDP.  Unless you assume Congress will slash Medicare or sharply cut other programs to accommodate those added costs, overall federal spending is going to blow through its historical 20.5 percent average. The story is a bit different when it comes to taxes. The CBO baseline assumes tax revenues rise to about 19.4 percent of GDP by 2039. But for that to happen, scores of now-expired tax breaks would have to stay expired—an outcome no one really expects. Tax reform, of course, could change all of those revenue calculations but for now, that whole topic should probably be filed in the “uncertainty” folder. Bottom line: Yes, the nation’s short-term fiscal health is better than it has been over the past half-decade. An economic recovery (plus the willingness of Congress to let some tax breaks expire) will do that for you. But no, we are by no means out of the long-term woods.  
Tags budget CBO fiscal 2014 spending tax revenues
Primary topic Federal Budget and Economy
Research Area Federal Budget and Economy