Government Spending, Taxes, and Debt:The Choices Ahead
Lecture by Robert M. Coen
Emeritus Professor of Economics
Northwestern University
November 13, 2012
Web site: faculty.wcas.northwestern.edu/~rcoen
Email: [email protected]
Outline
Federal revenue, outlays, surplus, and debt since WWIIReasons for recent surge in deficits and debtCBO medium-term projections of deficits and debt to 2022CBO long-term projections of deficits and debt to 2042Implications of the projections
Fiscal choices for the coming yearFiscal choices for the long-runHistory and prospects for tax reformSumming up
CBO Publications Utilized
The Budget and Economic Outlook: Fiscal Years 2012 to 2022, January 2012
The 2012 Long-Term Budget Outlook, June 2012
An Update to the Budget and Outlook: Fiscal Years 2012 to 2022, August 2012
Definitions
Surplus = Revenue - Outlays
Negative surplus = deficit
Debt = Accumulated deficits
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Surplus Revenue Outlays
Federal Revenue, Outlays, and Surplus, 1947-2012Percent of GDP
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Highlights of Deficit History
Deficits increase during recessions, decline during expansions
Up to 1970s, deficits in recessions offset by surpluses in expansions
In 1970s, expansions eliminated deficit but did not produce surpluses
1980s to early 1990s, persistent deficits due to increased outlays
Deficits decline in 1990s due both reduced outlays and higher revenue
In 2001-2008, persistent deficits reemerge due to lower revenues
Beginning 2008, record deficits
Why Do Deficits Increase During Recessions?
Tax revenue declines as incomes, profits, and sales fall
Outlays for unemployment benefits rise
Outlays for food stamps rise
Outlays for Medicaid rise
Outlays for aid to state and local governments rise
Why Have Deficits Been So Large Since 2008?Automatic stabilizers at work in most severe recession
Discretionary, temporary fiscal stimulus measures$150b package in early 2008, mostly one-off tax rebates, faster depreciationTax credit for first-time home buyers in 2008$787b stimulus package in early 2009
Personal tax cuts 288 Education 91 Business tax cuts 51 Aid to poor 83 Healthcare 148 Infrastructure 81 Bush tax rate cuts of 2001 and 2003, set to expire in 2010,
extended through 2012Emergency unemployment benefits enacted in for 2011-12 Payroll tax cut in 2011-12
Some non-reasonsTARP, AIG bailout, takeover of Fannie Mae-Freddie Mac, auto bailout
Depth of Postwar Recessions
Rise in Decline in unemployment rate real GDP1948-49 4.1 1.71953-54 3.3 2.61957-58 3.3 3.1
1960-61 1.7 1.61969-70 2.4 0.6
1973-75 4.2 3.21979-82 4.9 2.9
1990-91 1.7 1.4
2001 1.4 0.32007-09 5.4 4.7
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Federal Debt Held by the Public, 1946-2012Percent of GDP
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CBO Baseline Projection Assumptions
Based on current law
Lower tax rates, expanded tax credits and deductions enacted in 2001, 2003, and 2009 expire at end of 2012
Provisions limiting reach of AMT expired at end of 2011
Payroll tax cut, emergency unemployment benefits expire in Feb. 2012
Automatic spending cuts of Budget Control Act of 2011 take effect
Reductions in Medicare payment rates
CBO Baseline Projection, 2013-2022
2012 2013-17 2013-22Total deficits $1,128 $1,546 $2,258($ billions)
2012 2013 2017 2022Deficit/GDP 7.3 4.0 0.6 0.9(Percent)
Debt/GDP 72.8 76.1 67.9 58.5(Percent)
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Surplus Revenue Outlays
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CBO Baseline Projection, 2012-2022Federal Revenue, Outlays, and Surplus
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CBO Baseline Projection, 2013-2022 (shaded)Debt Held by the Public
Percent of GDP
Year
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CBO Baseline = “Fiscal Cliff”
(Federal revenue, outlays, and surplus in billions of dollars)
2012 2013 Revenue 2,435 2,913Outlays 3,603 3,554
Surplus -1,128 -641
%Δ Real GDP +2.1 -0.3
Unemp rate (%) 8.2 9.1
CBO Alternative Scenario Assumptions
Based on current policy, not current law
Expiring tax cuts extended (except payroll tax)
AMT is indexed for inflation
Medicare payments not cut
Budget Control Act automatic spending cuts not applied (but caps on discretionary outlays are imposed)
CBO Alternative Scenario, 2013-2022
2012 2013-17 2013-22Total deficit $1,128 $4,437 $9,975($ billions)
2012 2013 2017 2022Deficit/GDP 7.3 6.5 4.2 4.9(Percent)
Debt/GDP 72.8 78.6 82.5 89.7(Percent)
Comparison of CBO Projections, 2012-2022Revenue, Outlays, and Surplus
Baseline projection Alternative projection
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Surplus Revenue Outlays
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Surplus Revenue Outlays
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Alternative Baseline
CBO Projections, Baseline and Alternative, 2013-2022 (shaded)Debt Held by the Public
Percent of GDPP
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Budgetary Effects of Selected Policy Alternatives Not in CBO Baseline(Billions of dollars)
2013 2013-17 2013-22Baseline deficit 641 1,549 2,258
To reduce deficit: 45,000 troop reduction by 2015 -22 -324 -852 Freeze discretionary at 2013 level 0 -160 -904
To increase deficit: Maintain Medicare at current rates 10 85 245 Remove BCA automatic cuts 54 461 972 Extend income and estate tax cuts and index AMT for inflation 247 1,781 4,532 Same, but rates on rich expire 205 1,483 3,708
Alternative projection 1,037 4,437 9,975
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2000 2005 2010 2015 2020 2025 2030 2035
Population Age 65 and Olderas a Share of Population Ages 20-64
Year
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CBO Long-Term ScenariosExtended baseline scenario
Again follows current lawRevenue grows steadily after 2022 because -
Bush tax cuts expireMore taxpayers subject to AMTNew taxes imposed by Affordable Care Act Interactions with demographic change and economic growth
Discretionary outlays fall to lowest levels since WWII
Extended alternative scenarioAgain incorporates current policies to 2022 (Bush cuts continue)After 2022, revenue held at 18.5% of GDPAfter 2022, Medicare and HI costs not restrainedAutomatic cuts of BCA not imposedBCA Caps on discretionary keptDiscretionary outlays fall to average level of past two decades
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SURPLUS REVENUE OUTLAYS
CBO Long-Term Baseline Projection, 2012-2042
Federal Revenue, Outlays, and SurplusP
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DP
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SURPLUS REVENUE OUTLAYS
CBO Long-Term Alternative Projection, 2012-2042
Federal Revenue, Outlays, and Surplus
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Baseline Alternative
CBO Long-Term Projections, 2012-2042
Federal Debt Held by the Public
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CBO Long-Term Projections, 2013 and 2042(Percent of GDP)
2013 2042 Base Alt Base AltSocial Security 5.1 5.1 6.1 6.1Medicare 3.7 3.8 6.5 7.3Medicaid 1.8 1.8 3.8 3.9Other 10.4 10.8 6.8 9.5Interest 1.5 1.5 2.4 11.8
Total Outlays 22.5 23.0 25.6 38.6
Revenue 18.7 16.7 24.6 18.5
Surplus -3.8 -6.3 -1.0 -20.2
Choices for Next Year - Background
How great a priority is reducing deficits and debt?
We are still in recessionUnemployment rate = 7.8%Capacity utilization = 78.3 (85 in mid-1970s)Economies of Europe and Asia forecast to slow
Are deficits and debt obstacles to recovery? Two views.
YES. They undermine confidence of business and consumersAre US deficit and debt out of line with other nations? No.Signs of faltering confidence in US bonds or dollar? No.Interest on debt growing large relative to tax revenue? No.But what about downgrade of credit rating by S&P in summer 2011? Uncertainty about future tax and spending policies
NO. They aid recovery by adding to demand for goods and services
Central Government Debt, 2010 and Change from 2006Percent of GDP
Japan 184 22 Netherlands 52 13
Greece 148 40 Spain 52 19
Italy 109 12 Germany 44 3
Belgium 97 9 Finland 42 6
Portugal 88 20 Denmark 40 7
UK 86 42 Canada 36 8
France 67 15 Sweden 34 -8
Austria 66 5 Norway 26 14
US 61 25 Switzerland 20 -5
Ireland 61 40 Australia 11 5
Source: OECD
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Yield on 10-Year Treasury Bond, 1953M4-2012M10
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Federal Interest Payments, 1947-2012
Percent of Tax Revenue (excl. Social Insurance Taxes)P
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Choices for Next Year
Go over the cliffLikely to worsen recessionFixes medium-term imbalance without severe cuts in outlays
Temporarily extend some or all tax cuts, unemployment benefitsAdds about $250b to 2013 deficitCreates more inertia to keep themAdministration: Extend all except for top income groups
Adds about $200b to deficit
Undertake tax reform, leave rates low or cut them further, but close loopholes – no time for this
Pass a new stimulus package
Whatever the choice, debt limit will have to be raised around February
Choices for the Long RunConstitutional amendment requiring balanced budget?
Budget Act Required Congress to vote on it – failed
Establish safe range of debt to GDP and stay in it?
Permanently rescind tax cuts, keep Budget Control Act capsThis is the CBO baseline
Cong. Ryan: Hold revenue at “historical norm” ~ 18.5%Leaves little for nondefense discretionary outlays Cut income tax rates (10 and 25% rates), close loopholesReplace Medicare with private insurance plansShrink and restrict programs for poor, turn over to states
Simpson-Bowles: Raise some revenue, cut some entitlementsKeep income tax rates low, close loopholesRaise gasoline tax
Move away from income tax, toward consumption tax
Reflections on Income Tax Reform
Reduce rates, broaden base, keep revenue unchanged or increased
Appeals: Simplification Reduce distorting effects of tax Reduce waste of skilled labor on tax avoidance
Last major reform in 1986Reduced rates and number of brackets, top from 50 to 28Eliminated deduction for interest paid, expect on mortgagesEliminated deduction for state-local sales taxesEliminated favored rates for long-term capital gains
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Effective Personal Income Tax Rate, 1947-2012Ratio of Personal Income Tax Revenue to Personal Income (%)
Average (red line) = 9.7P
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Reflections on Income Tax Reform
Undoing of reform since 1986
1990 Top rate raised to 31%1993 Top rate raised to 39.6%
KG rate set at 28%1997 Child tax credit of $500
KG rate reduced to 20%2001 39.6% rate to fall gradually to 35% Child credit raised to $1K
Estate tax reduced, eliminated it in 2010 (temporary)2003 Accelerated reductions in top rates Dividends and KG rates reduced to 15%Numerous grants of accelerated depreciationNumerous new tax credits – biofuels, etc.
Rate increases, more rate differentials, loopholes, complexity!
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Effective Corporate Tax Rate, 1947-2012Ratio of Corporate Tax Revenue to Corporate Profits (%)
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Reflections on Income Tax Reform
How to make up for cutting rates?
Costly loopholes:Earned income tax credit (poor)Untaxed employer contributions to health insurance (middle)Mortgage interest deduction (middle)Charitable deductions (middle and rich)Favorable rates for KG and dividends (rich)Accelerated depreciation, investment credits (rich)Tax exemption of interest on municipal bonds (rich)
New proposal: Place cap on deductions/tax preferences
Closing loopholes reduces “tax expenditures”
Could hold rates constant, close loopholes, increase direct support
Taxes as Percent of GDP, 2010
Denmark 48
Sweden 46
Italy 43
Norway 43
France 43
Netherlands 39
Germany 36
UK 35
Canada 31
Switzerland 28
Japan 28
US 25 Source: OECD
Annual GDP Growth Rates, 2001-11 Taxes as Percent of GDP, 2010
Sweden 2.4 46
Canada 1.9 31
Switzerland 1.8 28
UK 1.7 35
US 1.6 25
Norway 1.5 43
Netherlands 1.3 39
France 1.2 43
Germany 1.2 36
Denmark 0.7 48
Japan 0.6 28
Italy 0.4 43 Source: OECD
Summary
Size of deficit and debt manageable in short runImmediate concern is to sustain economic recoveryRecovery will eliminate $400-500b of deficit
Debt limit must be raised in early 2013
Recent budget imbalance not sustainableSustainable budget requires both more revenue and lower outlays
In CBO baseline (sustainable path)Revenue grows to 24.6% of GDPYet drastic cuts are needed in discretionary outlays
In CBO alternative (excessive growth in deficits and debt)Revenue held at 18.5% of GDPOutlays for interest on debt swamp budget
US taxes comparatively low, room for some increaseTo promote growth, move more to consumption tax
Restraining growth of outlays impeded by philosophical differences
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