Heritage vs. the Center on Budget -- Is Spending Too High, or Are Revenues Too Low? February 8, 2004
Two of the most influential think tanks in Washington have squabbled in recent weeks over definitions of federal spending and the accuracy of some political talking points. But the dispute masks larger truths. The conservative Heritage Foundation says spending is growing too rapidly and the liberal Center on Budget and Policy Priorities says revenues have fallen too low. Both are right.
Outline:
Conservatives Say Spending Is Too High
Liberals Say Revenues are Too Low
Failure to Re-Prioritize Spending and Revenues After 9/11
Even if the Economy Booms, Federal Revenues Might Not
Conservatives Say Spending is Too High. The Heritage Foundation, in a series of articles by Brian Riedl, has documented the rapid growth of federal spending over the last 3 years (see Figure 1).
Figure 1.
Liberals Say Revenues are Too Low. In response, the Center on Budget and Policy Priorities has raised questions about Heritage's calculations and terminology. By the Center's measure, outlays for domestic social programs -- including programs for the poor -- are not the cause of the surge in spending. The implication, therefore, is that spending for the poor should not be cut to solve the budget problem.
But regardless of which sort of spending is at fault, the larger point that federal outlays are rising rapidly remains true.
The Center's most important contribution is the emphasis on the shocking decline in federal revenues. Total revenues (as a percent of GDP) are now at their lowest point since the 1950s (see Figure 2, below).
Figure 2.
Failure to Re-Prioritize Spending and Revenues After 9/11. At the most basic level, both think tanks are right, and for the same reason:
1. Spending Is Too High (because we have not re-prioritized since September 11)
2. Revenues Are Too Low (because we have not re-prioritized since September 11)
Figure 3 shows the trends in outlays and revenues as a percent of GDP over the last 6 years. Spending has increased by about 1.5 percent of GDP since 2001.
Most of this is military spending and new outlays for homeland security. But in the permissive fiscal climate in Washington -- prompted by a lack of political courage from both the White House and Congressional leaders -- spending for non-security programs has also risen. There have been no big cuts in social programs, agriculture, entitlements, transportation, education, and there have been some big, politically inspired increases.
Figure 3.
Meanwhile, revenues have fallen by 4 percent of GDP since 2001. Most of this was due to tax cuts enacted in 2001, 2002, and 2003.
Regardless of whether or not the tax cuts were appropriate for fighting recession and sparking economic recovery, there is little reason not to raise revenues now. The economy is growing (3.1 percent in 2003), and it can tolerate additional taxes sufficient to at least partially close the gap between spending and revenues.
The huge deficits raise the national debt, and debt service payments are poised to explode when interest rates rise in coming years.
On balance, we will need a mix of spending reductions and tax increases. There is little chance that an economic boom will close the budget gap all by itself.
Even if the Economy Booms, Federal Revenues Might Not. The Bush Administration and the Congressional leadership seem to believe that
1. the economy will boom over the next several years, and
2. revenues will surge as the economy booms.
To be fair, neither of these beliefs are reflected in the President's budget or the Congressional budget assumptions. They would be denounced as fanciful -- a "rosy scenario." But they remain the behind-the-scenes working assumptions behind U.S. economic policy.
Figure 4 (below) shows that under standard assumptions, even a sustained rapid 4 percent rate of real (inflation-adjusted) economic growth is unlikely to bring the budget back into balance.
A surge in GDP growth could lead to a spike in corporate profits, a rapid rise in stock prices, and a boom in incomes at the top of the income scale.
However, over the last three years we have reduced tax rates for capital gains, dividends, and high incomes. Meanwhile, effective corporate profit tax rates remain very low.
Therefore, with reduced tax rates on the forms of income likely to boom first, we will see a more restrained increase in federal revenues.
It's true that a sustained boom would significantly reduce the budget deficit. But with the baby boom generation poised to begin joining the entitlement rolls in a few short years, we need to do more. We need to get the budget back in balance, which will mean painful spending cuts and tax increases.
Finally, suppose we have a super-boom, with growth rates well above 4 percent for the next couple years. That would bring the budget closer to surplus than Figure 4 shows.
But the chances of a super-boom are small, and in any case, it would almost certainly be followed by a recession. Super-booms generally do not last -- in developed countries, booms inevitably sow the seeds of subsequent economic declines.
Wishing for an economic boom and a magical surge in revenues is not an economic strategy.
Figure 4.
Links:
Heritage Foundation Omnibus Spending Bill Hikes Discretionary Spending by 9 Percent in 2004 by Brian M. Riedl (December 16, 2003)
Heritage Foundation $20,000 per Household: The Highest Level of Federal Spending Since World War II by Brian M. Riedl (December 3, 2003)
Heritage Foundation Most New Spending Since 2001 Unrelated to the War on Terrorism by Brian M. Riedl (November 13, 2003)
Cato Institute Bush Spending Chart Page
Center on Budget and Policy Priorities Is Domestic Spending Exploding? An Assessment of Claims by the Heritage Foundation and Others by Robert Greenstein, David Kamin, Richard Kogan, and Joel Friedman (revised February 1, 2004)
Center on Budget and Policy Priorities The Omnibus Appropriations Act: Are Appropriations for Domestic Programs Out of Control? by Richard Kogan (revised February 1, 2004)
Center on Budget and Policy Priorities A Point-by-Point Response to Heritage Foundation Claims About Federal Spending (revised January 30, 2004)
Centrists.Org Issue Summary: Budget and Tax (Basics)
Centrists.Org Issue Summary: Budget Process
Centrists.Org Deep Cuts in Non-Security Spending and Rapid Economic Growth Won't Balance the Budget (February 2, 2004)
Centrists.Org CBO: Faster Real GDP Growth, Lower Revenues, Higher Deficits and Interest Costs Ahead (January 26, 2004)
Centrists.Org No-BS Long-Term Budget Baseline
