Deep Cuts in Non-Security Spending and Ultra-Rapid Economic Growth Won't Balance the Budget preliminary February 2, 2004
Using Centrists.Org's conservative "No-BS" budget baseline, and extrapolating from sensitivity tests published by the Congressional Budget Office (CBO), it is clear that wishing for deep cuts in non-defense, non-homeland security outlays will not re-balance the budget. Neither will sustained super-fast economic growth. Even in combination, deep cuts and sustained rapid economic growth won't be enough to balance the budget.
Outline:
Gimmicks in the President's Budget
The Biggest Gimmick is Wishful Thinking
Wish #1 -- Deep Cuts in Non-Security Spending
Wish #2 -- Sustained Rapid Economic Growth
Double Wish -- Deep Cuts and Rapid Growth
Gimmicks in the President's Budget. The President's budget was released today. It projects a gradually reduced deficit based on several gimmicks:
· A five-year budget "window," which by its nature fails to display the trillion dollar cost of President Bush's top domestic priority -- making tax cuts permanent -- and the cost of Medicare and Social Security as the baby boomers begin to join the entitlement rolls in large numbers after 2010.
· A temporary, one-year patch in the Alternative Minimum Tax (AMT). A full fix of the AMT -- to prevent the alternative tax from negating promised tax cuts and becoming the de-facto tax calculation for the upper-middle class -- would cost hundreds of billions of dollars over the next decade.
· The assumption that overseas military and reconstruction expenditures simply evaporate in 2005.
There are many more gimmicks or dubious assumptions in the budget, and analysts will be hunched over the detailed tables for the next several days looking through the minutiae for other tricks.
For example, the budget assumes a temporary surge in revenues from conversions of IRAs to new savings accounts. However, the President didn't mention this in his State of the Union Address and the Administration does not mean to push this policy in Congress.
For example, the budget would extend the popular child tax credit, marriage penalty relief, and 10 percent bracket only through 2010 (while extending the upper-income tax breaks and estate tax repeal permanently). Political pressure would surely force the extension of the middle class tax cuts too.
For example, the budget includes savings of precisely $23.553 billion over ten years from "program integrity" efforts in funding of health insurance for low-income children. Those sorts of anti-fraud efforts usually fall well short of expectations.
The Biggest Gimmick is Wishful Thinking. The largest, most important gimmick associated with the President's budgetary policy is wishful thinking. Here are three big wishes that underlie the President's new budget. To be fair, these are implied wishes -- they are not directly stated in the budget. Nevertheless, they are the core assumptions behind the Administration's reckless fiscal policy:
Wish #1. Freezing discretionary (non-entitlement) non-defense, non-homeland security spending will greatly improve the spending outlook.
Wish #2. Economic growth will be more rapid than expected (due to tax cuts), and this will greatly improve the revenue picture.
Double Wish. Non-security spending cuts and rapid economic growth together will bail out the budget and eliminate the deficits.
Wish #1 -- Deep Cuts in Non-Security Spending: First, the Administration has repeatedly implied that squeezing non-defense, non-homeland security, non-entitlement spending down to a rate of growth below 1 percent a year will greatly improve the budget picture.
Figure 1 shows the reality. Assuming non-security discretionary spending (about $360 billion in 2004) is immediately cut by 10 percent to $325 billion in 2005, and is then frozen at that amount through 2014 (without any adjustments for inflation or population growth), the overall federal deficit would fall to 4 percent of GDP in 2014. That is an improvement, but it is not a solution.
Figure 1.
Wish #2 -- Sustained Rapid Economic Growth: The second implied wish in the Administration's budget policy is that tax rate cuts will spur economic growth beyond that assumed in the official Administration and Congressional economic forecasts.
However, based on an extrapolation of CBO's sensitivity tests on the subject -- the so-called "rules of thumb" attached to the agency's latest projections -- this wish is also doubtful.
CBO projects that a sustained 0.1 percentage point increase in real GDP growth over the next ten years would reduce the deficit by a cumulative total of about one-quarter of a trillion dollars. By extrapolation, increasing growth by a full percentage point a year (from roughly 3 percent a year under baseline assumptions to 4 percent a year) would reduce the deficit by 10 times that amount, or about $2.5 trillion.
However, this is not nearly enough to re-balance the budget, since the cumulative deficits under conservative assumptions would otherwise exceed $6 trillion over the next 10 years.
Figure 2 shows that assuming 1 percent faster real economic growth throughout the 2005-2014 period would shrink the deficit by about 3 percent of GDP, from about 5 percent in 2014 to 2 percent. This is substantial, but the chances of sustained economic growth at that pace are slim. Growth of 4 percent a year is not uncommon for a few years at a time, but usually recessions intervene. The last time economic growth was so fast for a sustained period of time was in the 1960s.
Figure 2.
These calculations assume that the relationship between GDP growth and the budget is approximately "linear" over a range of growth assumptions between, say, 2 percent a year and 5 percent a year. Most of the impact of real economic growth on the budget is through revenues, and subsequently through debt service. The channels by which faster or slower economic growth results in higher or lower revenues and interest costs are fairly straightforward. Because capital gain and dividend income is taxed at lower rates, and because corporate income taxes constitute a fairly small share of overall tax collections, even explosive increases in asset prices or corporate profits that might be associated with higher-than-expected economic growth would not cause the more basic relationship between the economy and federal revenues to stray very far from its usual proportions.
CBO explicitly recommends against just this sort of extrapolation. However, the results are consistent with our own modeling. Moreover, the reductions in tax rates on high incomes, capital gains, dividends, and estates means that an economic surge that rapidly expands capital income will probably not translate into a "non-linear" burst of revenues.
Double Wish -- Deep Cuts and Rapid Growth: Even if the Administration was granted Wish #1 and Wish #2, the budget would not return to balance.
Assuming deep cuts in non-security spending and continuous rapid economic growth for the next 10 years, the federal deficit would only fall toward 1 percent of GDP (see Figure 3).
Moreover, the first wave of retiring baby boomers begins to affect entitlement programs around 2010. It would get very difficult to maintain progress toward a balanced budget after that point, without additional spending cuts or tax increases.
Figure 3.
Links:
Summary Tables of the President's Budget
Centrists.Org Issue Summary: Budget and Tax (Basics)
Centrists.Org Detailed Issue Summary: Budget Process
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 (Jan. 2004) (January 26, 2004)
Centrists.Org Preparing for CBO's Updated Baseline Projections and the President's New Budget (January 10, 2004)
Centrists.Org Commentary: CBO's New Long-Term Budget Projections (December 22, 2003)
Centrists.Org The Fourth Entitlement: Interest (December 1, 2003)
Centrists.Org Projected Structural Budget Deficit for 2004: $391 Billion (revised November 18, 2003)
Centrists.Org Faster GDP Growth Won't Solve the Budget Problem (November 6, 2003)
