More Good News on Jobs -- More Bad News on the DeficitJeff Lemieux
revised May 13, 2004
to fix a typo in the footnote to Table 1
First, the good news: Last Friday, the Bureau of Labor Statistics reported that the number of payroll jobs rose by about 288,000 in April, following a revised increase of 337,000 in March. These were the first substantial jumps in job creation since the recession began in 2001. The unemployment rate fell slightly from 5.7 percent in March to 5.6 percent in April.
The bad news is that the budget deficit keeps getting worse. The Congressional Budget Office (CBO) released its Monthly Budget Review for April on May 6. Through the first seven months of the fiscal year, the federal deficit was $82 billion higher in 2004 than in 2003, 40 percent worse than last year's deficit pace. Needless to say, there was no big "April surprise" of unexpected revenues this tax filing season.
CBO does say revenues are coming in slightly better than expectations, possibly due to "timing" issues (there was an extra Friday in April this year when tax refund checks were mailed out). However, spending growth remains very high, and more military spending is on the way.
On balance, the deficit will probably total about $450 billion this year, up from $375 billion in 2003. Importantly, CBO was already predicting strong economic growth in 2004 and 2005 and rapid growth in revenues in 2005 and 2006. So it would take an extraordinary surge in economic activity and revenues to improve the dismal budget outlook. Tax-cut fanatics who believe revenues will soon start to pour in and reduce the deficit are almost certain to be disappointed.
Outline:
The Economy is Showing Real Strength
The April "Revenue Surprise" Was a Fizzle
Economic Growth Alone Won't Solve the Budget Problem
Comment: A 1990s-Style Recovery, or a Nixonian Burst of Growth?
The Economy is Showing Real Strength: Two months don't usually make a decisive trend. However, the strong March and April employment numbers show that the labor markets are finally starting to improve. With that, the final piece of the economic recovery puzzle has slid into place. GDP growth has been strong since the third quarter of 2003, and with employment rising, it seems clear that a vigorous economic recovery is underway.
Figure 1 shows the upward momentum in the number of payroll jobs.
Figure 1.
If the March-April pace of job growth continues, the number of payroll jobs would reach its pre-recession peak this October.
That's good news and bad news for President Bush. On the one hand, job growth will put workers in a better mood this fall. On the other hand, it would highlight the fact that no jobs were added during his entire-4 year term.
Figure 2 compares the jobs performance of the U.S. economy in the last three recessions. Even with April's strong data, the total number of jobs is down by 1.6 million from the peak reached in March of 2001.
Figure 2.
The April "Revenue Surprise" Was a Fizzle: Anti-tax zealots like to discount the official budget projections. They assume those boneheaded estimators at CBO and the Joint Committee on Taxation (JCT) just don't understand that tax cuts cause such rapid economic growth that the Treasury will receive a huge, unexpected surge in federal revenues, despite the tax cuts themselves.
However, so far this year, the revenue projections have been roughly accurate (see Table 1).
Table 1.
| 2004 Revenue Growth |
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|
|
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| (annual percent change) |
|
|
|
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| |
|
|
|
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|
| |
|
Fiscal Year 2004
Through April |
CBO March 2004
Forecast for FY2004 |
| |
|
|
|
|
|
| Income Taxes |
|
-4.2 |
|
-4.0 |
|
| Payroll Taxes |
|
2.1 |
|
4.8 |
|
| Corporate and Other Taxes |
19.2 |
|
12.0 |
|
| |
|
|
|
|
|
| Total Revenues |
1.5 |
|
2.0 |
|
| |
|
|
|
|
|
| Sources: Centrists.Org, Congressional Budget Office. |
|
| Note: Fiscal Year 2004 preliminary estimates for October 2003 through April 2004, compared with the |
| same period a year earlier. |
|
CBO's latest report says that revenues through April were $30-40 billion higher than expected. That's hard to verify from Table 1, which shows that the earlier revenue forecasts appear to be right on track.
However, revenue flows bounce around throughout the year, and timing oddities between years can skew comparisons.
Moreover, revenues were especially weak in July and August of 2003, due to the tax cuts. By comparison, that will make this summer's revenues look especially strong. Finally, since revenues lag economic activity, it also makes sense that revenue growth will be stronger in the last 5 months of fiscal year 2004.
On balance, however, it is now clear that CBO's revenue projections aren't far out of line, and there is still no reason to expect that a continuing surge in economic growth will bail out the federal budget. CBO does not currently expect revenues for all of 2004 to come in more than $30 or $40 billion higher than previously anticipated.
Economic Growth Alone Won't Solve the Budget Problem: It would take an implausible, nearly impossible surge in economic growth and revenues to bring the budget into balance. That is because CBO and other forecasters already assume rapid economic growth in 2004 and 2005, and a surge of revenues in 2005 and 2006 (see Figure 3.)
Figure 3.
Rapid growth and higher revenues are already "built in" to the baseline estimates. Yet the budget is still projected to stay deeply in the red. It will be hard to "surprise" the current projections on the upside.
CBO assumes real GDP growth will be a brisk 4.8 percent this calendar year, and 4.2 percent in 2005. (By comparison, economic growth was 3.1 percent in 2003 and 4.2 percent in the first quarter of 2004.)
Revenues are projected to grow by a whopping 13 percent in fiscal year 2005 and 10 percent in 2006. That's over 7 percentage points faster than nominal GDP growth in 2005 and over 5 percentage points faster than projected GDP growth in 2006. By comparison, during the Clinton presidency between 1993 and 2000 -- which conservatives decry for its high tax burdens -- revenues grew by an average of only 2.3 percentage points faster than nominal GDP.
(Nominal GDP growth, which is not adjusted for inflation, is the best comparison measure for tax revenues, which are also not adjusted for inflation.)
A chunk of the projected revenue surge in 2005 and 2006 is based on the dubious assumption that Congress won't extend some tax cuts that hit their "sunset" or expiration dates at the end of 2004. If fact, Congress is likely to extend some of the tax cuts that would otherwise expire, and legislators may throw in some additional election-year tax cuts for good measure.
For example, the House just voted to spend $105 billion to further reduce marriage penalties in the income tax, and is scheduled to vote soon on additional tax cuts. According to press reports, the Senate has larded a must-pass bill designed to comply with a world trade decision and forestall punitive tariffs on U.S. products with $170 billion in new tax cuts.
Congress is almost certain to pass an extension of tax provisions designed to prevent the noxious Alternative Minimum Tax (AMT) from ensnaring millions more middle-income taxpayers. (CBO's new report on the AMT, which estimates that 90 percent of all taxpayers with incomes between $100,000 and $500,000 will pay the AMT by 2010, should be required reading for policymakers.)
Figure 3 compares the projected growth in revenues with that of nominal GDP, using two alternative assumptions:
1. The CBO assumption that all tax cuts expire as scheduled and no new tax cuts (or tax increases for that matter) are enacted.
2. The assumption that all tax cuts are extended indefinitely past their sunset dates -- including the AMT provisions -- but no new tax cuts are enacted. This assumption is used by Centrists.Org and many other budget observers.
In either case, revenue growth is already projected to be quite high over the next couple years. Therefore, it is unlikely that that it will be much higher than expected, even if sustained economic growth exceeds CBO's already-optimistic forecast.
If revenues aren't going to bail out the budget, is there a chance that Congress can and will lower spending sufficiently to balance the budget?
The short answer is "no." First, Recent military and political setbacks in Iraq make it likely that overseas military spending will be increased, not decreased. The Administration had just asked for an additional $25 billion in military spending, some of which could be spent this fiscal year (most of the outlays would probably fall in 2005). Congress expects another supplemental request for $50 billion after the elections this fall.
Second, CBO already assumes a very modest trend in discretionary spending. After 2005, CBO assumes spending for non-entitlement programs grows by only 2 percent annually, despite the fact that this category of spending has risen by an average rate of 9.5 percent a year since 2000.
Third, spending on interest to service the national debt is poised to soar (see Figure 4). Interest rates are rising, and each year's huge deficit raises the national debt accordingly. According to CBO, federal interest spending will double, from $155 billion in 2004 to $318 billion in 2010.
Assuming that tax cuts don't expire and that discretionary spending grows by 4-5 percent a year, Centrists.Org projects that interest costs would approach $400 billion a year by 2010.
Figure 4.
Comment: A 1990s-Style Recovery, or a Nixonian Burst of Growth? The big political question is whether the economy has gotten a sufficient bang for the deficit buck.
Given the extraordinary amount of economic stimulus in place over the last two or three years (ultra-low interest rates and the switch to large budget deficits), it is odd that a robust economic recovery didn't start sooner. Presumably, a lack of business confidence -- caused by deficits, war and terrorism worries, and the slow resolution of business accounting scandals -- held the economy back.
Now we must ask: Is a long-lasting 1990s-style recovery taking hold? The "jobless" recovery from the 1990-1991 recession took a long time to get underway, but once in place, economic conditions remained excellent for many years. (The 1990s recovery was accompanied by deficit reduction in Congress.)
Or will this recovery be more like the short-lived burst of economic growth in 1972 and 1973, which was also fueled by war spending, low interest rates, and a political desire to boost growth prior to an election?
On balance, we're better off now than in 1972, because productivity growth remains very strong. By contrast, growth in labor productivity dropped to very low rates beginning around 1973, as the economy adjusted to the new baby boomer workforce and higher energy costs.
But while it took the economy time to digest the baby boomers into the labor force in the 1970s, we now have to face that huge generation's staggering retirement costs, beginning in about 2010. The cost of funding the baby boomers' entitlements could negate much of the hard work and innovation that is behind the nation's decade-long spell of rapid productivity growth.
Links:
Centrists.Org Mortgaging the Future in Blueprint, the magazine of the Democratic Leadership Council
(May 7, 2004) Large budget deficits and ultra-low interest rates provided an enormous economic stimulus over the last three years. We will eventually have to pay for that stimulus, either with higher taxes, lower government spending, or higher interest rates.
Centrists.org It's The Sunsets, Stupid! CBO and JCT Should Show the Extended Cost of Expiring Provisions (May 3, 2004) The use of sunset provisions has distorted the budget process and can make a mockery of budget rules. The Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) should show the full, 10-year cost of expiring tax cuts or spending bills in the footnotes to their official estimates.
Centrists.Org Latest Economic Data -- Growth, But No Cigar (April 30, 2004) Many economists expected the first quarter of 2004 to be a near-boom -- instead, it was just a pretty good quarter.
Centrists.Org Budget Outlook Looking a Little Better in 2004? (April 8, 2004) New monthly budget figures imply that the deficit will be worse than last year, but a little better than forecast, possibly in the range of $425 to $450 billion.
Centrists.Org Realistic Budget Targets and Some Initial Deficit Reduction Options (February 21, 2004) Congress should reduce spending to 19 percent of GDP and raise revenues to 18 percent of GDP by 2007. It will require letting some tax cuts expire and "unaccelerating" others, reducing appropriations throughout the budget, and re-visiting the recently passed agriculture and prescription drug laws.
Centrists.Org The Fourth Entitlement: Interest (December 1, 2003) The discussion of entitlement reform is often limited to Social Security, Medicare and Medicaid. However, interest on the public debt is poised to become the largest and fastest growing entitlement over the next 30 years.
