Does the Increase In Revenues Mean the Budget Outlook Has Turned Around?
Ed Lorenzen
May 10, 2005

On May 5, the Congressional Budget Office (CBO) released new monthly budget figures, which indicates that if revenues and outlays maintain their current trend, the deficit will be better than forecast, possibly in the range of $350 billion.  This improvement is due almost entirely to higher than anticipated revenues. 

Some in Congress cited this report as evidence that the fiscal policies of the last five years are working.  However, the recent surge in revenues just partially begins to restore the decline in revenues over the last several years.

In January CBO projected that the fiscal year 2005 deficit would be $368 billion.  This estimate did not include the costs of the supplemental for military operations in Iraq and Afghanistan, which CBO now estimates will result in outlays of $30 billion in 2005. 

For the first 6 months of this fiscal year, the deficit was to $235 billion, $49 billion below the $284 billion incurred through the same period last year.  The deficit so far this year is 17 percent lower than last year.  CBO project that if the next 6 months continue on this trend, the full year deficit “will probably be well below $400 billion, perhaps in the vicinity of $350 billion."  A $350 billion deficit would be nearly $50 billion lower than CBO projected in January after taking the supplemental appropriations for Iraq into account.

The primary reason for this decline in the deficit is the rapid increase in revenues.  Total revenues for the first six months of this year were 13.6% higher than they were last year, more than CBO had assumed in it’s January baseline.  Revenues from individual income taxes increased slightly faster than CBO anticipated at 16%, but the primary source of the increase in revenues came from corporate income taxes, which were 48% higher than the same period last year.  CBO cautioned that it is difficult to predict whether the rapid increase in corporate tax revenues so far this year will continue for the remainder of the year because corporate taxes paid so far this year reflect corporations’ 2004 profits.  If corporate income taxes based on 2005 activities do not continue the rapid growth of the last six months, the final deficit for 2005 could be much higher than $350 billion.

As figure 1 illustrates, the recent increase in revenues just begins to reverse the decline in revenues since 2000 when Washington was awash in talk of large projected surpluses as far as the eye can see. Even with the recent surge in revenues, total revenues in 2005 will be only slightly higher than they were in 2000 and still considerably lower than 2000 when adjusted for inflation.  If the deficit declines to $350 billion for 2005 and entire improvement in the deficit forecast since January is attributable to higher than expected revenues, total revenues would be $2.105 trillion in 2005.  Actual revenues in fiscal year 2000 were $2.025 trillion, approximately $2.275 trillion in today’s dollars.  The results are even more pronounced when payroll tax receipts, which have been steadily increasing over the last five years.  If current trends continue, total revenues excluding payroll taxes this year will be approximately $1.315 trillion, $65 billion lower in nominal dollars than in 2005.

Figure 1:

Source: CBO

An examination of the recent history of revenue projections provides further reason for caution before jumping to conclusions about what the recent trends mean for the budget outlook going forward.  In January of 2001 CBO projected unified budget surpluses of $1.8 trillion from 2001 through 2005 and $5.6 trillion over the next ten years.  These projections were based in large part on assumptions that the trend of rapidly increasing revenues in the late 1990s would largely continue, with revenues projected to grow from $2.025 trillion in fiscal year 2000 to $2.570 trillion this year. 

As Figure 2 illustrates, actual revenues have been considerably lower than were projected in January of 2001.  Over the last five years, actual revenues have been $2.125 trillion lower than CBO projected in January of 2001.  Approximately $775 billion in this reduction was a result of tax cuts enacted since then, with the remaining $1.35 trillion the result of economic and technical changes.  The lower than projected revenues are responsible for more than 70% of the reversal in the budget outcomes over the last five years compared to the projections in January of 2001.

Figure 2:

Source: CBO and Centrists.Org

CBO made its projections of continued strong revenue growth in January of 2001 after examining the data from several years of higher than expected revenue growth. Even then, CBO warned policymakers that the projections were highly uncertain and there were no guarantees that the factors that caused revenues to increase rapidly in the late 1990s would continue.  In testimony before the Senate Budget Committee, then CBO Deputy Director Barry Anderson cautioned, “the U.S. economy and the federal budget are highly complex and are affected by many economic and technical factors that are difficult to predict.”  Policymakers chose to ignore these caveats and treat the projections as money in the bank that could be used to justify large tax cuts and increased spending. 

The recent increase in revenues has occurred over a much shorter period of time and provides much less evidence to determine whether the trend will continue than the revenue increases of the late 1990s that led to the projections of large surpluses in 2001. Consequently, any assumptions regarding revenue growth in the next few years based on the recent growth in revenues would be even more uncertain than the projections made in 2001. Policymakers should not repeat the mistakes of 2001 by allowing improvements in the budget outlook from higher than expected revenues serve as an excuse to relax fiscal discipline.

Links:
May 2004 CBO Monthly Budget Review