July 15, 2005
THIS YEAR'S DEFICIT PICTURE LOOKS BETTER,
BUT THE LONG-TERM DEFICIT PICTURE DOESN'T
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In its Mid-Session Review released this week, the Office of Management and
Budget (OMB) projected that the 2005 deficit will be $94 billion lower than
the level it projected when it released the President’s budget in February —
$333 billion rather than $427 billion — primarily because of
higher-than-expected revenues. This is welcome news, but the reduction in
this year’s deficit from a very large one to a large one has little bearing on
the nation’s shaky long-term fiscal foundation. In fact, the good news about
this year’s deficit might even turn out to have an adverse effect on the
long-term budget picture if it leads policymakers to become even more
resistant to start pursuing more responsible fiscal policies.
The surge in revenues does not indicate that that the President’s
“tax cuts are working” and substantially boosting economic growth.
Economic growth in 2005 has not been unusually rapid. Nor has it been
stronger than was projected earlier this year. In fact, the Administration’s
estimate of real economic growth in 2005 is exactly the same now as it was in
the February budget. Thus, the larger-than-expected revenue level this year
cannot be due to faster-than-expected economic growth.
Some of the major causes of the revenue surge this year, in fact, are
evidently “one-time” factors that have little to do with economic growth. Most
The expiration of a business tax cut at the end of 2004 has
generated an increase in tax collections of about $50 billion this year,
according to past estimates by the Joint Committee on Taxation. In this case,
revenue collections are up because a tax cut has ended, not because an ongoing
tax cut is generating growth. And since a tax cut can expire only once, another
$50 billion jump next year as a result of this factor is not in the cards.
Corporate tax legislation enacted last October allows businesses
with foreign profits being held abroad to bring the profits back to the United
States and pay taxes on them at a greatly reduced rate if the companies do so
in 2005. This will increase revenues in 2005, as corporations rush to
take advantage of this one-time windfall, but will result in modest revenue
losses in later years, according to the Joint Committee on Taxation.
Another factor behind the recent increase in revenues was the rise in the
stock market in 2004. That resulted in increased capital gains and other taxes
paid earlier this year, when 2004 tax returns were filed. In 2005, however, the
stock market has generally moved sideways rather than upwards.
A recent analysis by the investment firm Goldman Sachs explained that
“The [revenue] bonanza … was mainly a reflection of the prior year’s strength in
economic growth and the stock market… . The fact is that both growth and stock
market momentum have cooled in 2005.” As a result, Goldman Sachs expects much
of the revenue increase to fade.
Revenue growth always occurs during a recovery, whether the recovery is
accompanied by tax cuts or not. This recovery has been unusually weak in a
number of respects, and revenues remain low.
Even with the increase in revenues in 2005, revenues remain at low levels
for this stage of an economic recovery — and continue to be well below the
levels that were forecast for 2005 when the tax cuts were passed.
Moreover, since the recession hit bottom in November 2001, real
economic growth has averaged 3.3 percent per year, which is significantly
below the 4.2 percent average growth rate for other post-World War II economic
The current recovery is weak in terms of employment as well. It took
nearly four years — longer than in any other recovery since World War II — for
the number of jobs to rise back to its pre-recession level. Even in 2005, job
growth has continued to lag well behind that in prior recoveries.
Among non-supervisory workers, moreover, average real wages have actually
fallen since 2003 and are at their lowest level since the end of 2001.
Despite the added revenues, this year’s budgetary situation is nothing to
This year (2005) is the fourth year of the recovery. By this point in
the business cycle, deficits should be small or nonexistent. Instead, OMB is
projecting a deficit of $333 billion.
When measured as a share of the economy, the 2005 deficit will be at a
higher-than-average level for this stage of an economic recovery. This will be
the fourth consecutive year for which that is the case.
The budgetary outlook for future years has not significantly improved.
OMB now is assuming that a large portion of the unexpectedly high level
of revenues in recent months will continue for each of the next five years. OMB
now projects that total revenues over the next five years (2006-2010) will be
$409 billion higher than it projected earlier this year.
That is likely to prove overly optimistic, given the large role that
one-time factors have played in the recent revenue increase. But even in the
unlikely event that OMB’s revenue assumptions prove correct, deficits over the
2006-2010 period still will be considerably higher than OMB is now assuming,
because OMB’s projections:
include no funding whatsoever after 2006 for operations in Iraq
also include no funding after 2006 for the broader war on
assume no costs for continuing relief from the Alternative Minimum
These left-out costs will likely prove quite substantial. Simply
extending the current form of AMT relief would cost more than $750 billion
between 2006 and 2015, for example.
When these costs are taken into account, it is clear that the budget
outlook for the next ten years and beyond under the President’s proposed
policies remains rather bleak, even if OMB’s optimistic assumptions regarding
future revenue growth are borne out. Deficits will begin to grow at the
beginning of the next decade and mount to quite high levels by 2015. The budget
situation will deteriorate further in the years after 2015 as increasing numbers
of baby-boomers retire and per-person health care costs continue to grow faster
than the economy.
As Congressional Budget Office director Douglas Holtz-Eakin noted earlier
this month about the recent revenue surge, “I do hope people are taking this
with a grain of salt. . . . There’s simply no question if you take yourself to
2008, 2009, or 2010, that vision is the same today as it was two months ago.”