Why the surplus has disappeared

• This series of tables and short papers reflect the latest budget estimates, issued by the Congressional Budget Office on August 27, 2002.

  Why the Surplus Has Disappeared What Part of the Shrinkage Was Under Congress’s Direct Control? Revenue Losses, Not a Spending "Explosion" Why Projected Surpluses Have Disappeared What Has Happened to Debt and Interest on the Debt? CBO vs. OMB What Is Missing from the Projections? PDF of all seven analyses.

  Related reports: The New Congressional Budget Office Forecast and the Remarkable Deterioration of the Surplus Recent Federal Budget Analyses

  The $5.6 trillion, ten-year surplus projected in January 2001 has declined by $5.3 trillion, or 94 percent.

• Moreover, about 96 percent of the remaining ten-year, $336 billion surplus occurs in 2011.  Most of the surplus projected for 2011 is based on the assumption that last year’s tax cut will expire at the end of 2010.

• Table 1 shows that last year’s tax cut is the largest single reason the ten-year surplus has shrunk since January 2001.  The tax cut amounts to 31 percent of the total deterioration, and when the tax cut provisions of the stimulus bill are added in, tax cuts account for about one-third of the total deterioration.  (Note: these figures are artificially low because they assume the tax cut will expire at the end of 2010.)

• Most of the downward revenue reestimates (outside of those caused by tax cuts) are the result of “technical” factors, rather than because of the recession or a generally less optimistic economic forecast.  In other words, the revenue models used a year ago were too optimistic.  The recession is responsible only for a modest fraction of the downward revenue reestimates.

• The bulk of spending increases since January 2001 have been for defense, homeland security (including cleanup and reconstruction after the terrorist attacks), and international affairs.  Together, they account for 16 percent of the deterioration in the ten-year projected surplus.  Increased appropriations for domestic programs outside homeland security account for only 4 percent of the deterioration.

• The bottom-line estimate shown in Table 1 — a projected $336 billion surplus over ten years — itself is likely to prove illusory.  It assumes the tax cut will expire at the end of 2010 and omits a range of costs on both the tax and the spending side that are likely or almost certain to be incurred.  See Table 6.

What Part of the Shrinkage Was Under Congress’s Direct Control?

• Congress and the Administration are not directly responsible for revenue shortfalls outside of those caused by tax cuts, although they could have adopted less rosy estimates in January 2001 or left a larger margin for error.

• Of the costs that Congress and the Administration were directly responsible for, tax cuts are the largest factor.  They account for 56 percent of the deterioration in the ten-year surplus that Congress and the Administration are responsible for.

• Increases in defense, homeland security, and international programs are the second largest factor, accounting for 28 percent of the deterioration in the ten-year surplus for which Congress and the Administration are responsible.

• Increases in domestic spending (outside of homeland security) account for less than 15 percent of the surplus deterioration Congress and the Administration are responsible for.  This figure includes both appropriated (or “discretionary”) programs and entitlements such as those covered by the recent farm bill.

• Combined, the first three items listed in Table 2 — last year’s tax cut, the stimulus bill, and increases for defense, international affairs, and homeland security — account for 87 percent of the total deterioration in the ten-year surplus for which Congress and the Administration are responsible.  They account for a similar percentage in both the short run and the long run, because as the stimulus bill phases out, last year’s tax cut phases in.  In each of these three areas, the President is calling for additional costs: larger permanent tax cuts, more “stimulus” tax cuts, and larger increases in defense spending.

Revenue Losses, Not a Spending “Explosion”

• Table 3 shows the combined effects of legislation and of economic and technical reestimates from January 2001 through August 2002.  As with all tables, we attribute the cost of debt service (payments of increased interest on the debt) to the revenue loss or programmatic spending increase that caused the surplus to shrink.

•  Table 3 shows that revenue losses from all causes are the overwhelming reason the ten-year surplus projection has shrunk by $5.3 trillion.  Revenue losses account for 82 percent of the deterioration in the surplus.

• Increased costs of defense, homeland security, and international programs account for 16 percent of the deterioration.  Domestic spending increases outside of homeland security account for two percent of the deterioration.  (Projections of domestic spending have changed since January 2001 both because of legislative increases and because of reestimates of the costs of entitlement programs; some of those reestimates have been downward.)

• The notion in early 2001 was that the government was collecting “excess” revenues that would not be needed to pay off the debt or to finance the education, defense, or health initiatives in the budget the President proposed that February.  One argument the Administration and others advanced for last year’s tax cut was that without it, the government might pay off the national debt too quickly.  The new projections indicate that the revenue projections of January 2001, on which the tax cut was based, substantially overstated revenues.

The pie chart below depicts the same ten-year data in graph form, dividing the revenue losses (and associated debt service costs) between last year’s tax cut and all other causes of revenue losses.

WHY PROJECTED SURPLUSES HAVE DISAPPEARED

What has happened to debt and interest on the debt?

• CBO’s projections of publicly held debt and of interest payments on that debt have changed radically since January 2001.  In the beginning of 2001, CBO projected the elimination of the publicly held debt before 2011.  Now CBO projects that the debt will be $3.2 trillion that year.

• Over the ten-year period 2002-2011, interest payments on the debt are now projected to be $1.3 trillion higher — or more than three times as high — as CBO projected at the start of 2001.

• Some have used the increase in interest costs to buttress their claim that the surplus has shrunk because of a “spending explosion” — they have compared the projection of total federal spending (including interest) issued in January 2001 with the current projection and noted a substantial increase.  This is a serious misuse of data; increases in interest costs that are caused by tax cuts and downward reestimates of revenues should not be misrepresented as increases in spending caused by Congressional excesses in increasing funding for defense or other government programs.

• In fact, increases in interest costs caused by tax cuts and by downward reestimates of revenue are larger than spending increases for all other reasons combined (i.e., for increased funding for defense, homeland security, international and domestic programs, the farm bill, and the like, plus debt service costs on those pieces of legislation).  In other words, the tax cut and revenue shortfalls are responsible for more “spending increases” than all real spending increases combined.

CBO vs OMB

Previous tables in this series of analyses have covered the ten-year period 2002-2011 because CBO’s projection of January 2001 extended only through 2011.  Subsequent tables cover the period 2003-2012, which is the projected ten-year period CBO covers in its new report.  Through 2012, CBO projects a $1 trillion surplus.  But 83 percent of that surplus occurs in the last two years, after the tax cut is scheduled to expire. 

• CBO’s figures themselves reflect considerable optimism about the economy; CBO assumes that productivity will grow at two percent per year on average, which is almost the average growth rate of the period 1996-2001 and is noticeably higher than the average growth rate from 1991 through 1995.  There is a risk that the actual rate of productivity growth will not be this high.

• CBO’s new projections suggest that OMB’s “mid-session” figures released in July are too optimistic by more than $900 billion over ten years.  Some 98 percent of the difference occurs because of OMB’s rosier view of future revenue collections.  Given CBO’s optimism about both short-run and long-run economic growth, it is significant and potentially disquieting that OMB is almost $1 trillion more optimistic than CBO.

WHAT IS MISSING FROM THE PROJECTIONS?

CBO and OMB baseline projections merely reflect current law and therefore understate the likely further deterioration of the budget that is expected to occur as a result of legislation that is highly likely or virtually certain to be enacted.[1]

•  Major potential costs not reflected in the baselines include: the extension of tax cuts that are scheduled to expire within the decade; relief from the exploding reach of the individual Alternative Minimum Tax (AMT); the increase in defense funding requested by the President; and a prescription drug benefit.  The new CBO baseline essentially assumes that the entire tax cut will expire on schedule, the number of taxpayers subject to the AMT will rise from two million today to 35 million by 2010, defense funding will remain at current levels rather than the increased levels the President has requested, etc.

End Note:

[1]   When creating baseline projections, CBO and OMB both follow definitions and rules spelled out in the Balanced Budget and Emergency Deficit Control Act.  Those rules establish a baseline against which legislation can be measured for purposes of enforcing the “pay-as-you-go” rule and the discretionary caps established in 1990.  While such enforcement is officially due to expire September 30, that Act nonetheless provides the only statutory definition of a baseline.  CBO and OMB avoid controversy — and conceptual measurement differences with each other — by following those definitions.