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Federal Spending and Revenue Needs Will Grow

Spending and revenues will have to grow significantly as a share of the economy in coming years just to enable the federal government to continue carrying out existing functions that the public widely supports, our new analysis concludes. As policymakers consider tax reform this fall, ensuring adequate revenues to fund national needs should be a primary consideration.

A few basic realities drive this result: the aging of America’s population, health care costs that rise faster than the economy grows (especially as medical advances continue), potential national security threats, current and emerging domestic challenges such as large infrastructure needs that the nation can’t defer indefinitely, and rising debt-service costs. Those factors will boost federal spending by about 2-1/2 percent of gross domestic product (GDP) between now and 2035, we estimate. (See figure.)

The pressures for higher spending mean that revenues will also need to rise to prevent the debt from growing as a share of GDP (that is, the debt-to-GDP ratio). Reducing the debt ratio would require even more revenues.

It’s hardly a controversial notion that federal spending and revenues will have to rise as a percentage of GDP. Budget plans from such diverse organizations as the National Academy of Sciences, Bipartisan Policy Center, and American Enterprise Institute have found that spending and revenues need to exceed their historical averages in coming decades even if policymakers make significant budget cuts.

Higher taxes and spending need not be a barrier to economic growth, as past U.S. experience — for example, following the tax increases enacted in the early 1990s and at the end of 2012 — and that of other countries show. Policymakers should structure tax increases to promote economic efficiency and other important social objectives, such as by putting a price on greenhouse gas emissions and curbing inefficient tax deductions and exclusions —known collectively as tax expenditures. Higher taxes can also be growth-promoting if used to finance investments in public education, infrastructure, public health, basic research, and other forms of physical and human capital.

Given the long-run budgetary pressures due to the aging of the population, rising health care costs, and other factors, tax reform ought to raise revenues to help reduce projected federal deficits and debt. At an absolute minimum, policymakers should draw a bright line and insist that tax reform not lose revenues, either in its first decade or beyond.

Former Treasury Secretary Lawrence Summers, speaking today at CBPP, put it this way: “This is no time to sacrifice much-needed government revenue at the altar of tax cuts. Capital costs have never been lower for American corporations. Growth benefits will be negligible and the costs of a constrained public sector down the road will be felt by all Americans.”