February 12, 2003
ARE TAX CUTS A MINOR OR MAJOR FACTOR IN THE RETURN OF DEFICITS?
WHAT THE CBO DATA SHOW
by Richard Kogan
Over the last two years, the federal budget has gone from surplus to deficit. At the same time, Congress enacted major tax cuts. What role did those tax cuts play? Mitchell Daniels, the Director of the President’s Office of Management and Budget, has characterized the role of the tax cuts as “minor” and said that the budget would be in deficit even without them. The three short analyses that constitute this paper examine this question, based on the extensive data that the Congressional Budget Office issued in late January. The analyses find the following:
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- The CBO data show that one-third of the deterioration in the budget since 2000 has been caused by tax cuts enacted in the last two years. This makes the tax cuts one of the principal factors in the deterioration, rather than a minor element. Moreover, the share of the budget deterioration that is attributable to the tax cuts grows larger each year over the course of the decade.
- According to the CBO data, the recession, along with defense, homeland security, and other spending increases, would have driven the budget into deficit in 2002 and 2003 even without the tax cuts. But the budget would be back in surplus in 2004 and every succeeding year for the rest of the decade were it not for the tax cuts. (This CBO projection excludes the cost of policies not yet enacted, such as further defense increases, a war, or further tax cuts.)
- The CBO estimates do not reflect any impacts that tax cuts and spending measures enacted in 2001 and 2002 may have had on the economy. The President’s Council of Economic Advisers argues that the tax cuts have stimulated economic growth and that the recession would have been worse without them. The CEA has issued specific estimates of how much worse it would have been. Yet if one uses the CEA estimates on this matter — which are favorable to the Administration and portray the tax cuts as having had larger economic effects than some studies indicate — the tax cuts still would have been responsible for almost 30 percent of the budget deterioration since 2000. There is no escaping the fact that the tax cuts are one of the primary factors behind the deterioration.
- One also can examine the extent to which various types of federal legislation have contributed to the budget deterioration. The CBO data show that over the last two years, Congress enacted legislation that cost an average of $260 billion a year in 2003 and 2004. The CBO data also show that $150 billion — or 58 percent — of this $260 billion annual cost resulted from the tax cuts. These data demonstrate that the cost of the tax cuts substantially exceeded the combined costs of increases for the military, homeland security, foreign aid, the farm bill, and all other legislation. (Even if one uses the CEA assumptions regarding the effect of the tax cuts on economic growth, the tax cuts still account for 54 percent of the cost of the legislation enacted over the past two years.)
- Finally, under the Administration’s new budget — which would make the 2001 tax cut permanent, add further tax cuts on top, and institute some program expansions such as a prescription drug benefit — the federal budget would remain in deficit forever. The projections of permanent deficits come from the Administration itself. They are shown in a 75-year table in the OMB budget volume entitled Analytical Perspectives.
Structure of This Analysis
This analysis takes the form of three short papers that examine the role of tax cuts in three ways.
Part 1 uses new estimates issued by CBO to compare the estimated deficits in 2003 and 2004 with the actual surplus in 2000. It addresses the question, “How much of the budget deterioration from the actual surplus in 2000 to the estimated deficits in 2003 and 2004 has been caused by enacted tax cuts?”
Part 2 uses new CBO estimates to compare the estimated deficits in 2003 and 2004 with projections for 2003 and 2004 that CBO issued in January 2001. It addresses the question, “How much of the deterioration in the projected budget is attributable to the tax cuts?” In other words, Part 2 compares two-year-old projected budget figures for 2003 and 2004 with the most up-to-date CBO projections for 2003 and 2004.
Part 3 examines the claim that the economy would have been even worse without the 2001 tax cuts. If the tax cuts stimulated the economy (and therefore generated some extra revenue), the net cost of the tax cuts would be less than CBO reported. Using an analysis by the President’s Council of Economic Advisers that is favorable to the Administration, we translate the positive “economic feedback” assumed by the CEA into a favorable estimate of “revenue feedback.” Part 3 then compares the results found in Part 1 and Part 2, using CBO estimates, with the more favorable view of the net cost of the enacted tax cuts implied by the CEA estimates.
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 All estimates of the cost of the tax cuts enacted in 2001 and 2002 come from a publicly available table that CBO issued as backup to its recent annual report, The Budget and Economic Outlook: Fiscal Years 2004-2013, January 29, 2003. In this table, CBO shows the cost through 2011 of all legislation enacted since 2001. The table also shows the amount by which projected payments of interest on the debt have increased because legislation causes the debt to be higher than projected in 2001. The figures we use in this analysis for the cost of legislation cover both the direct costs of such legislation (e.g., the revenue losses from a tax cut) and the interest costs.
In addition, the CBO table shows the amount by which surpluses projected in 2001 have decreased for reasons other than legislation and interest on it, i.e., because the 2001 projections were based on economic and related assumptions that are now recognized as having been overly optimistic.