July 13, 2005


By James Horney and Richard Kogan

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The Mid-Session Review released July 13 by the Office of Management and Budget is consistent with a recent report from the Congressional Budget Office that shows revenues for fiscal year 2005 will be significantly higher than estimated earlier this year and that the deficit for 2005 consequently will be lower than was projected.  According to OMB, the deficit for the current year will be $333 billion, or $94 billion lower than the deficit level that it projected when it released the President’s budget in February.

The increase in federal revenues for the current fiscal year (OMB now estimates that revenues will be $87 billion higher than it projected in February), and the resulting reduction in the projected deficit for 2005, are good news.  But the Administration’s reaction to this news is troubling.  Based on the greater-than-expected level of revenues in recent months, the Office of Management and Budget now is assuming that revenues also will be substantially higher than earlier projected for each of the next five years.  Over the five years (2006-2010), the increase in projected revenues totals $409 billion.  As a result, OMB has reduced its projections of deficits under the President’s policies for the 2006-2010 period.  The Administration also is claiming that these reductions in projected deficits prove that the President’s 2001 and 2003 tax cuts are working and that deficits can be brought under control even if the additional tax-cut measures the President is proposing, including making the 2001 and 2003 cuts permanent, are adopted.


  • The Administration is overly optimistic in assuming that the recent increase in revenues signifies that revenues in future years, as well, will be substantially higher than earlier projections indicated.
  • An examination of factors behind the recent increase in revenues does not support the notion that the President’s tax cuts are substantially boosting the economy and increasing tax collections.
  • OMB’s estimates of deficit levels for the coming five years appear unrealistically low.
  • The troubling long-term budget outlook has not significantly changed.

The Administration almost certainly is being overly optimistic about the significance of this year’s increase in revenues.  There are good reasons to doubt:


A More Realistic Assessment of the Budget Situation

Despite the Administration’s claims, the budget outlook for future years has not been substantially improved by the increase in revenues for 2005.  A more realistic assessment of the budget situation finds the following.

Reasons to Doubt that Tax Cuts Caused the Revenue Surge
Excerpted from: “Daily Financial Market Comment,”
Goldman Sachs Daily, June 30, 2005.

  • “Withheld taxes have been sturdy but not inexplicably strong.  Unusually strong growth in withheld taxes would be the most logical way to verify the Laffer Curve…  As most observers are aware, neither employment levels nor work weeks have shown the kind of strength (relative to GDP growth in the case of employment) that would suggest a significant increase in work effort.  Although withholdings have been unquestionably sturdy over much of the past year, the strength is far from what would be required to provide such evidence or to make up the loss in personal income tax revenue…
  • “The bonanza has been concentrated in nonwithheld taxes… This surge 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.  Thus the strength in nonwithheld taxes is apt to fade as well.
  • “The rest is in corporate tax receipts.  In fact, in percentage terms, corporate receipts have exhibited the strongest growth… We discount strength in corporate receipts as a demonstration of the Laffer Curve for two reasons.  First, at its core, the Laffer Curve is an argument that lower marginal tax rates will induce greater individual work effort; corporate receipts may benefit, but only indirectly as economic activity strengthens.  Second, the increase in corporate receipts is easily explained as the combined result of last year’s strength in economic activity and a return to more normal tax levels following the expiration of the depreciation bonus [i.e., the business tax cut that expired at the end of 2004].”

As noted above, the left-out costs almost certainly will increase deficits over the next five years above what OMB has projected.  The added costs will be greatest after 2010, the last year that the Mid-Session Review covers.  For example, the funds omitted from the budget for overseas operations related to the war on terror would add more than $210 billion to deficits in 2011 through 2015.  (This reflects CBO’s estimate of these costs and includes the additional interest payments that would result from this spending.)  Simply extending current AMT relief would add more than $550 billion to deficits in 2011 through 2015 (assuming the expiring tax cuts are extended).  In addition, the Mid-Session Review includes the cost of only two years of the President’s Social Security proposal, because the plan would not take effect until 2009.  In 2011 through 2015, the proposal would add $681 billion to deficits (including interest costs), based on estimates issued by the Social Security actuaries.

When these costs are taken into account, it is clear that the budget outlook for the next 10 years under the President’s proposed policies remains rather bleak, even if OMB’s optimistic assumptions regarding future revenue growth are borne out.  Deficits would still begin to grow at the beginning of the next decade and mount to quite high levels by 2015.  The budget situation then would 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.



The unanticipated revenues in 2005, and the resulting reduction in the deficit for this year, represent good news.  But the good news is limited and should not lead to complacency.  In fact, the recent increase in revenues collections could even have the unfortunate effect of making the longer-term budget outlook worse if a misreading of the new data and their implications leads policymakers to ignore the plain reality that current budget policies are unsustainable.

End Notes:

[1] Jonathan Weisman, “Economic Growth, Tax Receipts Combine to Reduce Deficits,” The Washington Post, July 2, 2005, p. D1.

[2] “Daily Financial Market Comment,” Goldman Sachs Daily, July 13, 2005.

[3] Office of Management and Budget, Mid-Session Review: Fiscal Year 2006, p. 12.

[4] See, James Horney, “Repealing the Alternative Minimum Tax Without Offsetting the Cost Would Add $1.2 Trillion to the Federal Debt Over the Next Decade,” Center on Budget and Policy Priorities, June 9, 2005.