This is why this year will be a watershed for long-term fiscal policy. Congress is enacting legislation to extend the Tax Cuts and Jobs Act of 2017 (which will cost $2.5 trillion over five years) plus a wide variety of other potential commodities, such as adding state caps of $10,000 and local income tax relief ($700 billion in about five years) and excluding it from taxes (perhaps $100 billion or more).
Even temporary tax cuts are difficult to pay. Congress and the Trump administration are considering various spending cuts to offset costs, but these spending has proven politically challenging. The Department of Efficiency (or multiple doors) is touting cuts and cost savings, but the amount is unproven and has been heavily revised and unlikely to be large enough to put a meaningful dent in the long-term debt of the U.S.
Congress may attempt to informally “calculate” revenue through tariff actions, but the announced tariffs so far have been at most $1.5 trillion in a decade (it may be less once dynamic impact is taken into account). Therefore, Congress may rely in part on head dependency to help make the numbers work on paper.
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But why would Congress cut taxes if debt is unsustainable? Some answers budget deficits are due to overspending. Mandatory spending plans like Medicare and Social Security do raise costs. But the reality is that tax cuts have been the main driver of higher debt since 2000. Therefore, the idea of increasing income must be listed on the desktop. The story of tax revenue in the last century is best through everything, and it is an obscure, decades-long dry government report. In October 2000, the Congressional Budget Office (the Office of Independent Budget Analysis for Official Scoring Legislation) released an analysis that predicted the national long-term fiscal trajectory over the next 50 years. The first thing about the report is that the first thing for CBO is that the social undertaking of CBO even gradually increased social security and the age of the U.S. population at that time, and would gradually increase. The CBO correctly expects that in a decade, the boomer retirement wave will lead to a cost inflection point for these plans. Non-interest expenses will continue to rise from less than 16% of GDP in 2010 to more than 18% in 2020, and thereafter.
Another thing worth noting about CBO forecasts is that despite anticipating these costs, debt is still predicted not only to decline, but also to zero on net, and then to become negative over 10 years (cumulative savings!). How is this possible with the rise in social security and health insurance costs? The CBO evaluated that the revenue collected by the federal tax system in 2000 equals 20% of GDP, enough to cover the increased costs of these plans.
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This obviously didn’t happen. So why is CBO so wrong? One might think that CBO’s predictions have just come out, but it’s not surprising to the story. As shown in the figure below, the irrelevant federal spending as a percentage of GDP next year is almost entirely what the CBO expected in 2000. Since then, the latest forecasts from CBOs are targeting lower spending than they expect.
There are three greater reasons for the difference. First, the United States experienced three recessions in two and a half years. Two of them are the worst global financial crisis in U.S. history and the Covid-19 pandemic worldwide. The weak economy means the tax revenue brought by the government has decreased, which increases debt, and automatic stabilizer programs such as unemployment insurance have begun, especially in the two recent recessions, where the government has provided additional relief.
The second is that the federal government spending is higher than the CBO expected. This is partly because the law requires the CBO to assume discretionary spending increases through inflation, which may be too conservative, and it is a hypothesis (population + inflation or GDP will be more realistic). But a big part is because of the war between Iraq and Afghanistan that CBO could not have anticipated in 2000.
It is obvious that recession and war have increased debt to stocks, but this is the past and they no longer affect non-interest deficits. However, the third reason has both increased debt and ongoing budget deficits. Over the past 25 years, several rounds of tax cuts were carried out in 2001, 2003 and 2017, and delays by Republican and Democratic governments have weakened the tax base. As shown in the figure above, even if the income lost due to the recession, the actual income is almost lower than the CBO’s 2000 forecast, and almost every year’s forecast will continue to extend over the next decade, if the 2017 tax cut is extended. For example, by the end of 2024 (the strong side should be the strong side of the economy), the actual federal revenue accounts for 17-18% of GDP, which is well below the 20% forecast for CBO.
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Even if the 2017 tax cuts were not extended, or the tax cuts were fully paid for other incomes (such as tariffs), overall income would still be lower than the 2000 forecast due to the tax cuts before 2017 earlier. The result is that tax cuts have been a complicit in the deteriorating fiscal trajectory of the United States. There is no doubt that spending can save a portion of the conversation, but with 20% of the revenue to GDP in the 2000 era, higher incomes should be taken seriously.
This does not mean we should revisit the entire tax law to its 2000 look. As Kyle Pomerleau of the American Enterprise Institute noted, this will involve trade-offs that neither conservative nor liberals would approve, such as lower child tax credits and other minimum taxes for more taxpayers.
We should see it as an opportunity to keep improving over the past two and a half decades while also seeking efficient and equitable ways to increase new revenue. As Natasha Sarin (my colleague at Yale University’s Nonpartisan Budget Lab) writes, more powerful
Implementing existing tax laws can help close the gap and increase additional income.
But that is almost certainly not enough to restore us to 20% of our income to GDP. Long ago, lawmakers began to turn to more effective means of increasing income, such as VAT, and there are several ways to preserve the progressiveness of the overall tax system. No matter how we do it, it is becoming increasingly obvious that the United States will not correct its fiscal ship without increasing revenue.
