Federal Deficit Falling as Economy Climbs

Published August 1, 2006

Surging tax receipts have caused the federal budget deficit to drop more than 16 percent over the past year, in a period of tax rate cuts and high levels of government spending, according to reports released in June by the Congressional Budget Office (CBO) and Treasury Department.

Tax revenues were up nearly 13 percent, about $176 billion more than last year’s total, according to the Treasury Department. The Congressional Budget Office, using slightly different measures, reported tax receipts in the first eight months of the year were up 12.8 percent, the second-fastest growth in nearly 25 years. Only last year’s 15.5 percent growth was greater.

Below $300 Billion Soon?

The deficit peaked at $419 billion in December 2004, and some analysts are projecting the deficit this year will be well below $300 billion.

None of this comes as a surprise to Michael Englund, a Business Week columnist and chief economist at Action Economics, an independent firm that provides economic commentary and analysis.

“The CBO has a propensity to underestimate growth periods and overestimate downturns,” Englund said. “There is remarkable consistency in their forecast errors. They tend to have colossal errors in the initial year of a downturn. We’re now in a business expansion, when they consistently have forecast errors [underestimation of tax receipts] of $50 billion to $150 billion each year. Rarely do we have tax changes that big in each year.”

Tax Cuts Increase Revenues

“We argue that if you look at the business cycle, it dominates the budget numbers. If you want deficits to be smaller, you need to grow the economy,” Englund said. “The economy has been growing. In years after tax reductions, we have had massive overshoots in tax receipts. The obvious implication is, why raise tax rates?”

In a May 3 column for Business Week, Englund estimated the federal budget deficit this year would be about $270 billion.

“Last year’s $319 billion budget deficit was 2.6 percent of GDP, which is fairly normal relative to gyrations in the U.S. budget deficit over the last five decades, and which is small by current international standards,” Englund wrote.

His column continued, “In fiscal 2006, the gap will fall to 2.1 percent, and we expect a 1.6 percent gap next year. Note also that state and local governments in the U.S. run surpluses, so the ‘combined’ budget deficit needed to make international comparisons is even smaller than the above percentages by a few tenths.”

Chris Edwards, director of tax policy at the Cato Institute, called the revenue numbers “remarkable.”

“There is a flood of money,” Edwards said. “This ought to be of big benefit to the Bush administration as it argues for tax cuts. The previous tax cuts have resulted in a stronger economy and surging tax receipts. If we hold spending to what Bush now says he wants, the deficit would be just $50 billion by 2010.”

Spending Still a Concern

Edwards warned that spending control is not guaranteed. Bush has yet to veto a spending bill, even though spending has repeatedly exceeded his requests.

“From 2001 to 2006, the federal government increased spending 45 percent,” Edwards said. “Bush is easily the biggest spender since Lyndon Johnson.”

Brian Riedl, the Grover M. Hermann Fellow for Federal Budgetary Affairs at The Heritage Foundation, agrees Congress and the president should slow spending.

“Nearly all the deficit decline can be attributed to revenue increases. We’re seeing no spending restraint,” Riedl said.

Revenues More Volatile

Riedl said tax receipts have become more volatile since the 1990s because the tax burden is increasingly falling on upper-income taxpayers, who tend to have bigger swings in earnings than middle- and lower-income taxpayers. IRS data show that in 2003 (for which tax returns were filed in 2004), the top 50 percent of income earners paid 96.5 percent of all income taxes. The bottom 50 percent, who earned 14 percent of the nation’s income, paid just 3.5 percent of the federal income tax burden.

“We’ve had a lot more volatility in tax receipts over the last decade because of this,” Riedl said. “Tax receipts leaped in the late 1990s, plummeted in the early part of this decade, and are leaping again. The tax burden is more concentrated in the top of the income brackets, where people receive much of their income from capital gains, job bonuses, and other volatile income sources. When the tax burden was more spread out, we did not see so much volatility.”

Steve Stanek ([email protected]) is managing editor of Budget & Tax News.