Reducing Deficits Must Not Be Important

The recent deal between the President and Republicans would extend the Bush tax cuts for two more years and extend unemployment insurance benefits for another year. The purpose of the entire package appears to be to stimulate job growth at a cost estimated to be $984 billion in the next two years. According to the Christian Science Monitor $103 billion of that represents that cost of continuing the tax cuts for those with taxable incomes in excess of $250,000 and $50 billion is the cost of extending unemployment insurance benefits. Also included were a payroll tax cut ($120 billion), extending the child tax credit, college tuition aid, and the earned income tax credit ($21 billion), and accelerated depreciation ($146 billion). The Christian Science Monitor refers to $544 billion in "bipartisan" measures which would include continuing the tax cuts for those with taxable incomes less than $250,000.

The general consensus of economists is that the plan is positive for economic growth and, therefore, for creating jobs - estimated by some at 2.2 million in the next two years. If we just took $984,000,000,000 and created jobs paying $50,000 a year for two years that would create nearly ten million jobs - admittedly temporary. But it makes the proposed deal seem like not such a great job creation deal.

The fact is that the deficit will increase significantly - $984 billion less whatever additional revenue results from the stimulus.

Alan Simpson, co-chair of the deficit reduction commission recently was quoted as saying: "America, you have a serious problem, and time is short to address it." This proposal isn't addressing it.

A recent article in the AARP Bulletin said: "Voters said their major concerns were the $1.3 trillion budget deficit (along with the cumulative $13.7 trillion national debt) and jobs." Politicians seem only to have heard "jobs".

What to do with the Bush tax cuts

The Bush tax cuts passed in 2001 and 2003 were intended to return the surplus that existed in 2000 to the taxpayers and to stimulate the economy. I am sure that the tax cuts have eliminated the surplus many times over and we now have a tremendous deficit. The evidence is that tax reductions, especially those that go primarily to wealthy people, are not effective in stimulating the economy and that was certainly true with these cuts.

If it was proper to lower taxes because there was a budget surplus it follows that when there is a deficit, the corresponding course is to increase taxes. Or, in this case, let the tax cuts expire. The reason for the tax cuts no longer exists. Isn't that straight forward?

What amount of revenue is involved anyway? It isn't easy to find an estimate. One source estimated the reduction in revenue in 2004 at $276 billion. But despite numerous articles about the effects of the tax cuts on revenue, figures are just not included. One reason is that there is no fixed figure. The tax cut itself becomes a factor and other factors come into play. There are arguments made that tax cuts actually increase income tax revenues, counter-intuitive as that seems. It is certainly possible that if taxes are cut modestly when the economy is growing robustly income tax revenues could increase because there would be more income to tax. The argument is, in fact, that tax cuts stimulate the economy and that provides more income to tax. The evidence seems to be that any stimulus effect is small at best.

The figures I did find about income tax revenues were from Christopher Chantrill (who describes himself as a conservative) at www.usgovernmentrevenue.com. For the years 2000 through 2010 he lists income tax revenue (in billions) at $1,212, $1,145, $1,006, $976, $998, $1,206, $1,398, $1,534, $1,450, $1,054, and $1,093. For those same years he shows the surplus (deficit) (again in billions) as $236, $128, ($158), ($378), ($413), ($318), ($248), ($161), ($459), ($1,413), and ($1,556). I don't know whether the surplus/deficits after 2001 include the costs of the wars in Afghanistan and Iraq.

Assuming that income taxes would normally increase 5% annually (and I have no basis for that assumption), then, taking the 2000 income tax revenue as $1,212 billion, the expected revenue for 2004 would be $1,473 billion. The actual revenues of $998 billion would mean a reduction in income tax revenues in 2004 of $475. There was a recession in 2001 and there is no question that recessions after a depressing effect on income tax revenues. So the estimate of $276 billion in lost income tax revenues in 2004 as a result of the tax cuts may be in the ball park.

Letting the Bush tax cuts expire might result in increased income tax revenues of about $275 billion each year. That would have led to roughly balanced budgets until 2009 when the deficits soared. But the question still is, what possible reason can there be to extend those tax cuts?

Raising the federal debt

The federal deficit each year is added to the federal debt which is currently about $13.7 trillion.

The federal debt is subject to a limit and that limit ($14.2 trillion) will be reached this coming spring. Does that mean that the federal budget will have to be balanced in order to avoid exceeding the limit? No, but it means that the Congress has to vote to increase the debt limit. With so much recent political concern about the deficit how palatable will it be for political leaders to vote for an increase in the debt? There isn't any choice about doing it because no one expects the budget can actually be balanced immediately. [See the previous post about that.] A failure to increase the debt limit would bring the government to a halt and almost certainly create havoc in financial markets as well as inconvenience a lot of people.

Both houses of Congress have to approve an increase in the debt limit. By the time of any vote the House will be controlled by Republicans and the Senate by Democrats. Can we expect annoying partisan posturing when it seems obvious that the limit has to be increased? Probably.

"The debt limit, when it comes in April or May, will prove who's a hero, and who's a jerk and who's a charlatan and who's a faker," says Alan Simpson, the former GOP senator from Wyoming who co-chairs the White House deficit commission. He doesn't define what constitutes a hero or a jerk. I would rather say that we are likely to find out who is a realist and who is pandering for votes.

Where can budget cuts be made?

According to Wikipedia the estimated revenue for the 2010 Federal budget is $2,381 trillion (down 11% compared with 2009). Mandatory spending (such as Social Security, Medicare, Medicaid, interest on the national debt) is $2,184 trillion, an increase of 15.6%. Discretionary spending is $1.368 trillion, an increase of 13.1%.

Fox News reported on February 1st that the 2011 budget will include total spending of $3.834 trillion (an increase of about 8% over the figures above), with discretionary spending at $1.415 trillion (up 3.4%). The projected deficit is $1,267 trillion which means revenue is projected to be up nearly 8%.

The obvious question is why is spending increasing so much in 2010 and 2011 especially when revenue is expected to decrease compared with 2009. We know that we can't do that at home other than by running up our credit card debt.

Politicians are reluctant to state what spending would be cut. Mandatory spending can't be cut without changing the laws. That leaves discretionary spending. In our homes we always have the option of reducing discretionary spending.

Again going back to Wikipedia, the major items listed as discretionary spending are the following departments (the percentages are the increases over 2009): Defense $663.7 billion (+12.7%), Health and Human Services $78.7 billion (-1.7%), Transportation $72.5 billion (+2.8%), Veterans Affairs $52.5 billion (+10.3%), State plus international programs $51.7 billion (+40.9%), Housing and Urban Development $47.5 billion (+18.5%), Education $46.7% (+12.8%), Homeland Security $42.7 billion (+1.2%), Energy $26.3 billion (-0.4%), Agriculture $26 billion (+8.8%).

(1) Obviously we can't cut discretionary spending ($1.368 trillion) by the projected deficit ($1.17 trillion) without, among other things, leaving us defenseless.

Three other things stand out. (2) Defense spending is a whopping portion of "discretionary" spending. I don't think any Americans really think of defense as discretionary. Which is not to say some cuts won't have to happen there. (3) Balancing the budget can't occur solely by income tax increases. The revenue from income taxes is projected to be $1.283 billion. Tax revenues would have to more than double. (4) Eventually mandatory spending is going to have to be reduced.

It seems obvious that cuts in both mandatory and discretionary spending and increases in taxes will be required. It will be worth looking more carefully at the items of discretionary spending and also at the effects of continuing/ending/modifying the "Bush tax cuts".

Why.

I'm just a regular person. I've been concerned about federal deficits for some time and have paid taxes for an even longer time. The size of the deficit and the amount and use of taxes are important issues with major consequences to regular people but the political discussion is pretty partisan. And probably won't provide the results we need.

This is intended to be a non-political, civil discussion of tax and spending issues.