The Congressional Budget Office released its latest estimates of the long-term federal budget outlook yesterday. If you are familiar with the report, this year’s offers nothing that new, but it’s a good way to take a step back from current policy debates (dominated by the politics) and put impending decisions in the context of the bigger picture (important for the economics). The biggest difference between the unsustainable deficits resulting from the business-as-usual “extended alternative fiscal scenario,” and the sustainable deficits that would occur under the “extended baseline scenario” (current law), continues to be–as it has ever since 2001 when the Bush tax cuts were first passed–what we do about expiring tax cuts. From Table 1-2 in the report (page 12), under the “baseline”/current-law scenario where expiring tax cuts either actually expire or are extended but paid for with offsetting revenue increases, revenues grow from 15.8 percent of GDP in 2012 to 23.7 percent of GDP in 2037. If instead the expiring tax cuts are extended and deficit financed (as has been standard practice since 2001), revenues only reach 18.5 percent of GDP in 2037–which happens to be right around the 40-year historical average policymakers who don’t want to raise taxes like to label the “right” level of revenues for the future.
Comparing primary deficits (the difference between revenues and non-interest spending), the CBO table and graphic show that the 2037 deficit is 7.7 percent of GDP under business as usual, but is a primary surplus of 1.1 percent of GDP under current law. This implies that nearly 60 percent of the difference between the unsustainable deficits under business as usual and the sustainable ones under current law (or paygo-compliant extended policies) is explained by the financing of expiring tax cuts. Only about 40 percent of the difference is explained by the difference in spending paths under the CBO’s two scenarios. And if you look in further detail at the spending breakdown, you might notice that despite the major contribution of Medicare, Medicaid, and Social Security spending to federal spending growth over the next several decades, the difference between the CBO’s two scenarios on these spending levels in 2037 is just 0.8 percent of GDP–in contrast to the 5.2 percent of GDP difference in revenue levels.
This just reminds me that the current debate over what to do about the “fiscal cliff” is not irrelevant, even if somewhat misguided. The “fiscal cliff” is also largely about the expiring tax cuts, representing one possible way of making them comply with current law: let current law play out, literally, and let all the tax cuts expire at the end of this year–the Bush tax cuts, the payroll tax cut, AMT relief, everything!–along with letting the spending cuts of the “sequester,” and other cuts like those to Medicare physician payments, kick in as well. The emphasis on this particular version of sticking to the current-law baseline is misguided because it makes it seem as if the choice is between the “cliff” in full form (which seems dangerous and not very smart given the state of the economy) and no cliff or fiscal restraint at all. If that is the debate, it is easy to predict that “not at all” will win in the end (at the end of the year). The CBO report in the context of the fiscal cliff debate is very relevant, however, in reminding us that current law offers us a path to longer-term fiscal sustainability–at least over the next couple decades–which we ought to be considering more seriously beyond the “take the cliff now–or not” question. I’ve repeatedly harped on the point that sticking to the current-law baseline levels of revenues and spending (and even keeping the two sides of the ledger separate) doesn’t have to mean literally sticking to current law and that very particular composition and timing of the expiring tax cuts. We could achieve sustainable deficits by sticking to strict pay-as-you-go rules on expiring tax cuts. We do not have to let all the expiring tax cuts actually expire; we just have to be willing to pay for them over the next ten years. Spreading out the timing of the revenue increase (and the spending cuts) could turn the fiscal “cliff” in current law into that more manageable “climb” towards fiscal sustainability I’ve talked about before–an admittedly tough climb, but one we cannot keep avoiding forever.