Here’s a chart in CBO director Doug Elmendorf’s blog post on their just-released budget and economic outlook that says at least a thousand words about the importance of tax policy in deficit reduction–particularly any deficit reduction that we’ll accomplish in the next decade. This shows deficits as a share of GDP. Note that 3 percent has been considered a good target given an economy that grows at about that annual pace. Note that CBO’s economic forecast shows that’s not going to cut it as “sustainable” over the next few years though–with real GDP growth not coming above 3 percent until 2013 and then coming back down below 3 percent later in the decade. Note very plainly in the chart above that deficits under the “policy-extended” scenario where expiring tax cuts are extended and deficit-financed (as usual) are closer to 5 percent of GDP, a far cry from the copacetic (just over) 1 percent of GDP deficits under CBO’s current-law baseline.
If some of the changes specified in current law did not occur and current policies were continued instead, much larger deficits and much greater debt could result (see figure below [or the one above in this blog post]). For example, if most of the provisions in the 2010 tax act that were originally enacted in 2001, 2003, 2009, and 2010 were extended (rather than allowed to expire on December 31, 2012, as scheduled); the alternative minimum tax was indexed for inflation; and cuts to Medicare’s payment rates for physicians’ services were prevented, then annual deficits from 2012 through 2021 would average 4.3 percent of GDP, compared with 1.8 percent in CBO’s baseline projections.
The difference in dollars between the current-law and policy-extended scenarios, just in terms of revenue levels and not counting interest costs, is more than $4.7 trillion over ten years. (See Table 1-8 on pages 26-27 of the CBO report.) What should this tell us (and the policymakers)? Stick to the current-law baseline in terms of revenue levels, and we’ll do just fine. Does that mean we have to stick to current law and send Congress home so they can’t pass any new laws and are forced to let the tax cuts expire at the end of 2012? No, as appealing as that might be! It does mean policymakers have to commit to strict pay-as-you-go rules (at least in principle) and pay for any tax cuts they wish to extend in the future. And I don’t think that’s so hard to do, even in practice, and I don’t think we need to worry that paying for future tax cuts will devastate the economy, even with the probability that we’ll end up clinging to the economically-clumsier but politically-sexier ways of raising that revenue. The additional revenue will turn out to be far better than none, no matter what the tax policy looks like.
(My next Tax Notes column, coming out next Monday, focuses on the different ways to get to the current-law revenue baseline, so more on how to do it later.)
UPDATE (12:45 pm): The Concord Coalition has updated its “plausible baseline.” Note that deficits under the plausible baseline are just about three times larger than under the CBO current-law baseline. (But please remember that “plausible” doesn’t have to mean “most likely”–as I explained a couple years ago.)