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A Longer-Term View of the “Cliff”

June 5th, 2012 . by economistmom


The Congressional Budget Office released its latest estimates of the long-term federal budget outlook today.  The graphic above comes from the report’s cover.  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.

***UPDATE, 3:15 pm:  Here’s a link to the Concord Coalition’s press release on the CBO report.

13 Responses to “A Longer-Term View of the “Cliff””

  1. comment number 1 by: AMTbuff

    The current law scenario is nothing that the American public support. They never supported, for example, leaving the AMT parameters without any inflation adjustment from 1993 to 2040. That’s what the current law assumes. As a baseline, it’s a complete fantasy.

    Current law tax policy has always been a partial fiction over the long term. Any unindexed parameters are not politically sustainable through decades of inflation. Those parameters will be indexed or they will be modified. What’s relatively new is the increased use of expiration to mask the fiscal effects of maintaining current tax and spending policy. Anyone using current law as a baseline is pretending to be fooled and attempting to fool you into accepting adverse change as if it’s not change at all.

    Only the very sophisticated people can see a huge increase in tax liability from year to year as really not a tax increase. Most of us are too dumb to accept the violations of common sense required to use the current law baseline.

    In reality, major adjustments in current spending and tax policy are required. Appeals to fantasy baselines of Medicare SGR (assumed huge payment cuts to doctors) or tax increase assumed under current law do not advance the necessary frank discussion. The starting point is current policy, period. I am disappointed that Diane of all people chooses to play the current law baseline game. That game is the primary means by which the fiscal imbalance can has been kicked this far down the road by partisans on both sides.

    Users of current law baseline are enablers, on both sides. Concord needs to step outside the partisan game and ban baselines entirely. We have spending promises and current tax rates and exclusions. The two don’t balance now and it’s getting worse fast, even before you account for skyrocketing interest rates if the bond market loses faith.

    The most important decision is how to credibly achieve balance in the long run. The second question is how to build a bridge to that long-term balance.

    People who put the second question first are playing yet another partisan game, seeking to achieve an advantage in the long run resolution by advancing their position in the short run. That’s an irresponsible tactic which will backfire when the bond market loses faith and explodes the budget deficit.

    First things must come first. Do it for the children(TM). That means controlling government health care spending. Ryan has one way, and strict rationing as in the UK is another way. The public needs to choose. That’s step 1. It cannot be skipped.

    Then a tax reform and spending cut plan like Bowles-Simpson can be step 2. Step 3 is to sit back and watch the economy take flight now that the fiscal sword of Damocles has been permanently sheathed.

    If step 1 is not taken, the bond market will hand us steps 1, 2, and 3 all at once in the form of national bankruptcy. It will be much more painful to everyone, especially the poor. It will be our worst time as a nation since the Civil War. Nevertheless the economy will quickly recover to incredible growth rates once the impossible promises are voided and the unpayable debts are wiped out.

  2. comment number 2 by: Jason Seligman

    mmm… because everyone loves doing business with a deadbeat. I can see the Greeks trying to think this way, but even there the thinking is misguided. No one really pines for a leader who they can count on to be reckless with the nations credibility. We do all crave a ‘do over’ from time to time’ but that’s abstract. The reality is capital takes a
    massive hit, seniors have a difficult time affording a more basic lifestyle, and economic dislocation is certainty as the public sector disrupts and distorts economic activity without any control.

    H Stein’s ‘things that can’t go on forever stop’ does not appear to apply to fairy tales.

    That said I agree with many AMT point including the one(s) about the AMT. How sophisticated does a person have to be before they no longer feel their congress is heroic in offering one year solutions for AMT, the debt celing, doctors pay, or any of the other “offerings” that are conjured of an ignoble “baseline”

    Talk about your hyperbolic discounters…

  3. comment number 3 by: Gipper

    Focusing on the deficit is a game played by people who want tax increases. If you want to shrink the size of government spending on non-interest items, then deficits are your friend.

    Whether government spending is funded by taxed or borrowed money makes no real difference for GDP. When interest payments begin to grow, then we’ll begin to see cuts in federal programs. That will be a good thing.

    I’m not against raising taxes. However, taxes should only be raised AFTER spending cuts are implemented. Say 20% of GDP is our target. Let federal spending fall to 20% of GDP, then raise taxes to raise 20% of GDP so it’s balanced.

    In order to make this a long-range solution, there will have to be major cuts to Medicaid, Medicare, and Social Security. Raising minimum age to receive benefits to 70 yrs old will be likely. Retirement at 65 and collecting medical and pension benefits for 20 years or more is not affordable.

  4. comment number 4 by: B Davis

    Steveinch wrote:

    You are cute in a way. Remember when Republicans were leading the charge to stop the extension of the payroll tax holiday? Was that not a tax increase? Where was Grover?

    The Norquist thread is closed so we need to end the Norquist discussion and/or relate it to this discussion of the fiscal cliff. Following is a reply to your last point and a point regarding spending and revenue which relates somewhat to Gipper’s comment above.

    According to a National Journal article, Norquist says that the payroll-tax-cut expiration isn’t a tax hike. It states:

    Antitax campaigner Grover Norquist advised a room of House Republicans on Thursday that a failure to extend the payroll-tax cut would not be tantamount to raising taxes, regardless of what President Obama and other Democrats say.

    Interestingly, a Huffington Post article link says that Norquist similarly states that ending the Bush Tax Cuts is not a tax hike. It states:

    Ending the Bush-era tax cuts for the wealthy would not be a tax hike, according to Grover Norquist, the man behind a pledge against increasing taxes. That assessment gives the Republican Party breathing room to let some tax breaks expire without violating a pledge to Norquist’s Americans for Tax Reform.

    By the way, I did just post the graphs and tables from the last U.S. Budget. The first graph at this link shows that, as a percent of GDP, spending has rose sharply following the financial crisis, negatively affecting the deficit. However, the deficit has been similarly increased by plummeting revenues which have reached their lowest level (as a percentage of GDP) since 1950.

  5. comment number 5 by: Vivian Darkbloom

    B. Davis,

    According to Norquist, the pledge does not preclude failing to extend the “Bush tax cuts”, not only for the “wealthy” but for everyone else, too. Now, let’s see, wouldn’t that be about $4 trillion
    under the current law baseline?

    So, in light of this, what about your contention that per the Norquist pledge “taxes cannot be raised under any circumstance”?

  6. comment number 6 by: Arne

    According to Norquist, although failing to extend would not “technically” violate the pedge, “Let me be clear, Americans for Tax Reform would oppose any effort to weaken, reduce or not continue the 2001, 2003 Bush tax cuts and in fact any changes in tax should be kept separate from the budget deal.”

  7. comment number 7 by: Gipper

    Norquist is a dunce. He would oppose a $100 MM tax increase in exchange for a $1 trillion spending cut. He is not a factor.

    The problem is that Republicans remember Bush 41’s disastrous compromise with Democrats in 1991. No spending cuts followed the tax increases. So now it’s time to turn the tables. Make Democrats accept spending cuts and only raise taxes AFTER cuts are implemented.

    Any Republican who opposes that deal is a moron. Hard to strike a deal in an election year, but if Republicans win the Presidency and the Senate, it’s what they’ll have to do.

  8. comment number 8 by: Arne

    “So now it’s time to turn the tables.”

    So 43 did not already?

  9. comment number 9 by: Vivian Darkbloom

    “Norquist is a dunce. He would oppose a $100 MM tax increase in exchange for a $1 trillion spending cut. He is not a factor.”

    Thatis right, on both counts. The only thing Norquist is doing is serving as a convenient diversion for the extremists on the other end of the spectrum. He should be thrown overboard so appropriate attention can be paid to people who do matter, such as Nancy Pelosi and Krugman.

    Opposing something and failing to compromise when compromise is needed are two entirely different things. The irrelevance of the Norquist pledge is demonstrated by the aborted Boehner/Obama deal. By all accounts, including Obama’s, Boehner and the administration had a deal that included increasing revenues by up to $800 billion under the 10-year current policy baseline. Boehner was comfortable that this was a deal his party would support. How does that fit with the idea that the Norquist pledge is binding and precludes *any* tax increases *ever*?

    What happened then was that a report came out from the “Gang of Six”, including 3 Republicans that had signed the “Norquist Pledge” that would have raised revenues by $1.2 trillion (perhaps more because they used a hybrid baseline). Obama promptly reneged on his promise, presumably because he didn’t have the votes from his own party–and perhaps because he can’t be trusted to keep his own promises. No comfort here for those who believe that progressives can’t be trusted to cut spending for 10 years—-this promise wasn’t even kept for 10 days.

    B. Davis, perhaps this example of the circumstances under which “promises” and “pledges” are made and broken would be well worth contemplating, even while you are busy working on other things.

  10. comment number 10 by: B Davis

    Vivian Darkbloom wrote:

    According to Norquist, the pledge does not preclude failing to extend the “Bush tax cuts”, not only for the “wealthy” but for everyone else, too. Now, let’s see, wouldn’t that be about $4 trillion under the current law baseline?

    So, in light of this, what about your contention that per the Norquist pledge “taxes cannot be raised under any circumstance”?

    That just goes to show that even short, simple-minded pledges have gray areas. Norquist holds the not-unreasonable contention that letting a temporary tax cut expire as scheduled is NOT a tax hike. And the Bush tax cuts are technically temporary tax cuts. In any case, I agree that the Bush tax cuts do have a large effect on the baseline. That and their temporary nature are reasons that I’ve long considered the Bush tax cuts to be a bad government policy that just “keeps on giving”. Firstly, the large difference between the Extended Baseline Scenario and the Extended Alternative Fiscal Scenario shown in the graph above has caused continuous confusion as to what our country’s true fiscal situation is and has greatly complicated the debate. Secondly, our policymakers are now having to spend a great deal of time and effort each time the Bush tax cut comes up for expiration. We would have been much better off if we had passed a smaller permanent tax cut that was sustainable. I believe that we should ban all temporary tax cuts, at least those that are longer than a year.

    Speaking of bad policy decisions, does anyone know the exact history of how we came up with three negative economic policies (the Bush tax cut expiration, the payroll tax cut expiration, and the sequestration spending cut) all occurring at the same time? This was not some kind of unforeseen natural disaster, this was explicit policy created by our policymakers. I would hope that this will at least teach us not to schedule multiple such events to occur at the same time in the future. As tidy as it might seem, we don’t need to schedule all events to occur at the start of the fiscal or calendar year.

  11. comment number 11 by: Vivian Darkbloom

    B. Davis,

    You are truly a master at changing the subject and evading direct questions—and now you are doing a classic slow 180 degree turn.

    But, as for those “gray areas”, I agree. Nonetheless, your initial take on that ironclad, un-breachable Norquist pledge was pretty pretty black and white: “taxes cannot be raised under any circumstance”. It appears, at the end of the debate, that Norquist’s “not unreasonable contention” was, in fact, more reasonable than yours.

  12. comment number 12 by: B Davis

    Vivian Darkbloom wrote:

    You are truly a master at changing the subject and evading direct questions—and now you are doing a classic slow 180 degree turn.

    Yes, I am trying to change the subject to the topic of the article (A Longer-Term View of the “Cliff”) to which we are now posting comments. But I see that you are far to clever to be so diverted!

    But, as for those “gray areas”, I agree. Nonetheless, your initial take on that ironclad, un-breachable Norquist pledge was pretty pretty black and white: “taxes cannot be raised under any circumstance”. It appears, at the end of the debate, that Norquist’s “not unreasonable contention” was, in fact, more reasonable than yours.

    OK then, I’ll expand my prior statement to the following:

    The pledge says nothing about spending, only that taxes cannot be raised under any circumstance unless the great Norquist contends that the increase does not break the pledge. That certainly isn’t cow towing to an ideologue! I can’t understand why Jeb Bush said that he didn’t sign the pledge because “I don’t believe you outsource your principles and convictions to people”.

    In any case, I suggest that we both declare victory and withdraw on the Norquist issue. Any further discussion should involve the article to which we are posting.

  13. comment number 13 by: Gipper

    Arne wrote: “So now it’s time to turn the tables.” So 43 did not already?

    Did 43 cut spending? No, he took the easy route: Lower taxes and increase spending.

    I didn’t hear Democrats urging any spending cuts during 43’s term. In fact, they’ve always wanted to spend more and tax more.

    So instead of snarking, let’s be constructive. Aim for 20% of GDP federal share of spending. Set tax revenues to equal 20% of GDP AFTER spending targets are met.

    Do you have a problem with that?