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The 10-Year Fiscal Outlook Is a Story About Tax Policy Choices

August 22nd, 2012 . by economistmom

cbo-baselines-tax-vs-spending-aug2012

The Congressional Budget Office released their latest budget and economic outlook today, and although the basic messages are not really new, they do show some new ways of presenting their numbers that help reinforce those basic messages.

First, Figure 1-1 above, from page 3 of the report, highlights the difference between deficits under the current-law baseline (the bottom segment of the deficit bars) and deficits under the CBO’s “alternative fiscal scenario” where scheduled spending cuts are bypassed and expiring tax cuts are extended.  What’s clear from this chart is that:

  1. while current law produces economically-sustainable deficits (meaning deficits as a share of GDP that are lower than the growth rate of the economy), the alternative scenario produces hugely unsustainable deficits;
  2. it is choices over tax policy, not spending policy, that account for the bulk of the difference between the two policy scenarios within the 10-year budget window;
  3. by the end of the 10-year budget window, the additional interest payments alone associated with the extra deficit-financed policies under the alternative scenario swamp the entire deficit under the current-law baseline.  (Interest payments swell because: (i) the big difference between the scenarios starts immediately, (ii) interest compounds, and (iii) interest rates rise significantly over the 10-year window.)

Second, in Table 1-5 of the report (pages 18-19), a table showing the “budgetary effects of selected policy alternatives  not included in CBO’s baseline,” this year CBO offers a comparison of the cost of extending all the expiring Bush tax cuts (and continuing the related alternative minimum tax relief) with the cost of extending all but the upper bracket rate cuts.  The cost of extending all the tax cuts is $4.5 trillion over ten years.  The cost of extending all but the top bracket cuts is $3.7 trillion over ten years.  (Both costs are without associated interest costs.)  In other words, allowing the upper brackets to expire saves only about $800 billion out of $4.5 trillion–or just 18 percent of the total cost.  In other words, change the choice to extend the tax cuts to one extending just the “middle-class” tax cuts, and you only shave less than one fifth from the tax policy segments in the chart above, and policymakers would still be choosing to deviate quite substantially from the current-law baseline by extending and deficit-financing those tax cuts.  Based on the (over-)dramatic, political mud-slinging over the two parties’ tax policy positions, one would think there was a much bigger difference between extending the tax cuts “for the rich” and not.  (One big reason: the “not” isn’t really a “not,” because upper-income households still benefit the most, in dollar terms, from the lower-bracket rate reductions.)

By the way, it’s the data in Table 1-5 that the Concord Coalition uses to construct our “plausible baseline”–which I have emphasized before is not necessarily a statement of what is most likely to happen, but what is at least very “plausible” (possible, believable) from a “business as usual” perspective.  Concord’s updated plausible baseline, based on the updated CBO numbers, can be found here.

Third, Table 2-2 in the CBO report, on page 37 in the economic outlook chapter, makes an interesting comparison of the economic effects of the two different baselines at the beginning of the 10-year budget window (2013) and at the end (2022).  Because the alternative fiscal scenario involves higher deficits throughout, in 2013 GDP growth is higher and unemployment is lower, compared with the current-law baseline, because of the benefits of the continued stimulus to the demand side of the still-recovering economy.  But by 2022, GDP growth is lower and interest rates are higher under the alternative fiscal scenario, because of the longer-term economic cost associated with the higher debt and lower national saving.  This is a useful reminder that while the particular timing of the “fiscal cliff” (and sticking to current law, literally, over the next year) is problematic for the current economy, this shouldn’t rule out achieving the same amount of deficit reduction over the 10-year window that is implied by the current-law baseline.  (I’ve made this point before, and I’ll make it again and again until policymakers address the fiscal cliff appropriately.)

9 Responses to “The 10-Year Fiscal Outlook Is a Story About Tax Policy Choices”

  1. comment number 1 by: Brooks / Gordon

    it is choices over tax policy, not spending policy, that account for the bulk of the difference between the two policy scenarios within the 10-year budget window

    When conservatives (often) observe (correctly) that the projected long-term fiscal imbalance (per whatever projection — i.e., whatever baseline) is driven mainly by an increase in spending rather than by a decrease in revenue, and then argue (invalidly) that this proves that “we have a spending problem, not a revenue problem” and therefore we should solve the problem via reductions in projected spending rather than even partly by increasing projected revenues, I say that’s invalid because the composition of a differential vs. history doesn’t necessarily imply anything regarding how we should change course. It tells us nothing about our priorities among the trade-offs associated with alternative potential policies.

    Similarly, if — IF — the above quote is an implication that, because the differential between a current policy baseline and the current law baseline is composed mainly of a revenue difference, we should therefore be more inclined to increase projected revenue than to reduce spending (and/or more inclined to increase projected revenue than we would be if we hadn’t observed that differential), I say such an implication is invalid, for essentially the same reason: the composition of the differential in this case, too, tells us nothing about our priorities among trade-offs associated with alternative policies that could reduce/eliminate that differential (or reduce deficits even further).

    Baselines can inform us of the path we’re on, so we can consider consequences of not changing course, and then consider and discuss alternative policies and associated trade-offs (types and magnitudes of effects, in both macroeconomic terms and in narrower terms of who is directly affected by particular policy changes vs. the status quo assumptions of the baseline), and choose policies based on our priorities.

  2. comment number 2 by: AMTbuff

    The 10-year window is irrelevant until the long-term imbalance is corrected by adjusting promised payments. Once that adjustment is made, the 10-year picture can be addressed through compromise by both sides.

    Neither party will compromise on the 10-year window until the long term is addressed. Each party will correctly assume that the other party is trying to create some advantage in the long-term battle. The long-term horse MUST go before the 10-year cart. Pretending that the cart can go before the horse will not make it possible. I repeat for emphasis:

    Neither party will compromise on the 10-year window until the long term is addressed.

    Neither party will compromise on the 10-year window until the long term is addressed.

    Neither party will compromise on the 10-year window until the long term is addressed.

    And neither will the bond market.

  3. comment number 3 by: Vivian Darkbloom

    “it is choices over tax policy, not spending policy, that account for the bulk of the difference between the two policy scenarios within the 10-year budget window.”

    Perhaps so, but focusing on this demonstrates just how absurd these baselines are. It is a very unhelpful and misleading way of looking at things, because neither of these two baselines represent political (or budgetary) reality.

    In this election season, it is most instructive to view each sides “plans”, not as plans, as such, but rather as negotiating starting points. The political reality is that to make any meaningful reduction in the deficit, it is *spending* policy that will dictate the final results.

    First, the Obama proposal. The proposal is to eliminate tax cuts only for the “rich” and to keep them for everyone else. No cuts to health care (Medicare, Medicaid, ObamaCare) and no cuts to social security. The “current law baseline” is not even in the discussion and many of his colleagues have ruled out tax increases for those earning less than $1 million. So, the reality is that if Obama is re-elected he will have to negotiate from this proposal. He’s left precious little room to negotiate a solution that involves large tax increases to close the size of deficits and certainly nothing even close to the “current law baseline”. It is highly likely that the Republicans will control the House, and perhaps even the Senate. They will not go along with even the $800 billion in tax rate increases Obama’s *proposal* calls for. Thus, the bulk of any deficit reduction will need to come from spending cuts (i.e. reducing the rate of spending). Obama will need to go along with spending cuts and he can blame Republican intransigence for the need to compromise. In no way can he raise taxes on the middle class and blame the need to do so on the Republicans. But, that’s what the “current law baseline” stands for. He might be able to reduce tax expenditures and try to make those reductions “progressive”; however, to date he’s not specified which ones he’d eliminate. Any meaningful deficit reduction will therefore need to come from two sources 1) tax expenditure reductions; and 2) direct spending cuts. You can call the former spending too, but the reality is that neither of these two sources have anything to do with “tax policy” as it relates to the CBO’S two baselines.

    Now, if Romney is elected, it is likely the Democrats will be able to at least filibuster the Senate. Romney has ruled out any tax rate increases. He’s said that he would dramatically reduce tax expenditures to pay for tax rate reductions. He’s proposing that nearly all the deficit reduction will come from spending cuts.

    If Romney is required to compromise, it will likely again be on the nature of the tax expenditure cuts and the nature of spending cuts. He will likely need to scale back his proposal on rate *decreases*; however, any rate increases are clearly off the table. Any compromise on actual tax rate increases would be statistically meaningless with respect to the overall budget.

    Regardless of what your preferences might be, it is very unrealistic to think that tax (rate) increases are going to be the major source of deficit reduction. And yet, this is really the thing these baselines tend to force one to focus on. If you’re focusing on those two tax baselines with the idea that moving a certain distance away from them will make even a dent in the deficits, you’ve really taken your eyes off the ball. And that is exactly what Economist Mom has done here. She’s focusing on the difference between two constructs that are artificial to begin with–the “tax policy baseline” and the “current tax law baseline” —-and wants readers to agree that that the difference between the two is somehow the most meaningful thing about the deficits and the current policy debate. That’s pretty absurd when the current tax law baseline is not in *anyone’s* proposal and the chances of it actually happening are next to nil.

    That’s why the headline (and the basic premise behind this entire post) is rather silly. How could the story about the 10 year fiscal outlook be about the difference between a “current tax policy baseline” and a “current tax law baseline” when the latter is not even on the choice menu?

  4. comment number 4 by: AMTbuff

    Any compromise on actual tax rate increases would be statistically meaningless with respect to the overall budget.

    Right. You could take all the spending cuts proposed by Republicans plus all the tax increases proposed by Democrats and you wouldn’t be anywhere near fiscal balance. Politicians are cooperating to hide that truth from the public.

  5. comment number 5 by: Brooks / Gordon

    Re: Vivian’s point about the current law revenue baseline, indeed that baseline has very limited usefulness for current purposes, particularly given that (as Vivian points out), no one is proposing it (nor anything anywhere close to it). I don’t see much purpose in comparing any path to the current law revenue baseline.

    My view would be somewhat different if the bulk of the differential between the current law revenue baseline vs. a/the current policy baseline or vs. some proposal were not the expiration of tax rate cuts enacted in 2001 and 2003 (and extended more recently). If, instead, we were talking about some enacted, scheduled tax increase that was part of a deficit-reduction plan, the current law baseline could have some usefulness insofar as it would represent the fiscal path we’d take if the politicians stick to a deal they made (and thus, the American people made, via our political process) and enacted, rather than backtracking on part or all of that deal (backtracking on that ostensible progress of sorts, and perhaps doing so selectively in some way that is partial to one ideological/political “side” or segment/interest). But, although it can be argued that the time limits on the 2001/3 tax cuts were, in effect, a form of active fiscal restraint, I see it more as sort of “let’s do this for 10 years, then we’ll see”, rather than the expiration being part of a deficit-reduction plan deviation from which should earn politicians criticism or at least scrutiny for potential lack of guts/responsibility and/or partisan reneging on a previous deal.

    And as I said in my earlier comment, I see no reason to view the current law revenue baseline as something more desirable than some other path simply by virtue of it being the current law baseline.

  6. comment number 6 by: Brooks / Gordon

    As follow-up to my comment above, a couple of elements of the overall current law baseline that can reflect something useful per my rational above are (1) implemented AMT per law vs. patching (which I realize interacts with the tax rate difference, but that’s beside my point), and (2) the Medicare “doc fix”. Both seem to reflect deficit-reduction (and perhaps “fairness”) deals and plans that the American people, via our political leadership, chose and made (enacted), and politicians’ avoidance of implementation of those provisions is worth pointing out to invite scrutiny.

  7. comment number 7 by: Brooks / Gordon

    As a note, I don’t have any beef with the revenue path of the current law baseline, and in fact, I think that would be much better than our current course per CBO current policy baseline or per some plausible baseline (ideally with that course change achieved largely via reduction in tax deductions/credits/exclusions, and ideally as part of a deal including very substantial reductions in projected spending vs. current policy baseline).

    My point is just that the mere fact that that path (and associated set of implemented policies) is the current law baseline does not imply that it is preferable to any other path and associated policies.

  8. comment number 8 by: Brooks / Gordon

    Oh, and there is another way a current law baseline (even in this case) can be useful: to show the benefit or harm (depending on whether one likes or dislikes the scheduled policy changes per current law) of gridlock, and in some cases to show where one “side” has greater leverage in negotiations (the side that likes, or dislikes less, implementation per the law).

  9. comment number 9 by: Patrick R. Sullivan

    ‘She’s focusing on the difference between two constructs that are artificial to begin with–the “tax policy baseline” and the “current tax law baseline” —-and wants readers to agree that that the difference between the two is somehow the most meaningful thing about the deficits and the current policy debate. That’s pretty absurd when the current tax law baseline is not in *anyone’s* proposal and the chances of it actually happening are next to nil.’

    Exactly. EconMom’s entire analytical approach is worse than useless, as it distracts from what the real problem is.