TCS Daily

Not So Fuzzy Math

By John Merline - July 14, 2006 12:00 AM

The latest figures on the federal deficit had Washington all atwitter this week. The Bush administration is crowing about the fact that the deficit is coming in much lower than the budget forecasters had predicted a few months ago (which, come to think of it, doesn't say much for the White House's ability to made short-term budget forecasts). Democrats are casting aspersions, saying the result is merely a reflection of that fact that the rich are getting richer. What's the alternative they would prefer? That the rich didn't get richer, and the deficit is bigger? Or that the middle class paid more in taxes?

But what do to these budget results really mean? Are Bush's tax cuts throwing off revenue, Laffer-like? Has spending under this administration gotten out of control? Is the Medicare drug benefit blowing a hole in the budget? All of these arguments have been made by one side or the other.

One way to get some clear answers is to look back to the last long-term budget forecast made before President Bush took office and compare it with Bush's current budget numbers, to see how Bush's policies have changed things.

In January 2001, the Congressional Budget Office issued its annual long-term budget outlook, which forecasts spending and revenues for 10 years, assuming there aren't any policy changes.

The results of this comparison are illuminating, even if they aren't particularly helpful to either political party in the current debate.

Back in 2001, CBO predicted that the federal government would run a surplus of $505 billion for 2006. Now, the White House predicts a deficit of $296 billion.

What caused that huge swing?

It wasn't because the CBO goofed on its economic forecast. In fact -- despite the intervening recession, war on terror and spike in gas prices -- it came very close in its guess on the size of the 2006 economy, missing the mark by just 0.7%.

And it wasn't because the CBO missed the costly new Medicare drug benefit. The CBO was spot on in its prediction about overall entitlement spending.

The CBO also got corporate and payroll taxes just about right.

So what did change?

First, spending on discretionary programs was vastly higher than the CBO predicted -- $269 billion higher, in fact.

Yes, a good chunk of that was the result of the defense build-up. But spending on non-defense programs was also way up -- $109 billion higher than the CBO had projected. And only a small portion of that reflects the increase in spending on homeland defense.

Second, despite the wishes of Laffer-curve enthusiasts, individual income tax revenues came in far lower than the CBO had projected -- $1.06 trillion instead of $1.35 trillion. The result, presumably, of Bush's income tax cuts.

Sources: Congressional Budget Office, "Budget and Economic Outlook,"January 2001; White House Office of Management and Budget, "Mid-Session Review," July 11, 2006.

Put the two together, add in additional interest payments on the debt, and few other odds and ends and -- voila! -- a $500 billion surplus turns into a $296 billion deficit.

John Merline is a TCS contributing writer and was formerly an editorial writer at USA Today.



Agree with Krugman, almost
The main thrust of Merline's post is exactly what the Democrats and most main stream economists are saying. Tax cuts have decreased revenue (no magic Laffer curve).
These, together with huge spending increases, have turned a prudent surplus into a reckelss deficit. Note that interest on the national debt is almost as large as the deficit. In other words, we could (almost) sustain Bush economic policies if we first finish the Clinton debt paydown.

I want to state the obvious answer Merline disingenuously neglects in his first paragraph. It isn't a problem that the rich get richer, it's that only the rich get richer. I want the median income to increase, not just the GDP.

Speciousness befitting USA Today
Mr. Merline is not so explicit about what his point is, assuming that there is one.

But the drift of his piece seems to be that W's economic performance has been poor, as indicated by 2001 CBO economic estimates for 2006 and the real outcomes of 2006. Since the CBO estimate of 2006 GDP was quite close, and the fiscal deficit in 2006 is much higher than estimated in 2001, Mr. Merline insinuates that economic policy over the period was faulty.

Mr. Merline, however, has not cited any CBO estimates for 2001, 2002, 2003, 2004, or 2005. The closeness of the CBO 2006 GDP estimate is not the product of sound forecasting, but rather, the product of an impressive economic rebound. By ignoring a punishing slowdown of growth between 2000 and 2004, Mr. Merline overlooks a prime contributor to the size of the disparity of deficit estimates in 2001 and the reality in 2006.

Mr. Merline's spurious insinuations are exactly what I'd expect from a USA Today columnist, but they are beneath what I expect from a writer at TCS.

Here we go again-LG's dreamscape
While not defending deficit spending, what is so prudent about a "surplus"? Please tell how prudence is demonstrated by overcharging taxpayers who are forced to pay for something under threat of imprisonment?

As for your comment about median income, you clearly don't understand statistics. A median is merely an estimate of the point where 1/2 the statistical population is above and 1/2 below. In of itself, it tells you nothing about variance, which is what your are obsessed with.

Please learn something about economics before you prattle on again. I'm sure you could take intro micro and macro @ a local community college for 500 bucks.

It baffles me why anyone would think that sending more money to Washington somehow strengthens the country.

Right on.
I would be curious to see the CBO's estimates in 2001, during the height of the Clinton/Gore recession. I'm guessing it was much more pessimistic.

That said, this "analysis" comes nowhere near disproving the Laffer curve, a tool that has accurately described the result of every single major tax cut we've had since John F. Kennedy. Here's why:

The Laffer curve does not say that cutting taxes will magically result in higher taxes for the same amount of income. It says that cutting taxes will result in higher economic activity, which results in higher income, which results in higher overall tax revenues. e.g. imagine taxes are 50% and the US GDP is $100. Total tax revenues = $50. If we lower the tax rate to, say, 30%, the theory is that the US GDP will rise to $200, resulting in govt. revenues of $60. Cut taxes and the total take to the treasury goes up.

Now, let's look at the current scenario. You said that the CBO was about right in its estimates on GDP. You said that the fact that revenues were below estimates disproves the Laffer curve. No, no, no, you moron. Of course revenues were below estimates -- the tax rate was lowered, so at the same GDP, the revenues are guaranteed to be lower. As I said, Laffer is not magic. Where Laffer works is in the GDP itself. The fact that the GDP is equal to what the CBO was estimating in 2000 is exactly where Laffer was right! The CBO didn't take the recession or 9/11 into account when they estimated GDP. If Laffer was wrong, GDP should have been much, much lower than it is! If anything, this pretty much proves Laffer was right about tax cuts leading to higher GDP. Whether or not overall tax revenues would have been higher if we had higher taxes and the resulting lower GDP is impossible to tell without a time machine, but I can guarantee you one thing -- the American people would be much worse off regardless of how well the government may or may not have been.

By the way, how about that entitlements figure! $1.44 Trillion with a "T"! How about we cut that in half and we'd be back to about $400 in surplusses!

Bush is in no way a conservative...
...and conservatives would do well to distance themselves from him as much as possible. As damaging as Clinton was to the democrats it is looking like Bush could be more damaging to the republicans.

IMO Clinton and Bush where selected by party insiders before the primaries because the insiders thought that they could win (not becuase they would stand for the ideas of party members) but both have been divisive hurt there parties.

why surplus?
My post gave a reason for prefering a surplus: less interest to pay. There are other arguments: government borrowing drives up interest rates by competing with private enterprise in debt markets, inflexibility when you really want to deficit spend in a crisis. As an expert in economics, you probably have heard these arguments and more.

In other posts I've complained about the gap between the wealth of rich and poor in the US, but not this one. I used the term median correctly (unlike you: the median is the point, not an estimate of the point).

The increase in GDP might eventually improve the lives of most Americans, but recently it has improved the lives of only about 30% of them.

Though I am not an economist, I am a professor with a professional interest in some parts of economics. I read the microeconomics book by David Kreps. Would you like to suggest other texts?

You are good at insults, please add one here for yourself.

Clueless on the Laffer Curve
Pardon me, but the Laffer Curve has never stated unequivocally that all cuts in income tax rates raise income tax rate revenue.

The Laffer Curve implies that at some rates a rate cut will bring in more revenue and at some it will bring in less, but that, more often than not, the result is not linear.

Secondly, there are other taxes besides the income tax. Every time the Cap Gains tax has been cut the CBO has forecast a drop in revenues and the result has been a surprising increase in revenues.

Finally, Mr. Merline leaves out the fact that in 2000, Federal Revenues were at a record high as a percentage of economic activity. Does Merline have any justification for assumption that revenues could continue at a record proportion without any harm to economic activity? He just takes a record high and calls it his baseline. What was going to make that 20+% tax share go on forever?

Instead, federal receipts fell to below average and then returned to the average. There is at least some intuitive reason to believe that that is sustainable.

Surplus will never happen
unless the Supreme Court rules that Congress does not have the authority to spend money on anything it decides.

It would also help if the income tax were repealed.

But the bottom line is that the power of Congress to tax and to spend needs to be curtailed.

Comments on the comments
Thanks to everyone for the provocative comments.

I offer a couple specific responses. First, jg10101 complains that my article “insinuates that economic policy [during the Bush administration] was faulty.” I make so such insinuation. I merely report what the numbers indicate. Jg10101 also says that the relatively poor economic performance prior to 2006 is the “prime contributor” to the deficit in 2006. While that could explain some of the increase in interest payments, tax receipts and spending in 2006 – the main drivers of the deficit swing – were the result of policy decisions.

Gouldjw, meanwhile, says that “the fact that the GDP is equal to what the CBO was estimating in 2000…pretty much proves Laffer was right about tax cuts leading to higher GDP.” In fact, it doesn’t prove anything. It is true that there was a tax cut in 2003, and that the economy has grown since the recession ended in November 2001. But the economy was also growing smartly five years after the 1990-91 recession, despite an intervening tax increase (GDP climbed 3.7% in real terms in 1996; the current White House forecast for 2006 is 3.5% real GDP growth).

Gammaholic makes essentially the same argument as Gouldjw, saying in addition that I incorrectly assumed that tax revenues could continue to run at 20% of GDP “without any harm to economic activity.” I didn’t assume anything; I cited the CBO projections, which are based on its economic model. Merely asserting that the CBO’s model is wrong does not make it so.

All this having been said, let me state for the record that I supported the Bush tax cuts and argued that position while on USA Today’s editorial board. But arguing the merits of these tax cuts was not the purpose of this article, which was, as I stated in the article, to understand how the CBO’s projected $500 billion surplus for 2006 wound up being a $296 billion deficit.

I thought the Laffer Curve covered all taxes
That is, if you are above the income tax break even point, and if you cut income tax rates, then the revenue accrued to govt, from ALL taxes and fees, would increase.

It's possible that even though the income tax would bring in less money, that this loss could be made up by increasing revenue from other taxes.

Can you think of any 6 year CBO projection that ever came close to being right?
regardless of changes in tax policy or economic conditions?

At attempt at an answer
If you mean: Has the CBO ever got a 6-year budget deficit forecast right regardless of changes in tax policy or economic conditions, it hasn't. But no one could, because changes in tax policy and economic conditions directly affect the deficit.

However, if your question is, has the CBO ever got a 6-year economic forecast right, despite tax policy changes and some rough economic times in the intervening period, I would say yes. Consider this one: In December 1990, it forecast GNP (which was used at the time instead of GDP) for FY 1995 of $7.393 trillion. Actual GDP for 1995 was $7.398 trillion. That forecast was made in the middle of the 1990-91 recession and before Clinton's tax hikes. Here's the link to that report.

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