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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Shooting the CBO First, and Asking Questions Later



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Today, in a post over at The Corner, I wrote the following:

What’s ironic is that last year, the CBO projected a 2011 budget deficit of just $980 billion. What’s a $500 billion, 50 percent error among friends?

Indeed, I am the one who committed the error: that’s what I get for blogging immediately upon reading the CBO’s top-line summary, before I was able to read the entire report this afternoon. It turns out that $390 billion of the increase in the 2011 deficit was, according to CBO scoring, a result of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (see page 8 of the full CBO report). So, I owe an apology to the good people of the CBO.

However, Kevin Drum and others are also mistaken in arguing that “virtually all of [the $500 billion difference in projections] is due to the extension of the Bush tax cuts.” Page 9 of the full CBO report shows that only $103 billion of the $390 billion is attributable to renewing the Bush tax cuts: $98 billion for “tax rates, credits, and deductions initially enacted in 2001, 2003, and 2009,” and $5 billion for estate and gift taxes.

The rest of the provisions were unrelated to the Bush tax cuts: a patch in the Alternative Minimum Tax, a eternal budgeting device similar to the Medicare “doc fix”; a payroll tax holiday; a tax credit for purchases of equipment by businesses; and an extension of “emergency” unemployment benefits.

One of the most common complaints that conservatives have with CBO projections is that they do not take into account how changes in tax rates affect behavior and economic growth. Nick Gillespie makes an important point about the Bush tax cuts: the top decile paid more in taxes in 2008, as a share of total revenues, than they did in 2000. Conversely, the share of the bottom half of earners was lower in 2008 than it was in 2000. This, at least, confounds the widely accepted view that “tax cuts for the rich” under Bush worsened the deficit.

While we’re on the subject of the CBO’s new deficit projections, it’s worth highlighting some key passages from the new report (emphasis added):

CBO’s baseline projections…incorporate the assumption that current laws governing taxes and spending will remain unchanged. In particular, the baseline projections in this report are based on the following assumptions:

    * Sharp reductions in Medicare’s payment rates for physicians’ services take effect as scheduled at the end of 2011;

    * Extensions of unemployment compensation, the one-year reduction in the payroll tax, and the two-year extension of provisions designed to limit the reach of the alternative minimum tax all expire as scheduled at the end of 2011;

    * Other provisions of the 2010 tax act, including extensions of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and ARRA, expire as scheduled at the end of 2012; and

    * Funding for discretionary spending increases with inflation rather than at the considerably faster pace seen over the dozen years leading up to the recent recession.

The projected deficits over the latter part of the coming decade are much smaller relative to GDP than is the current deficit, mostly because, under those assumptions and with a continuing economic expansion, revenues as a share of GDP are projected to rise steadily—from about 15 percent of GDP in 2011 to 21 percent by 2021.

As a result, the baseline projections understate the budget deficits that would arise if many policies currently in place were extended, rather than allowed to expire as scheduled under current law.

Tyler Durden also makes some important points that have significant consequences for the stability of the dollar and of U.S. sovereign debt:

So between 2010′s $1.3 trillion, 2011 $1.5 trillion, and 2012′s revised $1.1 trillion, we have $3.9 trillion just in deficit costs to plug. And as Zero Hedge has repeatedly demonstrated the actual debt to be issued is usually about 33% higher than the deficit funding need, meaning that over the next 3 years the US will need to issue about $5 trillion in debt. Which means further debt monetization is guaranteed as foreign investors have now fully withdrawn and the Fed is all alone in gobbling up every dollar in gross issuance. QE3 is guaranteed and we are stunned that the market continues not to realize this.

Finally, there is a kind of epistemological divide in thinking about deficits. Those who believe that tax cuts are to blame for our deficit are, by definition, of the view that federal spending at 25 percent of GDP is acceptable, despite its deviation from the historical average of 20 percent. There is at least a plausible argument to be made that 20 percent of GDP should be enough for the federal government to fulfill all functions that are appropriate for it to take on.



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