Charles Blahous has written a fascinating guide to understanding the evaporation of the budget surpluses the federal government had anticipated as late as 2001 for my colleagues at Economics 21. How did we get from federal surpluses as far as the eye could see to mammoth deficits?
(1) Blahous begins by observing that the CBO’s 2001-era projections of the underlying growth trajectory of the U.S. economy proved overly optimistic, resting as they did on the experience of the late 1990s tech bubble. This, in turn, led to very optimistic revenue projections. The bursting of the bubble, Blahous explains, was enough to cause the expected surpluses of 2002 and 2003 to vanish.
(2) After the 9/11 terror attacks, federal discretionary spending increased dramatically, due in large part to defense expenditures. There was a second spike in federal discretionary spending in the wake of the 2008 financial crisis.
(3) There were also increases in mandatory spending, mostly associated with the expansion of the Medicare program backed by President Bush, TARP, and the 2009 fiscal stimulus law. It turns out that the Medicare expansion was not quite as significant a contributor to the federal government’s deteriorating fiscal position as is commonly understood.
(4) Blahous than zeroes in on the role of various changes to the tax code, including the Bush-era tax cuts of 2001 and 2003. The results are fascinating.
Roughly 49% of the fiscal deterioration relative to the expectations of the CBO circa its 2001 projections can be attributed to increased spending, 27% to the failure to predict the less-than-smooth business cycle perturbations of the decade, and 24% to tax cuts.
The tricky if not impossible to answer question is whether or how policies on taxes and spending impacted the country’s underlying growth trajectory. Left-liberals might argue that had we taxed more and spent on public investment rather than the wars in Iraq and Afghanistan, we’d be much richer today. Champions of the Bush-era tax cuts might claim that growth would deteriorated even more relative to expectation in their absence.