The Deficit Is Smaller . . .
. . . but government is bigger.


Phil Kerpen

The Treasury Department released the results for the fiscal year 2006 budget last week. As has become the norm in recent years, the numbers blew the official projections out of the water. The deficit, at $247.7 billion, is $175.5 billion less than projected in the January budget, and $48.1 billion less than the White House Office of Management and Budget predicted just three months ago. At about 1.9 percent of GDP, the deficit is lower than it was every single year between 1980 and 1996.


How did this happen? Did government get smaller?


No. In fact, federal spending increased at a brisk 7.4 percent rate in 2006, and stood at a record $2.65 trillion last fiscal year — more than 42 percent higher than it was during Bill Clinton’s last budget year in 2001. Spending on just one program, Medicare, increased by more than $40 billion last year alone.


While spending growth has been constant through the George W. Bush years, the deficit story has been one of falling and rising federal revenues. The collapse of the dot-com bubble sent the economy, and federal revenues, into a tailspin early in the decade.  Revenues declined for three consecutive years between 2001 and 2003.


But the 2003 Bush tax cuts coincided with a dramatic reversal of these misfortunes. Revenues jumped a total of 35 percent between 2003 and 2006, well outpacing the also-large 22.9 percent increase in federal spending over that period. By raising the after-tax returns on work, savings, and investment, those tax cuts revived economic growth, creating millions of jobs and a tidal wave of federal revenues. 

The 2003 capital-gains and dividend tax-rate cuts alleviated the double taxation of investment income, boosting capital formation and reviving the stock market. Consumer spending never flagged all that much during the recession, growing by 2.5 percent even in the recession year of 2001. The story of the recession was a collapse in business investment, which in real terms declined 4.2 percent in 2001 and 9.2 percent in 2002.


The 2003 tax-rate cuts supercharged business investment, which, in real terms, climbed by 5.9 percent in 2004 and an outsized 6.8 percent in 2005. Not surprisingly, by far the fastest growing revenue source since 2003 has been the corporate income tax. The corporate tax-revenue stream increased 27.2 percent in 2006 after two consecutive years of more than 40 percent growth. Since 2003, total corporate income-tax receipts are up a stunning 168.5 percent — an increase of $165 billion, which happens to be the precise amount the federal deficit shrunk over that period.


Non-withheld individual income-tax receipts, largely capital gains and dividend income, also are up sharply since rates were cut. They jumped 20.7 percent in 2006 (on top of last year’s 31.9 percent bulge) to a record $387.3 billion.


The 2003 tax-rate reductions have been so clearly successful in lifting the economy that well-meaning advocates of big government, including would-be House Ways and Means Chairman Charles Rangel, should stop calling for tax hikes to reverse them. There should be a broad consensus in favor of canceling the impending 2011 tax hikes that will automatically take effect if Congress fails to act. Unfortunately, there is no such consensus, which makes fighting to cancel those tax hikes a top priority for maintaining our prosperity.


On the spending side, advocates of smaller government must be careful not to rely on deficit reduction as a key rationale for reducing the size of government. The surprise disappearance of the deficit in 1998 disarmed many activists in the fight for smaller government. The result was a spending spree that more than undid the core achievements of the Contract with America.


While the deficit is significantly smaller this year, the federal government is much bigger, and continues to grow rapidly. It is more crucial than ever that advocates of limited government fix their attentions squarely on reducing the overall size of government, irrespective of the budget deficit.


– Phil Kerpen is a policy analyst in Washington, D.C.  His web site is