Budget Deficit to Top $1 Trillion a Year for Next Decade

Budget Deficit to Top $1 Trillion a Year for Next Decade

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Plus, the next big fiscal question
Tuesday, January 28, 2020

Budget Deficit to Top $1 Trillion a Year for Next Decade: CBO

The U.S. budget deficit is expected to top $1 trillion in fiscal year 2020 and remain above that level indefinitely, lifting the national debt over the next decade to its highest level since World War II, the nonpartisan Congressional Budget Office said Tuesday in its annual report on the nation’s fiscal and economic outlook.

CBO expects the deficit will rise from just over $1 trillion this year to more than $1.7 trillion in 10 years, averaging $1.3 trillion from 2021 through 2030. As a share of gross domestic product, the deficit is projected to rise from 4.3% next year to 5.4% in 2030.

“Not since World War II has the country seen deficits during times of low unemployment that are as large as those that we project—nor, in the past century, has it experienced large deficits for as long as we project,” CBO Director Phillip L. Swagel said in a statement accompanying the report. Swagel called the budget outlook “challenging” and “worrisome.”

As a result of the continuing deficits, the debt held by the public will rise from $17.2 trillion today, or 80% of GDP, to $31.4 trillion, or 98% of GDP, by 2030. “The long-term projections for the debt are higher than they were last year because the federal government's revenues are expected to decrease and spending is expected to increase due to legislation enacted by Congress in 2019,” the Washington Examiner’s Nihal Krishan explains.

The deficit is rising despite healthy economic growth: The economy is in its 11th year of expansion, and CBO expects gross domestic product to grow by 2.2% this year, up 0.1 percentage point from its August estimate (but shy of the Trump administration’s 3% annual target). While deficits typically shrink during periods of prolonged economic growth, the budget shortfall has surged as the result of the 2017 Republican tax law and a series of spending increases passed by Congress and signed by President Trump. And CBO expects economic growth to slow to an average annual rate of 1.7% from 2021 through 2030.

What’s widening the budget gap: More than half the current deficit is due to recent tax cuts and spending increases. Revenues are weaker than they would be without the 2017 tax overhaul, and federal spending is projected to grow faster than tax receipts, driven by increased spending for mandatory programs and interest payments on the debt, which CBO expects to rise as the government continues to borrow and interest rates eventually move higher.

Spending for Medicare is expected to rise from $835 billion this year to more than $1.7 trillion by 2030, while outlays for Social Security are forecast to climb from just under $1.1 trillion to more than $1.9 trillion. Brian Riedl, a senior fellow at the conservative Manhattan Institute, points out that the annual shortfall for Social Security and Medicare benefits payments will rise from $440 billion to nearly $1.9 trillion. “That's the ballgame,” he tweeted.

And deficits could be higher than CBO forecasts: The projections assume Congress will allow some of the 2017 tax cuts to expire as scheduled after 2025. If Congress extends the individual tax cuts, as it may be likely to do, the deficits and debt would be larger than CBO projects.

Low interest rates buy the government some time: Lower-than-expected rates have thus far served to provide some fiscal breathing room, as interest cost come in lower than projected. “Since CBO’s last budget forecast in August 2019, projected interest costs have declined by $441 billion over a decade, reflecting rates that are 0.3 percentage point below the previous estimate,” The Wall Street Journal’s Richard Rubin writes. But lawmakers have more than offset those gains, he explains: “loss of revenue from tax cuts enacted in December 2019 exceeded those savings, and CBO now projects budget deficits to be 1.3% larger than it did in August.”

Still, low rates may make addressing the short-term deficit picture less urgent. “To be sure, interest rates remain low today, suggesting that there is time to address our fiscal challenges and that fiscal policy could be used as a tool to address other challenges facing the nation, if the Congress chose to do so,” Swagel says in his statement. “But our projections also suggest that over the long term, changes in fiscal policy must be made to address the budget situation, because our debt is growing on an unsustainable path.”

But the deficits aren’t being used to invest in the future: “Trump is wasting these deficits,” Robert C. Hockett, a Cornell University professor who has advised Sens. Bernie Sanders and Elizabeth Warren on economic policy, told The Washington Post. “It’s fine to engage in deficit spending, but Trump has used them to give tax cuts to billionaires, which does nothing to increase the well-being of the vast majority of Americans or improve the nation’s productivity.”

The Next Big Fiscal Question: How to Raise More Revenue?

An all-star roster of fiscal experts gathered at the Brookings Institution Tuesday to debate the future of American tax policy. The initial discussion featured former U.S. Treasury secretaries Timothy Geithner, Robert Rubin and Lawrence Summers, all of whom agreed on one overarching point: Given the size and scope of its obligations for health care, retirement and national defense in the coming years, the federal government needs to raise a lot more revenue.

How to go about raising that revenue — and what to do with it as it comes in — was a slightly more contentious issue.

Both Geithner and Rubin said they worried about negative effects on growth from increased taxes, and spoke about the need to establish a fiscal framework that defines the constraints facing policymakers — most notably, what are the limits on deficits and the national debt? Summers spoke forcefully against that approach, arguing that policymakers should ignore the deficit and focus instead on creating a fairer society and increasing economic growth; once steps were taken toward those primary goals, the deficit could be brought under control more easily in a stronger economy.

Summers provided a list of specific policy changes he recommended to make the tax system fairer, reduce inequality and boost the economy:

  • Improve tax compliance to capture a significant proportion of the hundreds of billions in taxes that go unpaid every year. Sanders said better IRS enforcement could produce more than $1 trillion in revenue over 10 years.
     
  • Crack down on international businesses that are evading billions in corporate taxes by moving profits overseas.
     
  • Reform capital gains taxation by eliminating the step-up in cost basis at death, taxing gifts to charity and real estate transfers, and eliminating the carried interest tax break.

Once those policy changes are in place, raising the capital gains tax rate to income tax levels would raise billions in new revenue, Summers argued, without weighing on growth. But the full set of policy changes are necessary, Summers said, in order to close off as many avenues for tax avoidance as possible.

All told, Summers estimated that his proposals could raise more than $4 trillion over 10 years — without imposing a politically contentious and economically uncertain wealth tax.

A menu of policy options: Other participants in the conference discussed a variety of options for raising revenues, many of which are spelled out in greater detail in the book accompanying the conference, “Tackling the Tax Code: Efficient and Equitable Ways to Raise Revenue.” Some highlights:

  • VAT: William Gale of the Urban-Brookings Tax Policy Center proposed a value-added tax similar to that in most other developed countries. A 10% VAT would raise roughly $10 trillion over 10 years, Gale said.
     
  • Financial transaction tax: Antonio Weiss, a financier and senior fellow at the Harvard Kennedy School, said a tax of 10 basis points on trading in stocks, bonds and derivatives would raise $60 billion a year without hindering market efficiency.
     
  • Corporate tax reform: Jason Furman, who led the Council of Economic Advisers in the Obama administration, recommended a variety of tweaks to the tax code, including raising the corporate tax rate from 21% to 28%. He said the proposals would raise more than $1 trillion over 10 years and boost GDP by about 1%.
     
  • Taxing inheritances: Lily Batchelder of New York University Law School proposed more stringent inheritance taxes that would raise $340 billion or more over 10 years (more on that below).

The elephant in the room: While the conference provided plenty of ideas for improving the federal government’s fiscal situation, much less was said about how to enact the proposals in such a politically divided country. With one of the two major parties rejecting the very idea of using taxes to increase revenues, reaching a compromise to shore up Social Security and Medicare will likely be quite difficult. “We’re the sound of one hand clapping,” Geithner said, adding that he didn’t see a political coalition dedicated to fiscal reform coming together anytime soon.

The Case for Scrapping the Estate Tax — and Replacing It With an Inheritance Tax

Americans will inherit more than $764 billion this year and pay an average of 2.1% in taxes on that income, according to a paper published Tuesday as part of the Brookings Institution’s examination of the tax code. The paper, by New York University law professor Lily Batchelder, notes that wealth transfer taxes accounted for 2.1% of federal revenues in 1973. This year, they are projected to account for 0.5%. The share of estates subject to the estate tax fell from 6.5% to a projected 0.1% over that same period.

Batchelder, a former adviser to President Obama, proposes to replace the current estate tax with an “inheritance tax.” It would treat inherited money above a certain level as ordinary income, requiring heirs to pay both income and payroll taxes on it.

The Urban-Brookings Tax Policy Center estimates that the proposal would raise $340 billion over the next decade if the lifetime exemption were set at $2.5 million, meaning it would hit just the top 0.02% of heirs. If the exemption were set at $1 million, the proposal would raise $917 billion, and if it were set at $500,000 — affecting just the top 0.18% of heirs — the proposal would raise about $1.4 trillion.

Batchelder says her proposal would reduce inequality and “take a large step toward leveling the playing field between income from inherited wealth and income from work.”

She also argues that her plan would more successfully build public support for taxing inherited income compared to the current estate tax.

“[T]he structure of an estate tax makes it easier for opponents to characterize it as a double tax on frugal, generous entrepreneurs who just want to take care of their families—even though nothing could be farther from the truth,” she writes. “Instead, the estate tax is the only tax that ensures wealthy heirs pay at least some tax on large amounts of inherited income, even if at much lower average rates than apply to income from good, old hard work. Nevertheless, inheritance taxes are more self-evidently ‘silver spoon taxes’ and, as a result, appear to be more politically resilient.”
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