By 2012, the CBO had adjusted its forecasts to reflect the fallout from the economic recession. By then, they were predicting that the roughly $1 trillion-a-year deficits the prior three years would fall to roughly $200 billion today. In fact, in 2012 the CBO was predicting that by 2015, and for years after, the federal government would be achieving a “primary” surplus, a surplus when one doesn't include the interest paid on the debt (currently more than $250 billion a year, and climbing). Instead, stated government deficits have not come close to that level ($665 billion deficit in 2017) since those projections were made in 2012 despite the lack of recession, continual “strong” economic growth, near record-low unemployment rates and lower-than-expected interest rates.
One area where the CBO has been quite accurate is on the projections of yearly government spending. According to the CBO, in 2017 federal spending was $3.982 trillion, off just 1% compared to the projection made a decade earlier. Where projections have been so wrong is in the area of tax revenues. Back in 2007, the CBO projected more than $4.2 trillion of yearly government revenues by 2017, compared to the $3.3 trillion actually collected. The result has been that projected surpluses have become large realized deficits.
The chart below shows government collections and expenses as a percentage of Gross Domestic Product (GDP). We see that for the last few years government revenues and spending outlays have been roughly in line with 50-year averages. But because of the large deficits incurred during recent recession and recovery years that have to now be carried forward, with associated interest due on that debt, it will become increasingly difficult to reduce or even maintain this gap between expenses and revenues. In past decades, the U.S. government did not have such an enormous outstanding balance of debt as over the last one, and because of this, interest rates will play a more crucial factor than ever in helping or hurting the government stay in control of its finances.
It will become more difficult for the government to avoid escalating sharply escalating interest payments, and a broken budget, with anything other than the rock-bottom interest rates that have existed over the last several years. I have made the case before that if interest rates were truly normalized (i.e., short-term interest rates 5% or higher), then it would be a near impossibility for the budget to ever be balanced. (If average interest rates on government bonds immediately went to 5% tomorrow and stayed there there would be roughly another $600 billion a year in government spending, widening the revenue-income deficit by another three percentage points or so, adding even more debt onto its balance sheet, and continuing the negative spiral.) As U.S. government debt has exploded from $5.6 trillion to over $21 trillion in just the last 16 years and as interest rates on its outstanding debt have started to climb, the government has now gotten itself into such a predicament that it must reduce deficits now in order to have any chance of arresting runaway federal debt and keeping yearly interest payments, and the budget in check.
Projecting prosperity (and higher taxes)
In contrast to the CBO and many economic forecasters from across the aisle, the White House has a different perspective on economic fundamentals over the coming years. Here is the White House's own projections budget from the beginning of this year.
Based on White House predictions, deficits are projected to steadily fall from about $600 billion a year today to a balanced budget by 2027. Note that these projections for a balanced budget are far different that current (April 2018) CBO 10-year projections. Those projections estimate that current deficits of more than $600 billion a year will only rise in the years ahead to over a trillion dollars by 2020, and average about $1.2 trillion a year for the next decade. The sharp contrast in these two plans is the result of the White House projecting higher economic growth, as well as reducing expenses and “reforming” programs like Medicaid, welfare, student loans, and steadily reducing discretionary spending (1% per year) across the board. These White House projections for a balanced budget also assume higher tax collections than other forecasters, and in fact, much higher than average increases over the last decade.
While it's admittedly a relatively short period of time compared to 10-year projections (although their own projections also include predictions for individual years), we can get an idea of how projections are lining up with reality during the early months of the new administration. Below I've compared monthly government spending and revenues, and correlating deficits/surpluses, for the fiscal year of 2017 and the first six months of fiscal year 2018.
On the spending side, outlays for the first six months of fiscal 2018 totalled $2.097 trillion compared to $1.999 trillion the previous year, an increase of about 4.8%. White House projections for the full year are of a spending increase of less than 1%. Their projections of higher revenues and lower expenses is expected to reduce the federal deficit by more than $160 billion this year compared to the previous year. While the full fiscal year is only half over (the spending/revenue results of the month of April will be a very significant month when released), the year-to-date budget deficit is actually higher, not lower, as projected - $599.9 billion compared to $526.7 billion the prior year. So at least thus far in the current year (which again, we are told is in an environment of very strong economic conditions), the deficit has not improved, but has gotten larger.
Looking out at a longer perspective, the White House projects that tax revenues will increase by an average of 5.2% per year for the the next decade, with average yearly spending increases of 3.5%. If these projections become reality, then revenues will eventually exceed expenses and a balanced budget will be the result. That remains to be seen, but for now we can see that current year spending and revenues results do not line up with expectations for either their long-term plan as well as current year predictions.
When numbers are more honest than words
The White House's own estimate for increasing tax revenues by an average of 5.2% per year for the next decade seems to be at odds with the administration's recent “tax cuts” and long-term promises of lower taxes for individuals, families and corporations. Since the government is nearly completely funded by taxes, the only way to increase yearly government revenue by an average of 5.2% per year is to collect 5.2% more in taxes each year. Yet if the stated goal is for businesses and individuals to pay less in taxes, then why does the administration project 5.2% yearly average increases in revenues? Even if the government can create a super-charged economy with 5.2% yearly average growth for a full decade, recession-free (such long-term growth rates have not happened in the U.S. since the decade following the end of World War II), this still implies that collectively, citizens and business will receive no reduction in overall taxes paid.
There has been much enthusiasm over the impact of lower tax rates on the prospects for economic growth and government reform, but we see that despite the excitement over the lower tax rates put forth by the new administration, Americans should not expect lower taxes over the coming decade compared to previous administrations. Over the past decade, the CBO reports that government revenues (taxes) have increased an average of 2.6% per year. Both CBO and White projections are for much higher tax increases in the coming decade. The CBO's 10-year projections show government revenues (taxes) increasing an average 4.8% per year, compared to the 5.2% per year projected by the White House. Where the CBO's plan differs is projecting higher government spending, an average increase of 5.2% per year, compared to the administration's 3.5% per year.
For conservatives, their goal of lower taxes rates and lower tax revenues coincides with the idea of getting the government out of the way and letting the free market take over. It is said that this will then lead to higher economic growth, stability and prosperity. But we see how difficult it is for governments to simply cut taxes across the board and cut spending even more.
Taxpayers, justifiably, don't like to pay taxes, especially when they don't see much in the way of benefits. In the old days, governments would support higher spending by increasing the taxes from their constituents, and to do so they would have to make the case to taxpayers to justify those tax increases. They had an easier time getting taxpayers to go along with them when they could convince citizens that these were “unusual” times, with a recession or depression, a war, perhaps a financial “crisis”. It's a little different these days when politicians generally want to provide “free” goodies without having to do the hard work of being discriminate about their spending. Asking taxpayers for more taxes, especially to pay the overdue taxes from the previous generation has become generally unacceptable to politicians.
As a result, even though more than $10 trillion in debt has been given to Americans over the last decade that will need to be paid for, at least financed, citizens are still willing to believe they are being given something – tax cuts - for nothing. That there is in fact, such a thing as a free lunch. That the massive overspending of the last decade will not have to be paid for by anyone, and that in fact, Americans can actually pay even lower taxes.
It is all well and good to have lower tax rates and taxes, but better to not try to trick Americans into believing they're going to pay lower taxes when they aren't. In past generations, it was more difficult to convince taxpayers that tax cuts in the midst of large budget deficits and massive debts would be anything other than temporary. Since taxpayers in such conditions would realize that the tax cuts will likely result in even larger deficits in the future, they will perceive the tax cuts as temporary that will actually lead to higher taxes to be paid in the future. In this case, taxpayers will save much or all of any offered tax cuts in order to pay the higher taxes (and interest due) in the future
Bad lessons learned
It may have been that way in the past, but I'm not so sure this is how American taxpayers look at tax cuts now. First, those with financial aptitude can see that taxes are becoming much less relevant to balancing the buget then they used to be. In the past, spending increases nearly always needed to be covered by higher taxes. But in the past generation or so, borrowing has become a more acceptable method to “balance” budgets. In 2012, U.S. individual income taxes collected were just 13% above the level from the year 2000, while government spending had increased 98% over the same span. When the government turns to borrowing (or money-printing, where the government “sells” bonds and buys them right back) so quickly and so easily to support its overspending habit, even during good economic times, it may seem reasonable to believe the government will never come to taxpayers to pay for past (and future) overspending.
Secondly, the financial markets appear to have given a green light to governments to overspend and use money-printing and debt issuance to do it. I believe this was the big lesson governments learned from Japan's financial path since 1990 (which perhaps not so surprisingly, has also coincided with nearly three decades of economic stagnation). Japan showed that a government could simply print money and borrow to fill budget deficits. And do so for a very long time. Even better (for politicians, not for economic stability and sustainability) governments could borrow in large amounts, run huge deficits and still pay miniscule rates of interest on their debt. This has been been the huge takeaway from Japan for governments around the world.
Lastly, even for those without much knowledge of financial markets, government bonds and interest rates, most citizens have likely realized that a long time has passed without taxes going up. Among political circles and commentary there is rarely any discussion of tax increases: the only discussion is for lower taxes. This has been a very unusual period in history, in the U.S., and elsewhere, when tax rates move consistently in one direction, without regard to economic cycles, war or general financial conditions. But with limited historical and economic perspective, every year that passes without taxes rising, even in an environment of large deficits and debts, convinces millions more that they can have tax cuts, and have them permanently.
I do think the current administration's talk of slowing the rate of increase in government spending is admirable, since so many Americans don't seem to understand these basic financial realities. Frank discussions about economic reality and necessary spending reductions don't endear government officials to voters, which is why weak-minded politicians don't offer plans of how they will reduce spending, and increase taxes to pay for past overspending. A government willing to cut spending 2% per year across the board would see a balanced budget soon enough, but a politician suggesting such won't be elected in an entitlement economy. Suggested limits on government spending increases by the current administration may not be enough, but it is at least a step in the right direction. However, in a truly honest conversation on taxes and the economy, there would be less smokescreen and slight-of-hand with taxes laws and tax rates, but the truth of what the government really has planned tax-wise for its constituents in the years ahead.