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New Year, Same Old Debt

By Joseph Minarik

This article originally appeared in RealClearPolicy on February 04, 2019.

The Congressional Budget Office (CBO) recently released its latest annual review of the state of the federal budget. This report does not make merry. Despite small improvements in the budget picture, the budget deficit will continue to grow, and by fiscal year 2022 the deficit is projected again to exceed $1 trillion. The first four instances of trillion-dollar deficits had the excuse of coming in the wake of the 2008 financial crisis, which was the worst economic calamity since the Great Depression. This fifth digit-buster inexcusably comes in an economy that almost every scholar would acknowledge is exemplary, and therefore should give us a budget at least near balance, to build a fiscal cushion for harder times.

The $1 trillion mark is not a tripwire that will cause dire and unavoidable consequences. However, because all financial markets are rooted in group psychology, policymakers should be concerned. If the federal government is running huge and growing budget deficits in the very best of times, what will the deficit do when the inevitable happens? And how will the markets react? And what will in turn, will that cheerless response do to the deficit? And so on. That is how vicious cycles are initiated.

Speaking of vicious cycles, CBO’s analysis confirms that the fastest-growing component of federal spending is interest on the debt — up 19.4 percent from the same quarter of last year. The large deficit is feeding the rising interest rates that naturally and predictably follow from the continuing economic recovery and expansion after the financial crisis. There is nothing that elected government can do to prevent the rise of interest rates back up to at least the very low end of their normal historical range for periods of healthy growth. Both the strong economy and the norms of central bankers demand that transition. And as it occurs, debt service costs will continue to lead the way toward higher deficits.

Overall, spending thus far this fiscal year is up by $93 billion. Taking into account spending that is shifted from month-to-month or quarter-to-quarter by whether payment dates happen to fall on weekends, spending increased by about 4.8 percent in total. That rate of growth is not shockingly large, but unfortunately the other most troublesome entry in the federal government's ledger, after debt service costs, is revenues. Compared with the same quarter last year, total receipts are up by a glorious $2 billion, or about 0.26 percent. Individual income taxes are down by $17 billion. Corporate income taxes are down by $9 billion. Other receipts — payroll taxes; excise taxes; and customs duties, or tariffs (up by $8 billion) — made up the difference. Ironically, if the nation does settle its trade wars and extraordinary tariffs go away, it will leave a larger hole on the already deficient revenue side of the budget.

To listen to the public debate over the 2017 tax cut legislation and the budget deficit, you might think that if the tax cuts increased economic growth by a scintilla of a percentage point, the budget deficit would fall. Unfortunately, that is not how the arithmetic works. If the direct effect of the tax law is to cut tax revenues and tax rates, then it takes a significant amount of additional economic growth to generate enough taxable income to fill the revenue hole — especially at those reduced tax rates. The CBO always assumed that the tax cuts would increase growth in the short run because of somewhat greater consumer spending and incentives to produce. But by CBO's estimates, that growth would not be enough to make up the first-round revenue loss. Then, in the longer term, CBO estimated that the additional deficits and debt would "crowd out" productive business investment, and actually stifle growth. So far, unfortunately, that interpretation seems to be holding true.

So the budget picture, already unsustainable, is only getting worse — worse enough to break the $1 trillion deficit barrier. Happy New Year.

Incidentally, the tax filing season is looking worrisome as well. For starters, of course, many IRS employees were for more than a month on furlough without pay. But there is at least one additional bad omen. The go-to explanatory document for tax filers to find answers to their questions is a thick book called IRS Publication 17. It provides an overview of just about every issue, with references to other more-detailed publications when questions become really deep. Go to the IRS website for Publication 17 today and you will find a 292-page all-purpose guide ­— to filing your 2017 return. Last year's return, in other words. The tax bill that touched upon many provisions that affect millions of typical taxpayers passed in the waning hours of 2017, and even now, the IRS has not fully caught up to help troubled taxpayers to file. Many happy returns.