Federal budget projections: higher spending and taxes

Raymond Keating
Raymond Keating

Where is federal government spending headed? It seems like everyone wants to know, though for different reasons.

Some mistakenly believe that big government is somehow good for the economy — or at least good for their efforts to get re-elected. Others, with a better understanding of how the economy actually works, remain concerned federal spending will persist at historically high levels.

Two problems exist with big spending by government. First, resources, whether via taxes or borrowing, are drained away from private- sector ventures, including entrepreneurship and investment, and handed over to government to be spent far less efficiently according to political incentives. That’s a clear negative, or drag, on the economy. Second, higher taxes that come with or are threatened by big government diminish incentives and resources for private-sector risk taking (again, such as starting up and investing in businesses) that generates economic growth, higher incomes and more jobs.

So, massive increases in federal outlays over the past few years have inflicted considerable economic harm. If government spending remains high, it will threaten future U.S. economic well-being. Keep in mind that in just four years, from 2007 to 2011, federal outlays jumped by a third. As a share of gross domestic product, federal spending moved from 19.7 percent in 2007 to 25.2 percent in 2009 and then registered 24.1 percent in 2010 and 2011. Those levels have never been hit before, except during World War II. At the same time, the economy has been dragged through a deep recession and a grossly under-performing economic recovery.

So, what’s ahead?

Well, the Congressional Budget Office just released its annual look at the budget and economy — titled “The Budget and Economic Outlook: Fiscal Years 2012 to 2022” — which offers 10-year projections. While providing a wealth of estimates, three fundamental questions emerge from this report:

What’s the outlook on federal spending? According to its baseline, the CBO reports: “Projected spending averages 21.9 percent of GDP over the 2013-2022 period, a percentage that is less than the 23.2 percent CBO estimates for 2012, but that is still elevated by historical standards.” Specifically, outlays slightly and slowly decline from the 24.1 percent share of GDP in 2011 to a projected 21.5 percent in 2018, then start moving up again to reach 22.4 percent in 2022.

In terms of dollar amounts, spending would be effectively flat for 2012, with a tiny decline in 2013. But then outlays would resume steady growth, going from $3.57 trillion in 2013 to $5.52 trillion in 2022.

In effect, the CBO is projecting no true adjustment back to the level of spending that existed before the massive increases in spending from 2008 to 2011 — going from $2.73 trillion in 2007 to $3.6 trillion in 2011. Recall that those increases were overwhelmingly billed as temporary or emergency measures.

What are the expectations on the revenue side of the federal budget equation? Due overwhelmingly to large, scheduled increases in taxes, the CBO projects a big jump in federal revenue in 2013. As explained in the CBO report: “Much of the projected decline in the deficit occurs because, under current law, revenues will rise considerably as a share of GDP — from 16.3 percent in 2012 to 20 percent in 2014 and 21 percent in 2022. In particular, between 2012 and 2014, revenues in CBO’s baseline shoot up by more than 30 percent, mostly because of the recent or scheduled expirations of tax provisions, such as those that lower income tax rates and limit the reach of the alternative minimum tax (AMT), and the imposition of new taxes, fees, and penalties that are scheduled to go into effect.”

More on this in a moment.

What assumptions regarding economic growth are used? The CBO assumes that GDP growth will come in at 2.2 percent in 2012, 1 percent in 2013 and then average 4 percent annually from 2014 to 2017 and 2.5 percent from 2018 to 2022.

From 2012 to 2022 then, the CBO assumes that real annual GDP growth will average 2.9 percent. That’s below the 3.2 percent annual growth rate that the economy has averaged post-World War II, and far short of the 3.6 percent rate post-World War II to 2000.

Unfortunately, if the aforementioned scheduled tax increases go into effect, then real GDP growth could easily turn out to be even less than the CBO expects. That will translate into slower revenue growth and increased pressure to further jack up spending.

The CBO projections on the budget and economy provide powerful reminders as to the box in which federal officials in recent years have put both the government and economy.

But these projections are merely guesses as to what future policymakers might do. They can, and need to be, changed. Indeed, until a different path is chosen — in particular, smaller government and lower taxes, along with regulatory relief and more open trade — then the U.S. will remain stuck on an uncertain, uneven and ultimately under-performing economic path.