Diane Lim RogersThe Brookings

InstitutionMay 2006

How Did We Get Back to Big Deficits?

(and What Can We Do About It?)

drogers@brookings.edu

Federal Revenue and Outlays

(as a Percentage of GDP, 1965-2016)

Source: FY 2007 Budget of the United States Government, Historical Tables, 1.2; Brookings-Urban Tax Policy Center, Budget Outlook Tables, January 2006, Appendix 3

Revenues

Outlays

Average Revenues, (1965-2005)

Average Outlays, (1965-2005)

15

16

17

18

19

20

21

22

23

24

25

19651967196919711973197519771979198119831985198719891991199319951997199920012003200520072009201120132015

Per

cent

age

of G

DP

PredictedActual

Source: Brookings-Urban Tax Policy Center, Budget Outlook Tables, January 2006, Appendix Tables 2, 4

The Recent Tax Cuts Have Been Costly

Budgetary Impact of 2001-2004 Tax Cut Legislation

-800.0

-700.0

-600.0

-500.0

-400.0

-300.0

-200.0

-100.0

0.0

2001 2003 2005 2007 2009 2011 2013 2015

(bill

ions

of c

urre

nt d

olla

rs)

Revenue Losses From Current Law Revenue Losses From ExtensionAdditional Debt Service

Yet Tax Cuts Have Not Held Down Growth of Spending

Real Annualized Growth Rates in Total Federal Spending

5.7%

3.0%

2.6%

4.1%

1.9%

1.5%

4.9%

2.6%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

Lyndon Johnson

Richard Nixon

Gerald Ford

James Carter

Ronald Reagan

George H.W. Bush

William Clinton

George W. Bush

Source: Authors’ calculations from Budget of the United States Government, FY 2007, Table 8.2

Much of Spending Growth Has Occurred in Defense

Real Annualized Growth Rates in Defense Spending

4.9%

-2.5%

3.0%

-3.8%

-1.7%

8.1%

-6.6%

4.4%

-8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Lyndon Johnson

Richard Nixon

Gerald Ford

James Carter

Ronald Reagan

George H.W. Bush

William Clinton

George W. Bush

Source: Authors’ calculations from Budget of the United States Government, FY 2007, Table 8.2

Although Other Spending Not Exactly “Austere”

Growth in Non-Defense, Non-Homeland Security Spending

3.8%

2.2%

3.7%

2.0%

4.4%4.4%

6.6%

9.2%

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%

LyndonJohnson

RichardNixon

GeraldFord

JamesCarter

RonaldReagan

GeorgeH.W.Bush

WilliamClinton

GeorgeW. Bush

Source: Authors’ calculations from Budget of the United States Government, FY 2007, Tables 1.3, 4.1, 8.2

7%

1%

9%

20%

49%

0%

10%

20%

30%

40%

50%

60%

LowestQuintile

SecondQuintile

MiddleQuintile

FourthQuintile

HighestQuintile

Income Inequality Has IncreasedIncreases in Pretax Income by Quintile (1979-2003)

Sources: Congressional Budget Office, “Historical Effective Tax Rates, 1979-2003,” Brookings-Urban Tax Policy Center, “Table T05-0062,” February 2005

0.3%

2.0%

2.3% 2.4%

3.7%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

LowestQuintile

SecondQuintile

MiddleQuintile

FourthQuintile

TopQuintile

and the Recent Tax Cuts Have Exacerbated the Trend

Increases in After-tax Income (2005) From 2001-2004 Tax Cuts

Sources: Congressional Budget Office, “Historical Effective Tax Rates, 1979-2003,” Brookings-Urban Tax Policy Center, “Table T05-0062,” February 2005

• Lower long-term growth through lower national saving

• Unfair burden on future generations• Greater dependence on the rest of

the world OR

• Higher interest costs

Why Deficits Matter

Americans Are Not Saving for the Future

Personal Saving as a Percentage of Disposable Income, 1947 - 2005

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1947-I 1949-I 1951-I 1953-I 1955-I 1957-I 1959-I 1961-I 1963-I 1965-I 1967-I 1969-I 1971-I 1973-I 1975-I 1977-I 1979-I 1981-I 1983-I 1985-I 1987-I 1989-I 1991-I 1993-I 1995-I 1997-I 1999-I 2001-I 2003-I 2005-I

Starting in the second quarter of 2005, the personal saving rate fell below zero for the first time since the Great Depression.

Source: Bureau of Economic Analysis, National Income and Product Accounts, Table 2.1, Personal Income and Its Disposition

Public Saving As a Public GoodNet Public, Net Private, and Net National Saving as

Share of GDP

-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

10.0% 199

0-I

199

1-I

199

2-I

199

3-I

199

4-I

199

5-I

199

6-I

199

7-I

199

8-I

199

9-I

200

0-I

200

1-I

200

2-I

200

3-I

200

4-I

200

5-I Sa

ving

as a

Per

cent

age

of G

DP

(Total) Net National Saving (%GDP)Net Private Saving (%GDP)Net Government (Public) Saving (%GDP)

But Interest Rates Have Stayed Low Through Foreign Financing of

Our DebtForeign Holdings as a Share of Marketable U.S.

Public Debt

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

55.00%

3/ 31/ 2000 3/ 31/ 2001 3/ 31/ 2002 3/ 31/ 2003 3/ 31/ 2004 3/ 31/ 2005

Date

Percentage of Public Debt That Is Foreign-Held

May 2005: Foreign holdings exceed 50% threshold for first time.

• First and foremost, public recognition that deficits are unwise and unfair:– Deficits financed by foreign borrowing

are direct threat to our “competitiveness”

– Unfair burden on our children and grandchildren who will have to pay it back

• Public willingness to forgo tax cuts or accept spending cutbacks

What Can Be Done?

• Politicians responding to constituents’ demands for fiscally-responsible policies

• Bipartisanship required to make the tough choices

• Higher standards for tax cuts and spending programs from an economic “bang per buck” perspective

• Rules to help politicians stay fiscally responsible—and on both sides of the budget (taxes and spending)

What Can Be Done, continued

Status Quo Won’t DoSavings from Deficit Reduction Act of 2005

Compared with Plausible Baseline of Projected Deficits

-100

0

100

200

300

400

500

600

700

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

(bill

ions

of d

olla

rs)

Deficit Reduction Act of 2005 (scored by CBO, 1/ 27/ 2006, Senate version, S.1932)Projected Deficit (Brookings-Urban Tax Policy Center, 2006)

Longer-Term Revenue Effects of IRA Conversion Provision

in 2006 Tax Reconciliation Agreement(This Is Called Paying for the Tax Cuts?)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

2006

2009

2012

2015

2018

2021

2024

2027

2030

2033

2036

2039

2042

2045

2048

Fiscal Year

Rev

enue

Cha

nge

($m

illio

ns)

Source: Brookings-Urban Tax Policy Center

Improving the Budget Process

• Caps on discretionary spending for ten years

• PAYGO rules on both tax cuts and spending

• No sunsets of tax or entitlement changes to avoid out-year costs

• Stricter definition of emergency spending

• Some accounting for long-term costs

Conclusions• Current deficits threaten economic well-being

—they are unwise and unfair.• Huge commitments to long-term entitlements

and tax cuts make the most recent attempts at deficit reduction look puny.

• Fiscal imbalances present an opportunity to rethink what government does and how we pay for it.

• Eventually, taxes must be raised and spending cut.

• The sooner this is done, the less costly and painful it will be.

• Presidential leadership and bipartisanship compromise will be required, and the public must demand it.