Tax Reform and Deficits

As fiscal 2017 shows, deficits will explode without faster growth.



While you are reading about Donald Trump’s Twitter irruptions, real news keeps happening. To wit, results for the government’s complete fiscal year 2017, which ended on Sept. 30, prove again that the federal budget will never be balanced without faster economic growth.

In news that few noted, the Congressional Budget Office reported on Friday that the budget deficit for fiscal 2017 grew for the second straight year—to $668 billion, an increase of $82 billion in 2016. That equals 3.5% of the national economy, up from 3.2% the year before, and it confirms that the deficit progress in the early years after Republicans took Congress in 2010 has been stanched.

But here’s the bigger story: Spending rose only 3% overall for the year, according to the CBO gnomes. Federal outlays climbed by some $130 billion to $3.982 trillion. Three percent is probably more than most of our readers received in raises, but by federal standards it’s penurious. Some of the big outlays were, as ever, for the three giant entitlements—3% for Social Security, 4% for Medicare, and 2% for Medicaid as the pace of new enrollments slowed under the Affordable Care Act. 

The biggest single spending increase was 45% for education thanks to an upward revision of $39 billion in the “estimated net subsidy costs of loans and loan guarantees issued in prior years.” In plainer English, the Obama Administration low-balled the costs of nationalizing student loans. Tens of thousands of borrowers are defaulting on their student debt, and the taxpayer tab is coming due.

But the main reason for the rising 2017 deficit was a mere 1% increase of $47 billion in federal revenues. Individual income taxes climbed a meager $39 billion, or 2.5%, while corporate taxes fell $3 billion, or 1%. This reflects the slow-growing U.S. economy, especially in the first half of fiscal 2017.

A typical economic expansion throws off 3% or more in additional revenue each year as wages and profits rise, and in the go-go 1980s and 1990s increases of 5% or more were common. It’s no coincidence that the federal budget deficit closed rapidly as a share of GDP during those expansions, even going into surplus in the 1990s, in contrast to the current expansion.

All of which ought to inform the debate over tax reform. We are now hearing from the same Democratic economists who blessed the blowout spending of the early Obama years that tax reform is a mortal threat to the federal deficit. But the real threat is a continuation of the slow economic growth that their economic policies produced. They blame slow growth on “secular stagnation,” as if some unchangeable force of nature is responsible.

CBO estimates that under current policies the U.S. economy will grow by an average of only 1.9% a year. That’s after not reaching even the 3% historical norm in a single year since 2005. If that’s as good as the economy can do, revenues will continue to trickle in and deficits will climb as far as the eye can see.

President Trump and the Republicans are proposing a tax reform with a goal of lifting growth to 3% or more a year. That’s hardly a far-fetched goal, and if growth reaches 3% for even a few years the Treasury will get a windfall of new revenue far exceeding current estimates. Entitlement reform will still be important to controlling deficits, but without faster growth there is zero chance.

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