Did you know? A final fiscal reflection on 2015

By Jared Bernstein  December 31, 2015 

Jared Bernstein, a former chief economist to Vice President Biden, is a senior fellow at the Center on Budget and Policy Priorities and author of the new book 'The Reconnection Agenda: Reuniting Growth and Prosperity.'

Happy New Year, everyone!

Now, back to the economics.  The macro-economy ends the year on pretty solid ground, with steady, if plodding, real growth in gross domestic product and low unemployment. We’re not yet at full employment, but if payrolls keep posting monthly gains in the 200K neighborhood, we might get there by late 2016. Of course, given the extent of inequality upon the land, the 6?-year-old recovery still isn’t reaching working households the way we need it to. But if we get to and stay at full employment, that will improve as well.

Where we have a real problem is in regard to federal revenue. Under current law, I simply don’t see us collecting what we need to meet the fiscal challenges we face — such as aging baby boomers, crumbling infrastructure or climate change — that the private sector will not solve for us. Moreover, while I’ve worried about this for a while, various developments have deepened my concerns.

Since the 1970s, federal revenue as a share of GDP has averaged around 17.5 percent. The expectation, based on Congressional Budget Office forecasts, is that this share will grow a bit, to slightly north of 18 percent of GDP over the next decade. But even while I suspect that target is insufficient to our needs, there are four reasons why we might not hit it.

First, CBO assumes that any new tax cuts would be paid for, but Congress just passed a bunch that aren’t. To be clear, some of those measures are very valuable, particularly the anti-poverty ones. But they mean $680 billion less in revenue than are in CBO’s baseline.

Second, tax avoidance is hitting an absolute fever pitch, especially among the wealthy, who, as they often remind us, pay the bulk of the federal revenue (they’ve also collected the bulk of the pretax income growth, so hold the tears). This remarkable New York Times piece exposes an “income defense industry” that’s flourished among the billionaire class to shelter their income in ways that have pushed their effective tax rates down to historic lows. Much of this is legal, as the code privileges asset-based income, but some probably morphs into evasion (illegal non-payments), aided by the Republicans’ defunding of the IRS. The Times points out that “[b]etween 2010, the year before Republicans took control of the House of Representatives, and 2014, the I.R.S. budget dropped by nearly $2 billion in real terms, or nearly 15 percent. That has forced it to shed about 5,000 high-level enforcement positions out of about 23,000, according to the agency.”

Third, real GDP growth has slowed in recent years, and most forecasters have not quite incorporated this reality into their work. CBO has real GDP growing about 3 percent over the next two years (2016 and 2017). They may be right, but more up-to-date forecasts are in the 2 to 2.5 percent range. Slower growth means less revenue than expected. If real growth is closer to 2 than 3 percent, revenue as a share of GDP could fall by maybe 0.25 percent of GDP.

Fourth, every Republican presidential candidate proposes tax cuts targeted at the wealthy that, were they to pass, would drain the Treasury’s coffers of trillions (e.g., Bush: minus $6.8 trillion; Trump: minus $9.5 trillion). Democrats have issues here as well, though not nearly so egregious. Candidate Hillary Clinton is certainly right to begin raising revenue from those in the top 3 percent (households with incomes above $250,000), but her pledge to go no lower than that is not sustainable. We cannot raise the revenue we need solely on the top few percent.

To be fair, there are, of course, lots of other important moving parts in fiscal world. For example, interest rates have also consistently surprised budget forecasters on the downside (meaning they’ve been a lot lower than expected). If that continues, it will reduce the costs of debt service and free up a bit of fiscal oxygen, but not enough to change the outlook.

Above I noted a few of the costs coming due but here’s a bit more detail. With no policy changes — holding per-capita spending constant — simply inflation and population growth will require a 40 percent increase in revenue over the next decade. Then there’s the fact that the 65 and older population is 15 percent of today’s population, going up to over 20 percent around 2040. These “mechanical” factors will require more revenue, even if we don’t want to add anything to existing policy.

Remember, the challenges of global warming, public education, roads, bridges, mass transit, poverty, inequality, outbreaks of illness, geopolitical threats and who knows what else will not and cannot be met by private industry. For that, we need a functional, adequately funded federal government.

Like I said, our resilient economy continues to putter along. But eventually, dysfunction and the underfunding of that list of challenges will cost us. So go ahead and party tonight. Then maybe we can get to work on this.