Commentary: The accomplice in America's fiscal mess? Tax cuts

Now almost $30 trillion, America’s debt trajectory going forward is unsustainable. The U.S. will require roughly $10 trillion in deficit reduction over the next decade just to keep debt growing at the same pace as the economy.

Which is why this year is shaping up to be a watershed moment in long-term fiscal policy. Congress is crafting legislation to extend the Tax Cuts and Jobs Act of 2017 — which would cost $2.5 trillion over five years — plus an assortment of other potential goodies such as lifting the $10,000 cap on the state and local income tax deduction (roughly $700 billion over five years) and excluding tips from taxation (perhaps $100 billion or more).

Even a temporary tax cut will be hard to pay for. Congress and the Trump administration are contemplating a variety of different spending cuts to help offset the costs, but these are proving politically challenging.

The Department of Government Efficiency, or DOGE, is touting cuts and cost savings, but the amounts are unsubstantiated, have already been revised down substantially and are unlikely to be large enough to put a meaningful dent in America’s long-term debt.

Congress may try to informally “count” revenue raised by tariff actions, but the tariffs that have been announced so far only raise at most $1.5 trillion over a decade (and likely less once dynamic effects are taken into account). So, Congress may rely, in part, on gimmicks to help make the numbers work on paper.

But why is Congress cutting taxes at all if debt is unsustainable? Some answer that budget deficits are due to overspending. Mandatory spending programs like Medicare and Social Security have indeed grown costlier. But the reality is tax cuts have been a major driver of higher debt since 2000. It stands to reason, then, that ideas to increase revenue need to be on the table.

The story of tax revenue the last quarter century is best told by, of all things, an obscure, decades-old dry government report. In October 2000, the Congressional Budget Office (the nonpartisan independent budget analysis office that officially scores legislation) issued an analysis projecting the nation’s long-term fiscal trajectory for the following 50 years.

The first thing that’s notable about the report is that CBO understood even back then that the aging of the American population would gradually put upward pressure on social spending, and in particular Social Security and Medicare.

CBO correctly anticipated that after a decade, the wave of Boomer retirements would cause an inflection point in the costs of these programs. Non-interest spending would rise from less than 16% of gross domestic product in 2010 to more than 18% by 2020 and keep rising for a time thereafter.

The other notable thing about CBO’s projections is that, despite foreseeing these cost increases, it still forecasts that debt would not just decline but be zero on net and then turn negative (cumulative savings!) within 10 years.

How was this possible with rising Social Security and Medicare costs?

CBO assessed that the federal tax system, which in 2000 collected revenue equal to 20% of GDP, would be more than sufficient to cover the increased costs of these programs.

This obviously didn’t happen. So why was CBO so wrong? One might think that CBO was just off in its forecasts, but that’s surprisingly little of the story. As the chart below shows, noninterest federal spending next year as a percent of GDP will be almost exactly what CBO projected in 2000. Thereafter, CBO’s latest projections are for lower spending than what they projected.

There are three bigger reasons for the discrepancy. The first is that the U.S. experienced three recessions in the intervening two-and-a-half decades. Two of them — tied the global financial crisis and the worldwide COVID-19 pandemic - were among the worst in U.S. history. A weak economy means the government brings in less tax revenue, which adds to debt, as do automatic stabilizer programs such as unemployment insurance that kick in, and, especially in the last two recessions, extra relief provided by the government.

The second is that the federal government saw higher discretionary (operational) spending than CBO projected. This is partly because CBO is required by law to assume that discretionary spending increases by the rate of inflation, which is probably too conservative an assumption (population + inflation or GDP would be more realistic). But a big chunk is because of the wars in Iraq and Afghanistan, which CBO couldn’t have anticipated in 2000.

It’s clear that recessions and wars added to the stock of debt, but that’s in the past and they are no longer affecting the non-interest deficit.

The third reason, however, has raised both debt and the ongoing budget deficit. The past 25 years have seen several rounds of tax cuts — in 2001, 2003, and 2017, as well as extensions passed in both Republican and Democratic administrations — that eroded the revenue base. Even accounting for revenue lost due to recessions, actual revenue was lower than CBO’s 2000 projections almost every subsequent year and are projected to continue on this trend over the next decade if the 2017 tax cuts are extended.

For example, by the end of 2024 — a strong economic year when revenues should have been on the robust side — actual federal revenues had come in between 17-18% of GDP, well below CBO’s 20% projections.

Even if the 2017 tax cuts weren’t extended, or if the tax cuts were fully paid for with other revenue, such as from tariffs, overall revenue would still be lower than 2000 projections because of earlier pre-2017 tax cuts.

The upshot is tax cuts have been an accomplice in America’s deteriorating fiscal trajectory. No doubt there are savings on the spending side that can be part of the conversation, but higher revenue should be under serious consideration with the 2000-era trajectory of 20% revenue-to-GDP a sensible aspirational goal.

This doesn’t mean we should reflexively reset the entire tax code to how it looked in 2000. As the American Enterprise Institute’s Kyle Pomerleau points out, this would involve trade-offs that neither conservatives nor liberals would approve of, such as a lower Child Tax Credit and more taxpayers subject to the Alternative Minimum Tax.

We should view this as an opportunity to keep what improvements have been made over the last two-and-a-half decades while also looking for efficient and equitable ways to raise new revenue. As Natasha Sarin (my colleague at the nonpartisan Budget Lab at Yale) has written, stronger enforcement of the existing tax code could help close the gap and raise additional revenue.

But that almost certainly wouldn’t be enough to get us back to 20% revenue-to-GDP. It is long past time lawmakers started shifting toward more efficient means of raising revenue, like a value-added tax, and there are several ways of doing so that preserve the progressivity of the overall tax system. No matter how we do it, it is increasingly clear the U.S. is not going to right its fiscal ship without raising significantly more revenue.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ernie Tedeschi is the director of economics at the Budget Lab at Yale University and the former chief economist at the White House Council of Economic Advisers under the Biden administration.

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