On The Economy -- Where Did The $658 Billion Go?

The federal budget deficit for the fiscal year just completed was 3.6% of GDP. That is not the largest peacetime deficit ratio on record. That distinction goes to fiscal year 1983, when the deficit ratio was 6% of GDP. Nevertheless, during the past four fiscal years -- the federal government's accounting year runs from Oct. 1 to Sept. 30 -- there was a $658 billion swing from a budget surplus of $236 billion in fiscal year 2000 to an estimated deficit of $422 billion in fiscal year 2004. And that swing from plus to minus was the largest peacetime swing in both absolute terms and as a proportion of GDP. Where did the money go? My calculations show tax revenues dropping dramatically on an annualized average basis from the Clinton administration to the Bush administration and federal expenditures increasing dramatically. In rough terms the swing in taxes has been twice as large as the swing in expenditures. The tendency at large is to assume that most of the drop in taxes was due to the Bush tax cuts, but in fact that is not the case. More than two-thirds of the reduction in tax receipts was due to the recession and rather sluggish recovery. As for the next four years, the most reasonable assumption would be that expenditures in Iraq will gradually wind down, while other defense spending will remain flat in inflation-adjusted per capita terms, resulting in no net change in defense spending. Interest payments will rise as rates rise and the national debt rises. Social Security programs will probably remain unchanged -- despite the Bush administration's talk that the program will be partially privatized. Assuming the economy grows at 3% real growth and inflation rates remain unchanged -- and assuming no changes in current tax laws -- tax receipts should rise about 6% per year, or an average of $125 billion per year over the next four years. That figure could be substantially higher if the Bush tax cuts are not renewed, but that seems increasingly unlikely now. During the Clinton years, Social Security tax receipts rose an average of just under 6% per year. During the past four years, they rose an average of just under 3% per year. Since the rates didn't change, the slowdown obviously has nothing to do with the policies of the Bush administration. In answering the $658 billion question, the difference in receipts accounts for $82 billion of the shortfall, or $20 billion per year. Now if we use the same proportionality factor for income -- personal and corporate -- it rose 9.7% per year; without the Clinton tax hikes, the figure was 9.2% per year. The percentage gain was much greater than Social Security because of the progressive nature of the income tax schedule and the huge gains in the stock market. I estimate that income taxes would have risen 4.6% per year over the past four years had there been no changes in tax rates. The difference on income tax receipts works out to $239 billion, or $60 billion per year. Applying the same arithmetic to all other taxes and borrowing the Congressional Budget Office's figures of about $140 billion, or $35 billion a year, for the cost of the Bush tax cuts, my bottom line is that Bush's tax cuts accounted for only 28% of the total decline in receipts for fiscal years 2000 through 2004. The budgetary wild card, in my opinion, was not tax rate changes, but changes in the government's medical care program. The total cost of Medicare and Medicaid was $518 billion this past fiscal year, up from $352 billion in FY 2000. With double-digit increases in the cost of health care in the private sector as well, a major overhaul is on the near-term horizon. To me, as I have written several times before, the obvious idea is to let people choose through the mechanism of the market which medications they want instead of taking "everything" available because it is "free." It is an idea whose time is overdue. Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.