November 29, 2005
What are prospects for Federal debt/GDP?Did recent surge in tax revenues signal a meaningful improvement in fiscal prospects?
According to the Congressional Budget Office's Outlook published in August, the relief is temporary, and in fact does not show up in the direction of the debt/GDP ratio. Only when the tax cuts expire in 2011 does the debt/GDP ratio improves.
Using the CBO's figures, plotted the baseline projection of the debt-to-GDP ratio in red.
This projection incorporates expectations that discretionary spending grows at the rate of inflation, and that expenditures in Iraq remain at their 2005 levels (in inflation adjusted terms). It is true if there is a drawdown in forces, then the outlook improves faster (green line, labeled "Iraq Phasedown", author's calculations). However, if the 2001 and 2003 tax cuts are made permanent, then the black line labeled "Tax fixes" traces out the trajectory of debt-to-GDP. Finally, if discretionary spending grows at the rate of nominal income -- a much more realistic proposition, given historical norms -- then the teal line labeled "discretionary spending" is the applicable one. In other words, spending restraint on its own is not sufficient to put us on a sustainable path. Indeed, it is not implausible that the debt-to-GDP ratio hits 52% in fiscal year 2015.
Posted by Menzie Chinn at November 29, 2005 06:10 PM
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Tracked on November 30, 2005 01:23 AM
During the summer, the Administration pointed to the surge in tax revenues and the decrease in the current year's budget deficit as proof that the deficit is on a path for sustained improvement.
Was this due to the repatriotization of foreign earnings? Increased revenue from housing capital gains may have contributed as well but the major thrust from that source seems to have eased? It struck me as an oddity at the time and the more so, that nobody seemed interested in detailing exactly what economic policies could have caused this turn around.
Posted by: calmo at November 29, 2005 09:47 PM
Cal Morton: Not certain of the answer, and not certain anyone knows the answer. The CBO states
"Receipts in 2005 from corporate income taxes grew sharply--by about $90 billion (or 48 percent)--to $279 billion, CBO estimates, far surpassing their previous high of $207 billion reached in 2000. Corporate receipts were 2.3 percent of GDP, the highest point since 1980. The strength in receipts reflects economic activity in both 2004 and 2005. It also results from the expiration at the end of 2004 of provisions enacted in 2002 and 2003 that allowed additional first-year depreciation deductions for investments in equipment."
Ted Weisman at Morgan Stanley writes in the November 16 issue of the Global Economic Forum:
"This may have partly reflected significant repatriation of overseas earnings under temporarily lower tax rates enacted in the Homeland Investment Act ? a subject much discussed in the past year in the FX markets in particular but, at least through Q2, almost entirely absent from the capital account figures."
So it appears that the repatriation factor may be part of the explanation. Either factor (depreciation or profit repatriation provisions) implies a one shot effect.
Posted by: menzie chinn at November 30, 2005 12:34 PM
While the expiration of the special depreciation provisions, and the repatriation of earnings are as you point out both "one shot" affects, there is a significant difference.
The depreciation deduction basically decreased tax revenues in 2003 and 2004, but this is simply timing, because tax revenues will grow in 2005 and thereafter because there will be smaller depreciation deductions over the next seven years than would have occured without the law change.
It is argueable that the enhanced depreciation deduction spurred capital investment thus generating more profits from the sellers with the result that the tax effect was neutral. However, in general terms the one shot effect of depreciation was to depress tax revenues in 2003 and 2004 with a compensating increase in 2005 and thereafter.
The repatriation provisions have an entirely different effect. To a large extent these provisions generated taxes in 2005 that could have been deferred indefinitely, and this provision probably has minimal effect on '06 tax rates.
I would also note that many businesses had significant losses in 2001 and 2002. The losses can be carried back to generate refunds, a process that lags year end by at least six months, or may be carried forward to offset future profits with the result that a return to profitability does not generate an immediate tax liability. Thus the growth in 2005 could be a return to the norm rather than an unsustainable burst.
Posted by: Bill Ellis at November 30, 2005 01:49 PM
Thanks for that clarification (menzie and Bill). One shot it is then and a possilbe incentive for MNC to continue/expand their foreign plant operations.
Posted by: calmo at December 1, 2005 05:58 PM
This situation is essentially the same as 1995 and 1985 with a "temporary war on top", the debt growth looked daunting. In those cases, the business expansion continued and the problem deminished until the first Gulf War or the next recession hit. Each prior situation had similar twists and turns. The bigger picture is that the economy has been and continues to grow more rapidly than any forecast as have reported profits. The unbroken trend is for Government revenues to exceed expectations. Looking at our country as a business, it is not over leveraged. It would be interesting to know what percentage of individuals and businesses have a debt to revenue ratio of .4 or less.
Posted by: Jack Miller at December 4, 2005 03:38 AM
Jack Miller: In 2000 and 2001, I was looking at the Administration's revenue forecasts from the inside. Revenues in 2002 and 2003 did not exceed (unofficial) projections.
The point is not the debt ratio now, but expectations regarding its future trajectory. You are right that for the moment revenues exceed projected, but projections always miss turning points, at which time revenues will undershoot projections. We may be closer to a turning point than you think, given the near inversion of the yield curve.
Finally, as I note in my last post of December 3rd, the war may be temporary, but if the President's requirements remain in place, temporary may not be the same as short.
In that case, we may be looking at $80 billion a year for a while.
Posted by: menzie chinn at December 4, 2005 10:46 PM