Tuesday, December 06, 2005

A Forecast and a Budget

Last Thursday, the Administration released its economic forecast that will be used as the basis for its FY 2007 Budget, to be released early in 2006. See the actual forecast summary here, and a transcript of a conference call with CEA Member Matt Slaughter here. It is in general little changed from the mid-session review forecast released 6 months ago.

Even with the hurricanes, the real GDP forecast is up a tenth of a percentage point over the 4 quarters of 2005. That will allow for more revenues relative to expenditures. The "wedge" between inflation in the GDP price deflator (which corresponds most closely to the tax base) and the CPI price deflator (which corresponds to the way government expenditures, like Social Security benefits, are indexed) widened for 2005, with some narrowing forecast for 2006 and 2007. I suspect that energy prices are the culprit--given how much we consume rather than produce (i.e., import). When the wedge gets wider, that suggests faster growth in expenditures than tax revenues, and this will offset to some degree the impact of a higher GDP growth assumption. If the deficit is to come down in the FY 2007 budget relative to past forecasts, most of the work will have to be done by changing taxes and expenditures, not by relying on a more favorable economic picture.

Yesterday, the President was on the road to promote continued extension of some of the soon-to-sunset tax cuts. The ones in question pertain to the tax rates on dividends and capital gains. I find this whole discussion to be disheartening. The first order issue with tax policy is that we are not raising enough revenue to match our expenditures. Making the lower tax rates permanent just makes sure that we will permanently not have enough revenue to match our expenditures, unless we decide to lower expenditures by even more.

That brings us back to the FY 2007 budget. I would be much happier if the President spoke about which expenditures he will cut in that budget with the same specificity that he talks about which tax cuts he'd like to make permanent. Yesterday's road show was not a high point. Consider this:

Bush fell back on campaign-style rhetoric yesterday: "When you hear people say that we don't need to make the tax relief permanent, what they're really saying is, they're going to raise your taxes."
I'm prepared to be very unhappy come budget time.

UPDATE: This post was picked up by a Post with a much larger circulation.

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Anonymous said...

On taxes: making the tax rate on dividends and capital gains permanent at 15%, and lowering tax rate on interest income to 15%, might be okay if the top tax rate on ordinary income were raised slightly (to 37 or 38% from 35%). Even at 38%, this would be lower than during Clinton. Bush would have a legacy as a tax reducing president. Another one to consider would be a slight consumption tax on gasoline, with proceeds on from the tax used to fund the EPA.

The U.S. is currently saving no money. This has to have negative ramifications at some point in the future. Govt policy does not encourage saving, and even punishes people who save (ie,high taxes and "missed" opportunities for tax-free gains on leveraged real-estate transactions).

PGL said...

Well said. Maybe the Democratic platform sound read "tax me now or tax me later". Obviously, Bush is opting for the tax 'em later approach.

Bibamus said...

After five years of this, it can hardly be a surprise anymore, can it? Is there any evidence that this President takes deficits seriously? Or that he has any real interest in shrinking the size of the Federal government?

The choice in the last election was never between a small-government Republican and a big-government Democrat; it was between a big-government, high deficit Republican, and a big-government low-deficit Democrat.

The current state of affairs is not a surprise. It is exactly what Bush voters were asking for in reelecting him.

(Which is not to say that the dismay of some Bush supporters at this state of affairs, yourself included, isn't genuine. Only that it must have been anticipated. Whatever else you like about this guy must have led you to make a calculation at some point along the lines of 'well, the deficit is getting bigger if I help reelect this guy, but that is the price I am willing to pay to ensure/avoid X.' Right?)

Robert Schwartz said...

In my view, the 15% dividend tax rate has been a huge success, causing corporations to hike dividends. I hope itis continued. I agree that the federal government, as it is currently constituted, needs more revenue. Given our national foreign policy involvments and the state of the world I think that we should add to federal revenue by imposing a $2.50/gal. gasoline tax.

Anonymous said...

A lot of corporations have increased cash dividends to shareholders. My opinion is this was good, and was somewhat induced by the tax rate cut on dividends.

Managers at corporations generally need discipline, structure, and bonding commitments. One might argue this was especially the case toward the late 1990s and early 2000s. Dividends provide this.

True, the market has not gone to all-time, new highs given the tax rate reduction. But it also did not sink as far as it might have given no income tax rate reduction on dividends. So people who say that the dividend tax cut did not help equity prices can not say this is true with 100% certainty.

Anonymous said...

Dividends to Pay
E.D. Kennedy

I am pretty sure this is the book I read at a used book store.

It would be interesting to know who is getting the increased dividends, and what they are doing with the dividends.

Arun Khanna said...

I suggest five steps to reduce deficits. First, a 1% income tax increase. Second, Bush administration needs to consider outsourcing peacekeeping duties to emerging countries like India and keep U.S. forces for actual wartime operations. This is a cost-effective strategy which will help emerging markets who as a quid pro quo will probably want free trade access to U.S. markets. Third, U.S. and EU foreign policy should focus on breaking the OPEC cartel. This will help bring oil prices down to competitive levels. Fourth, privatize U.S. government owned entities like Tennessee Valley Corp. Fifth, eliminate all U.S. agriculture subsidies like sugar subsidies etc.

Anonymous said...

As long as we are talking budget, outsourcing and globalization...

We should budget a lot for foreign language and intercultural studies at undergraduate colleges, with an emphasis on studying language and cultures in countries that are hotbeds for terrorists. This will help the intelligence and homeland defense personnel pipeline. We need more U.S. citizens who know how to read and speak middle-east languages. This might help us find Bin Laden. Ideally people with language skills coupled with other skills (eg, CPA and general problem-solving and thinking skills). This would be a nice background to track down terrorists.

Anonymous said...


The forecast of 5.0% for the interest rate on the 10-year treasury in year 2006 is interesting. The bond market currently has been driving down the yield on the 10-year treasury. Last I checked it was 4.44%


The comeback of the 30-year treasury bond may make the yield on the 10-year treasury less of an indicator anyways.

Nevertheless, the govt forecast of 5.0% yield on the 10-year treasury for year 2006 will be interesting.