How The Deficit Happened

How the Surplus Became a Deficit

By Morgan Housel Morgan Housel Wed Feb 2, 11:26 am ET

Exactly 10 years ago, the nonpartisan Congressional Budget Office issued a report projecting that, in 2010, the federal government would run a $796 billion surplus. In reality, 2010 produced a $1.3 trillion deficit.

The difference between the two — $2.1 trillion — highlights two important points: Long-term forecasting is futile, and something went horribly wrong over the past decade.

But what? To find out, I compared CBO’s 2001 projections with what actually occurred in 2010. Turns out, two factors alone account for the majority of the difference: tax revenue and defense spending.

Tax revenue
In 2001, the CBO estimated $3.27 trillion in tax receipts would flow into the government’s coffers in 2010. The actual number ended up being $2.14 trillion. This $1.1 trillion gap makes up over half of the total difference between the CBO’s 2001 budget projection and what actually occurred in 2010. The effect is even greater when you shorten the time frame: The difference between 2010’s actual deficit and budget projections made in 2006 was 63% attributable to tax shortfalls.

What type of tax revenue fell short? All of it, but taxes on individual income was the largest drop. In 2001, CBO estimated personal income taxes would draw in $1.68 trillion in 2010. In reality, it was $891 billion. Corporate tax revenue was $188 billion versus a projected $303 billion. Social insurance taxes came in at $862 billion last year, compared with 2001’s projection of $1.1 trillion.

Why tax revenue has fallen short isn’t a mystery — we’ve had tax cuts, and a deep recession. Using CBO’s estimates, the 2001 and 2003 tax cuts will reduce tax revenue by $250 billion this year over what would have been collected in their absence. Other tax cuts that were part of the 2009 stimulus package reduced tax receipts by $164 billion last year.

And then there’s the recession. In 2001, CBO projected GDP would be $16.1 trillion in 2010. Turns out it was $14.7 trillion. The difference between the two means there was less income to tax last year than was projected in 2001. This is a major reason recessions naturally cause deficits to rise — a point lost upon many.

Defense spending
Discretionary spending by the government was $513 billion more in 2010 than CBO projected in 2001. This is the source of so much angst about the budget deficit; that discretionary spending is running out of control.

And it’s interesting to know what type of discretionary spending is surging past previous estimates. In 2001, CBO expected defense spending would come in at $390 billion in 2010. It ended up being $720 billion. This $330 billion difference makes up over 64% of the difference between projected and actual discretionary spending. Whether this has been necessary or worthwhile is a debate for another forum. The numbers, however, speak for themselves.

Just the facts
Still with me? Here’s a review: Compared with 2001’s projections, tax revenue in 2010 fell $1.1 trillion short, and defense spending went $330 billion over.

Add ’em up, and you get $1.4 trillion. See where we’re going here? Had tax revenue and defense spending each met CBO’s 2001 projections, today’s budget would effectively be balanced.

Spending in other areas has, of course, surged as well. Outlays for Social Security, unemployment benefits, and interest on the national debt — among others — were all significantly higher in 2010 than projected 10 years ago. But no two areas made as much a difference as tax revenue and defense spending.

The point of this isn’t to place blame. It’s to show that much of the debate surrounding our current deficits is misguided. The factors that took the country from surpluses 10 years ago to deficits today aren’t, for the most part, those that are constantly maligned by the media and political parties — bailouts, stimulus spending, earmarks, bridges to nowhere, foreign aid, and social causes.

It’s simpler than that. We had massive tax cuts, two wars, and a giant recession. It’s difficult to take seriously any deficit-reduction proposal that doesn’t take these into consideration. Something to think about.

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