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Saturday, July 14, 2007

The deficit watch should be fun

A couple of years ago, after the 2003 tax cuts had begun to show their positive effects and revenue and expenditure trends were established, it appeared that the federal budget might be at or near balance by the 2008 election. I mentioned this to a left leaning friend and he was incredulous. After he calmed down he offered to make a bet. I passed and simply said, "we'll see." It's not that I didn't believe the projection, just that if it got close politicians might alter the spending pattern. Also, I have no enthusiasm for a budget surplus (it forces the private sector to operate at a net deficit - bad,bad,bad!) which would be a natural extension of the projection. Observing was preferable to rooting. All of which brings me to this:

2004 - $413 billion
2005 - $318 billion
2006 - $248 billion
2007 - $205 billion

The New York Times's Paul Krugman, in December, wrote that President Bush "plunged the budget deep into deficit by cutting taxes on dividends and capital gains even as he took the country into a disastrous war." Senator Clinton went to the Senate floor in February of this year to speak of the "fiscal recklessness" of the Bush administration, which she charged had contributed to "record deficits." In March, Senator Schumer, who is now the chairman of Congress's Joint Economic Committee, spoke of "budget excesses of the past six years" that have brought us "a mounting debt to the rest of the world."

But as the shrinking figures above show, in fact the deficit is shrinking. When you look at it as a percentage of GDP, the decline is even more striking:

2004 - 3.6%
2005 - 2.6%
2006 - 1.9%
2007 - 1.5%

Steve Conover thinks that the number don't look right. Donny B. suspects some Georgejitsu:

He postulates that something bad will happen to derail the current virtuous trend very soon or that the White House is padding so as to surprise on the upside. I vote the latter. One thing that I, as a fairly close observer over the past few years, have noticed about this administration's political tactics is that they wait patiently (often to the chagrin of their cheerleaders who interpret the patience as indifference) while their political opponents stick their necks out farther and farther before they chop off their heads. Such is why I wouldn't have been surprised if Osama bin Laden had turned up dead at an opportune time (I still wouldn't). Nor will I be surprised when in the heat of the 2008 campaign, some things happen or start to get revealed that drastically alter the political calculus of the race to the detriment of this administration's opponents. As it relates to the deficit, I wouldn't be surprised if the deficit went away and the administration floated the idea of a surplus and allowed whoever gets the Republican nomination to ramp up the talk of additional tax cuts just as the 2008 campaign gets hot.
What would be nice to see as a reinforcement of positive trends would be a fix of the globally least competitive aspect of our tax code: the high corporate tax rate.
...the U.S. now has the unflattering distinction of having the developed world's highest corporate tax rate of 39.3% (35% federal plus a state average of 4.3%), according to the Tax Foundation. While Ronald Reagan led the "wave of corporate income tax rate reduction" in the 1980s, the Tax Foundation says, "the U.S. is lagging behind this time."

Foreign leaders are also learning another lesson: Lower corporate tax rates with fewer loopholes can lead to more, not less, tax revenue from business. The nearby chart shows the Laffer Curve effect from business taxation. Tax receipts tend to fall below their optimum potential when corporate tax rates are so high that they lead to the creation of loopholes and the incentive to move income to countries with a lower tax rate. Ireland is the classic case of a nation on the "correct side" of this curve. It has a 12.5% corporate rate, nearly the lowest in the world, and yet collects 3.6% of GDP in corporate revenues, well above the international average.

Research from Mr. Hassett and others has shown that high corporate tax rates reduce the rate of increase in manufacturing wages (See our editorial, "The Wages of Growth1," Dec. 26, 2006.). For that matter, most economists understand that corporations don't ultimately pay any taxes. They merely serve as a collection agent, passing along the cost of those taxes in some combination of lower returns for shareholders, higher prices for customers, or lower compensation for employees. In other words, America's high corporate tax rates are an indirect, but still damaging, tax on average American workers. One immediate policy remedy would be to cut the 35% U.S. federal corporate tax rate to the industrial nation average of 29%. That's probably too sensible for a Congress gripped by a desire to soak the rich and punish business, but a Democrat who picked up the idea could turn the tax tables on Republicans in 2008.

As to what will actually happen, "we'll see."


Oroborous said...

Steve Conover at The Skeptical Optimist thinks that the fiscal year '07 Federal budget deficit will come in at around $ 135 billion, or about 1% of GDP.

Harry Eagar said...

Smaller deficits are still deficits.

Not bad in themselves, but it depends what else is going on.

I am not smart enough to figure out what happens when China breaks down, but I suspect it ain't gonna be pretty for the US Treasury

Bret said...

If China breaks down, I suspect it will be somewhat inflationary for a while and nominal deficits would increase somewhat.

However, I also suspect that the change in ratio of nominal total government debt to nominal gdp will stay fairly constant since the rising inflation will also erode the existing government debt. I also suspect that the bond market has already priced in Chinese instability so I don't think longer term interest rates will rise all that much.

In other words, I personally don't see much of an economic apocalypse if China goes off line for a bit.

Bret said...

"In other words, America's high corporate tax rates are an indirect, but still damaging, tax on average American workers."

Since the average american worker does not understand this and the rich are perfectly happy for the average american worker to pay some taxes, I suspect that there's no real passionate constituency for lowering this tax.

Harry Eagar said...

Taxes are not, in themselves, damaging. Corporate taxes are not damaging to workers at all, since if they were eliminated, the money would not go to the workers.

Not in the present climate, anyway.

Bret, if the Chinese had to cash in all their US securities, I don't think the turmoil would be a slight as you think. I am also not sure it would be inflationary.

If supply and demand has anything to do with it, I would expect deflation.

But I'm not smart enough to figure it out.

Hey Skipper said...

Taxes are not, in themselves, damaging. Corporate taxes are not damaging to workers at all, since if they were eliminated, the money would not go to the workers.


The worst thing about corporate taxes is that they are a complete lie: corporations do not pay taxes, consumers do. The reason they exist is to hide from voters the true cost of government.

(Just like the employer paying half of the 15% socisl security tax is a complete lie).

You are right to the extent that the total take from taxpayers will be the same -- prices would go down, and explicit taxes would go up.

Harry Eagar said...

At Volokh Conspiracy today, Jonathan Adler started a series of posts on fair taxation.

He has figures showing the corporate taxes amount to less than 10% of the income of the richest 1% of the country. Trivial, but useful as long as the government is running a deficit

A $200B deficit exceeds the national product of all but a few countries. Is this a great country or what?