WASHINGTON — The term “unexplained” doesn’t appear too often in official government documents, unless they are dealing with possible paranormal events, like UFOs. Yet the reference is sprinkled throughout the Congressional Budget Office’s latest budget and economic outlook to describe the recent strength in federal tax receipts that’s blown away prior estimates.
Individual income tax collections for the fiscal year ending Sept. 30 are projected to land at their highest level as a share of the U.S. economy since the advent of the income tax in 1913. Overall federal tax revenue this year is expected to hit 19.6 percent of gross domestic product, a figure that’s been topped only three times: twice during World War II and again in 2000, before the dot-com bubble burst.
It’s not entirely unexplained; the CBO attributes much of the revenue growth this year and in the coming years to faster economic growth, higher wages and profits and capital gains realizations from elevated asset prices — and, yes, higher inflation.
Additional revenue comes from one-time measures like payroll taxes deferred during the pandemic that are now coming due, and from changes in estimations of foreign corporate profits in tax havens and low-tax jurisdictions.
“The remaining growth in individual income taxes this year cannot yet be explained,” the report says in one instance. “Corporate tax collections were larger in 2021 and early 2022 than can be fully explained by currently available data on business activity for those years,” the CBO says later in the document.
Tax receipts aren’t going to stay that high forever. The report estimates that revenue as a share of GDP will drop to 17.6 percent in fiscal 2025, the last year that major expiring provisions of the 2017 tax cuts are still in effect. That would still be higher than the average of the past five decades, the CBO said.
‘Economic,’ ‘technical’ factors
To put the current windfall in perspective, it’s useful to look at some comparisons to estimates made before key legislative policies were proposed or enacted.
For the fiscal 2022 through 2031 period, the CBO estimates that tax receipts will come in $3.4 trillion higher than expected the last time the agency published its semiannual forecast, in July 2021. Compare that with the budget reconciliation package House Democrats passed last November — known as “Build Back Better” — estimated to raise taxes by about $1.5 trillion.
In 2017, prior to passage of the GOP tax law, the CBO estimated that federal tax receipts would total $43 trillion over fiscal 2018 through 2027. Combining actual results in the early years after enactment with the latest forecast, tax revenue is now expected to be $1.7 trillion higher during that time than the agency had forecast before the tax cuts became law.
That’s due to higher individual income and payroll tax receipts, which offset a $146 billion drop in corporate tax revenue. But some of that decline was pandemic-related, and from fiscal 2021 through 2027, the latest CBO figures show corporate receipts outpacing the pre-2017 tax law forecast by a combined $255 billion.
Back out the last two years of that budget window when major pieces of the tax law are set to expire, and total revenue is still on pace to come in
$1 trillion higher than the June 2017 forecast for those eight years.
The new figures reflect a big swing from last July, when the CBO’s forecast indicated overall tax revenue would fall about $127 billion short of pre-2017 tax cut estimates over a decade; even that was a positive surprise, given earlier warnings.
None of this is to say “tax cuts pay for themselves,” an argument some tax-cutters have made. It’s altogether possible, even probable, that receipts would have been higher in the absence of the GOP tax cuts.
But since we’ll never know, it’s useful to see the power of “economic and technical” revisions to their forecasts, as the CBO calls them. And those factors appear all the more powerful in light of subsequent legislation that reduced revenues, as well as a global pandemic that led to a brief recession and temporarily sapped tax receipts.
Of course, the CBO’s forecast doesn’t take into account what’s expected to occur in later years: extension of large chunks of those 2017 tax cuts, since letting them all lapse would mean tax increases for millions of lower- and middle-income households.
That could cost $2 trillion or more to extend through fiscal 2032, the CBO said, though that’s a “static” estimate that doesn’t factor in potential changes in the economy. Letting the provisions lapse would “temporarily slow economic growth,” according to the CBO, so it stands to reason that extending them would boost growth and lessen the revenue hit somewhat.
Taxes are just one side of the federal budget ledger, but the recent strength in receipts has been a positive upside surprise, at least temporarily, for one of the biggest long-term debt drivers: Medicare. Greater-than-expected payroll taxes due to faster wage growth have pushed back the date of the Medicare hospital insurance trust fund’s exhaustion by three years, to 2030.
Taxes are just one side of the federal budget ledger, but the recent strength in receipts has been a positive upside surprise, at least temporarily, for one of the biggest long-term debt drivers: Medicare. Greater-than-expected payroll taxes due to faster wage growth have pushed back the date of the Medicare hospital insurance trust fund’s exhaustion by three years, to 2030.
Big spending deals
Nonetheless, federal spending has grown substantially since the CBO’s summer 2017 forecast. Major contributors include discretionary spending deals that have undone tight spending caps imposed a decade ago, pandemic relief laws enacted since March 2020, and the five-year infrastructure spending law enacted last year.
Spending over the fiscal 2018 through 2027 time frame is up $6.4 trillion — and that’s a net figure that includes an $842 billion reduction in expected interest payments on the federal debt due to lower interest rates. Spending on everything besides interest payments is up by $7.3 trillion.
Combined with $1.7 trillion in higher tax revenue, deficits are about $4.7 trillion higher over the fiscal 2018 through 2027 period, pushing debt held by the public to an estimated $30.2 trillion at the end of that decade.
The size of the economy is expected to be over $2 trillion greater by then, which offsets some of the rise in debt as a share of GDP. But debt would still hit 100 percent of GDP by 2027 — up from 91 percent of GDP in the June 2017 forecast.
The Federal Reserve’s role in the Treasury debt market is a big one, however, and particularly since COVID-19 washed ashore in early 2020. Despite the Fed’s pending move to shrink its balance sheet as part of its battle against inflation, the CBO expects it to begin buying up Treasury debt again in several years.
If we assume the Fed’s pre-pandemic $2.4 trillion pile of Treasurys remained in place in fiscal 2027, the amount owed to private and foreign creditors would equal about 82 percent of GDP in the CBO’s June 2017 forecast.
Fast forward to last week’s updated forecast, which assumes that the Fed’s Treasury holdings hit $3.9 trillion in fiscal 2027, when total private credit market exposure would amount to 87 percent of GDP. That’s still higher than assumed in 2017, before so many major fiscal events occurred, but not by as much.
Some of the CBO’s spending assumptions probably aren’t realistic. By law, the agency has to assume that emergency spending on things like the war in Ukraine go on in perpetuity. It also assumes Congress will reauthorize the infrastructure law at similarly high levels after its major provisions expire; it’s not clear what lawmakers’ appetite will be for another massive infrastructure deal like the $830 billion the CBO estimates Congress plunked down last year.
Still, with tax-cut extensions likely on the horizon, it stands to reason that deficits and debt could be greater than the CBO currently estimates. And the long-term picture isn’t pretty regardless, with an aging population and no answer for rising health care costs. But as we’ve seen over the past year, there’s always the chance for some kind of “unexplained” intervention that upends the conventional wisdom about the federal budget picture.
Debt limit
One final piece of good news in the CBO report, depending on where one sits politically: The revenue surge might push off the moment when lawmakers absolutely must deal with the statutory debt ceiling or Treasury will have to risk not making good on its obligations.
The CBO forecast has debt subject to limit, which encompasses “intragovernmental” debt owed to federal trust funds as well as debt held by the public, hitting nearly $31.8 trillion by the end of the next fiscal year, Sept. 30, 2023. That means that sometime in the middle of next year, Treasury could hit the current debt limit, which is just shy of $31.4 trillion.
But there are always “extraordinary measures,” such as suspending certain trust funds’ investments, as well as elevated cash balances that could be drained, all of which could push the moment of truth off to late 2023, conceivably. Given that Republicans appear likely to control one or both chambers next year, an extended runway for the GOP and President Joe Biden to hammer out a solution might be the safest thing for the economy and global financial markets.
