- The Washington Times - Wednesday, October 3, 2007

ANALYSIS/OPINION:

The Congressional Budget Office’s recent federal fiscal update drew attention for its positive deficit news, while its more ominous news on the rising tax burden was largely overlooked. Measured as a percentage of the U.S. economy, this year’s federal tax receipts will exceed the last 40 years’ average by an even greater amount than last year’s. Projections are for this burden to increase next year as well — and this increase is with the 2001 tax cuts, to expire after 2010, still in place.

The concern is threefold. Five of the last six recessions have occurred when the federal tax-to-economy ratio exceeded the 40-year average. Five of those six recessions have come on the heels of far stronger growth than our economy is now experiencing. And two political factors will only add to the tax burden pressure: the near-term expiration of the 2001 tax cuts and coming entitlement spending explosion.

It is clear the economy is cooling. As CBO states, “After growing at an average rate of 3½ percent from early 2003 to the middle of 2006, real GDP increased by only 11/4 percent during the second half of 2006 and the first quarter of this year.”

Hit first by rising gas prices and now by the subprime mortgage credit crunch, it is not surprising that reports of solid second quarter economic growth were immediately discounted. Or that the remaining year’s performance has been downgraded. TheWall Street Journal’s recent polling of economists projected “economic growth will be between 2 and 3 percent in the current quarter before softening further.” For 2007, CBO projects growth of only 2.1 percent, the lowest since 2002.

Despite slowing economic growth, federal tax receipts continue to climb. While slower than 2005’s 14½ percent increase and 2006’s 11.8 percent increase, 2007’s projected 7.1 percent increase (three-quarters of which is attributable to income and corporate tax receipts) would still be well ahead of the economy’s nominal 4.9 percent projected growth and tax receipts’ 1995-2005 average growth rate of 4.8 percent.

The result of revenues’ overperformance has been an overlooked increase in the federal take from the economy. Last year’s ratio of federal tax receipts to GDP was 18.4 percent, this year’s is projected at 18.8 percent and 2008’s 19.2 percent — all well “above the average of 18.2 percent recorded between 1966 and 2006,” as CBO notes.

While good deficit news, it may not be good for the economy. During that 40-year period, there have been six recessions. All except the 1990-91 recession had a federal tax-to-economy ratio above the 18.2 average.

But the lesson from the 1990-91 exception should only increase concerns for the current economy. Its federal tax ratio was just under the 40-year average at 18 percent. Then in last-quarter 1990, the same quarter that the recession began, then-President George H.W. Bush committed political perjury by signing a tax rise estimated at $137 billion over the following five years.

Additionally troubling, only one of these six recessions did not have relatively strong economic growth in the year preceding the recession. With the exception of the 1981-82 recession, which followed the 1980 recession (-0.2 percent growth), all these were significantly higher than this year’s projected growth.

Today’s economy is weak and already above-average tax burdens are slated to increase with the 2001 tax cuts’ expiration. According to CBO’s estimates, the tax-to-economy ratio will increase to 19.4 percent in 2011 and 20 percent in 2012. By 2017, the burden would be 20.3 percent — the highest post-World War II level since 2000’s 20.9 percent. By 2015, federal income taxes would equal 10.3 percent — an all-time record — and corporate taxes as a share of GDP are already their highest since 1978.

The economic and political components that favor a recession are increasingly prevalent and troubling. And reversing them will be difficult.

The economy is dealing with the twin shocks of higher energy prices and the subprime shock to the credit markets. The tax-to-economy ratio is growing and will only accelerate after 2010. Under Capitol Hill’s prevailing pay-go approach, preventing the 2001 tax cuts’ expiration will require either offsetting tax increases or — even less likely — spending cuts.

As great as these pressures are, they pale in comparison to the looming entitlement spending explosion from Medicare, Medicaid and Social Security. Next year lights the fuse, as Baby Boomers can begin retiring. CBO points out, Medicare and Medicaid could reach 17 percent of the economy by midcentury. Combined with CBO’s 2050 estimate for Social Security, these three programs alone would account for well more than the entire current federal tax burden — only increasing tax increase pressures.

Policymakers should remember that the 1990 tax hike did not have to take effect to have an effect. Even before rates rose in 1991, the economy fell. Today’s lesson should be that time is even shorter than it appears. With a weakening economy and rising tax burden, the country may not have to wait until 2011 to see the fallout from a rising tax burden.

J.T. Young served in the Treasury Department and the Office of Management and Budget 2001-2004 and was a congressional staff member 1987-2000.

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