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Growing Deficit and the Future of U.S. Fiscal Policy

Apr. 11, 2024

Tax Analysts' chief economist Martin Sullivan discusses the Congressional Budget Office’s latest economic forecast, new insights on the effects of the Tax Cuts and Jobs Act, and what all this means for tax policy.


This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: fiscal review.

With new budget projections showing deficits out beyond the horizon, and intriguing research into the effects of the Tax Cuts and Jobs Act, we thought it would be a great time to catch up with Tax Analysts Chief Economist Martin Sullivan for his take on the numbers and the research and what they mean for the future of tax policy.

Marty, welcome back to the podcast.

Martin A. Sullivan: Thanks for having me, Dave.

David D. Stewart: All right, so why don't we start off with a baseline of the latest projections from the Congressional Budget Office. What are they forecasting?

Martin A. Sullivan: That's right. The CBO is our official government forecaster. They just released in February their latest deficit and debt forecasts for the next decade. And no surprise to anybody, the outlook is quite gloomy. Our current deficit is about 5 percent of GDP and it's going to continue to grow to about 6 percent of GDP. And for people who want to know what that means, we're talking about $2 trillion a year of extra debt the U.S. is expected to be issuing over the next decade. That is not good.

Another way of describing our fiscal situation is the ratio of federal debt to GDP, to the gross domestic product, to the size of the economy. Now I'm just going to give you a little historical perspective. Back in the 1980s and early '90s, we were all freaking out about how bad the fiscal situation was and our debt-to-GDP ratio at that time was in the 40s. The net federal debt was about 40 percent of gross domestic product. And then things got better when the economy grew and there was a lot of deficit reduction legislation in the '90s.

And then the financial crisis hit in 2007 and our debt-to-GDP ratio doubled in three years and it was up to 70 percent and we were all totally freaked out about that and we had a Bowles-Simpson Commission that tried to find ways of reducing the debt, but that didn't really go anywhere and nobody could reach agreement. And so things just kept going on until the pandemic struck and hit us with an enormous recession and lots of fiscal expenditures and our debt-to-GDP ratio went up to 100 percent, which was unthinkable decades ago.

And the current projection from the CBO is that a debt-to-GDP ratio will continue to grow from 100 percent now to 116 percent at the end of the next decade. Those deficit levels I mentioned are incredibly high considering we don't have any recessions in the forecast and the debt levels are incredibly high even by World War II standards. These are numbers you might've already heard about, but it is important to take into account, you kind of get a little bit of a deficit fatigue, that we're really headed into uncharted territory.

David D. Stewart: Is there a sort of threshold? So you're talking about these huge amounts of debt to GDP, is there some place where that is just a breaking point where it's not sustainable? Is there some magic number where it's "you can't breach beyond here?"

Martin A. Sullivan: No, there is no magic number. In fact, it's quite uncertain as to what's going — I'll just give you three half answers. Back in the '80s, we thought if we went over 50 percent, that would be the end of the world and interest rates would skyrocket. We were a hundred percent wrong because the debt-to-GDP ratio went up and interest rates actually went down.

Economists are not really good at this. The other thing to notice is that other countries, for example, Italy, have much worse fiscal situations and they don't have the dollar to back it up and they're not in financial crisis yet. And then the only thing economists will say is, "Well, this is not sustainable," and that means this can't go on forever.

But what that breaking point is, we know that it can't go on forever. In the year 3000 we'd be in trouble. I guarantee you that if you continue on this path, but we don't know if it's five years from now or 20 years from now. I guess the important point is we don't know and we should be a little bit fearful of that.

David D. Stewart: So why are you a little bit even more pessimistic than the CBO?

Martin A. Sullivan: OK. I got a bunch of reasons and I'll just go through them really quickly. There's four big parts to our government spending. First, there's that mandatory spending, Social Security and Medicare, and we always knew that was going up. There's no surprise because people are living longer and there are fewer workers to support the aging population. And as you probably have heard, neither President Biden or former President Trump will touch it. That trajectory is going up quite rapidly. It was 13.6 percent of GDP, now going up to 15.3. That's a very large increase, but it's already cooked and baked into the numbers.

The other parts of spending are interesting and get less attention. Defense spending. And I'm no expert in military matters, but I do recall that during the Reagan years defense spending was about 6 percent of GDP. Then the Berlin Wall fell and the USSR dissolved and we reduced our defense spending from 6 to 3 percent of GDP. These are enormous numbers. That was called the peace dividend.

And so we had a lot of automatic fiscal relief in the '80s, '90s, and then right now our defense spending is about 3 percent of GDP, very low by historical standards. And it is projected by CBO — because of mechanical rules I won't get into it — to go down to 2.5 percent of GDP. And I ask you, as a observer of the world right now, do you really believe we can or should reduce our defense spending with what's going on in Eastern Europe and in Taiwan? Those projections seem unrealistic to me in my unprofessional opinion.

On nondefense discretionary spending, that's the "big government," all the government agencies here in Washington, D.C. — FDIC, Food and Drug Administration, the Department of Justice, Department of Transportation — all that stuff is really a small part of the federal budget. It's only about 3.5 percent of GDP now and CBO is projecting that will go down to 2.6. This is where folks who want to reduce the deficit usually look first. We already have baked in very low numbers into these projections.

One final observation is about interest on the debt, which is not an option for us to cut. We have been privileged over the last 20 years to have very low interest rates and when you're the world's largest debtor, that's really good and the United States government is the world's largest debtor. I think we just didn't realize how good we had it. Interest rates dropped in the '80s from double digits to 8 percent to 6 percent to 3 percent to 2 percent over the next few decades.

Well, now interest rates are back up, up 4, maybe going to 5 percent. So our debt burden as measured with interest costs on the debt is going to actually triple. Just a few years ago, federal government was spending about 1.5 percent of GDP on the debt and in the next decade, that's probably going to go up to about 4 percent, according to CBO projections. The numbers are bad, but if we had done it 20 years ago, it would've been so much easier. But now not just because of the size but because of the nature of the obligations that we face, it's going to be very difficult to reduce this deficit.

David D. Stewart: I have a bit of a practical question here about CBO projections. If they're making all these assumptions that don't seem particularly realistic, why are those assumptions baked into their projections?

Martin A. Sullivan: Well, one assumption they make just in the rule of law that they assume that discretionary spending is going to increase with the rate of inflation since the economy grows faster than the rate of inflation. That explains why defense spending and nondefense discretionary spending is projected to decline.

That's just a rule of thumb that they — not a rule of thumb actually — it's in the statute that they're required to do. All they're doing is assuming current law stays in place. And they are the first to admit about the uncertainty and the unrealism, they also have alternative projections for different scenarios.

So is it unrealistic? Well, let's get to what we tax folks are really interested in, which is the scheduled expiration at the end of 2025 of the individual tax cuts in the TCJA. Under current law, that's what's going to happen. And so that's what CBO estimates in their revenue projections and they actually show revenue increasing in their official projections.

But we all have a pretty good idea that those tax cuts will be extended for individuals no matter who's elected, at least in most part, and that will add another 1 percent of GDP to the deficit. They at CBO, they do a fantastic job. They are very professional, very nonpartisan and very good at what they do, but the members, they don't like hearing, "It might be about this much." They're going to use definite numbers, and so they will be using these CBO projections as their starting point.

David D. Stewart: Since we're now talking about the Tax Cuts and Jobs Act, I guess the other question I'd like to ask you about is the recent study looking into the effects of the TCJA, you wrote about it recently. Could you tell us about this study?

Martin A. Sullivan: A bunch of government economists, three of whom worked or are working at the Joint Committee, which means they have access to tax return data, which we folks on the outside do not. Anyway, and they have access to tens of thousands of tax returns. They have this great data advantage over the rest of us to see what's going to happen.

Anyway, what they did was they took thousands and thousands and thousands and thousands of tax returns and they tried to estimate the effects that it would have on the economy and it's a very exhaustive study. Unlike other studies which are not based on such good data or a little more speculative.

Anyway, what they found was that the economy as a result of the TCJA, it grew by just a little smidgen, not really that much. There was some growth from the TCJA, but not this. I mean, if I showed you a chart — this is a podcast, I can't show you — you wouldn't even notice the difference before and after TCJA. That is in that study. And also what they found was that most of the benefits of the corporate tax cuts went to the shareholders and to the high-paid employees at the companies so that the TCJA, according to this study, was very regressive in the sense that most of the benefits went to upper-income taxpayers.

Now let me just say that's one study, which gave a very unfavorable view of the TCJA. I have right in front of me a list of, literally a list of 30 other studies that I'm looking at right now. As you might imagine, we economists are not always in agreement, but that one study that we're talking about was really well done and it's a good point of reference for folks who want to evaluate the effects of TCJA.

David D. Stewart: How much are we talking about in trade-offs terms, like the amount of forgone revenue versus increased economic activity?

Martin A. Sullivan: Since I published that article, they have revised their paper. What they're saying is, about for every dollar of revenue cut you get about a 40-cent increase in GDP. If you play with those numbers and you put them into context those amounts are not very large. What clearly comes out of this study and almost every other study that I've seen, and I'm seeing dozens of them from people on both sides of the aisle, is that tax cuts — yes, they may have a positive impact on economic growth, although it's probably very modest. That there's really no way that they pay for themselves or even come close to paying for themselves. The so-called dynamic estimation, which is a good idea, the results are not telling us that tax cuts pay for themselves or even come close to paying for themselves.

David D. Stewart: The other large question that always comes up in terms of corporate taxation is this question of incidence of taxation. The higher you raise the rate, that burden falls on different categories. Did we learn anything about the incidence from this study?

Martin A. Sullivan: This study pretty much confirmed what the Joint Committee and other folks have been assuming, which is most of the burden of the corporate tax is on the owners of the corporations as the shareholders. And this study confirmed that very convincingly. What's interesting about that is, if you noticed I said most of the burden falls on the shareholders who are relatively wealthy, but there are many of us who make under, let's say $400,000 a year, who have portfolios in our retirement accounts.

And so for folks, some of the burden does fall on people who own stock, who may be low- and middle- income and below $400,000. To get to the controversy of President Biden's claim that he will not raise taxes on anybody below $400,000, that is correct in the sense that he is not directly raising taxes that those folks pay on their 1040s, but some of those folks who own shares in corporations might receive smaller dividends and lower profits. So a small fraction of the burden of the corporate tax does fall on incomes below $400,000, according to the study.

And therefore, you can technically and correctly claim that some of the burden of President Biden's proposed tax increases does fall on households with incomes below $400,000.

David D. Stewart: The next question is, where do we go from here? We have this rather bleak outlook from the CBO that you are telling us should be bleaker and we have expiring provisions of the TCJA coming up next year that will make it worse. So what do we do now?

Martin A. Sullivan: We hope they'll form a fiscal commission and Republicans and Democrats will compromise and the deficit will come down. And then I woke up. The way I look at it, there's four outcomes after the 2024 election. Either the Republicans sweep, in which case we're going to have a certain extension of the entirety of TCJA, or the Democrats sweep, in which case we'll probably have lots of tax increases like those proposed by President Biden, or we're going to have gridlock where neither party controls all three parts of the federal government.

If you have gridlock, nothing's going to happen, which is not good. If you stay on this course, it is unsustainable. What you would want to have happen is compromise where Democrats and Republicans get together and they make concessions to each other. The reason that's hard to imagine — I have two reasons why it's hard to imagine. One is, the partisanship seems to be greater than ever I can remember. It's always been great, but it's fantastically large right now.

But it's hard to imagine a compromise without — that Democrats would agree to that didn't include tax increases and it's hard to imagine a compromise that Republicans would agree to that had tax increases. Both parties have sort of drawn lines in the sand that they will not cross over, which suggests that compromise is not possible.

The other scenario is, gee, maybe we'll have some sort of great crisis that will get these folks to do the right thing and reduce the deficit. But we had a financial crisis in 2007 that scared the bejesus out of me and I think most everybody, and if that didn't do it, I don't know what it's going to take to scare these two parties to get together and work out a long-term fiscal solution.

There is one possibility I think about to look at cutting tax expenditures. For example, one tax expenditure, or one type of tax expenditure, are the alternative energy credits in the Inflation Reduction Act. Now, would Republicans support a tax increase that included repeal of those tax credits? I think the answer is yes on that. So maybe technically they could agree to a tax increase in that form, but of course I don't think Democrats are going to be willing to concede on that point either. I don't have any good answers here, I'm sorry to say.

David D. Stewart: If you were in charge, what would your first action be to get this ship going in the right direction?

Martin A. Sullivan: Ideally, we would have a combination of tax increases and spending cuts. I think the more obvious place for spending cuts is on the mandatory for senior citizens, raising the retirement age because people are living a lot longer than they were when Social Security was started in the 1930s. I don't think it'd be any great hardship for most people, especially higher income people, to have the retirement age on Medicare and Social Security raised.

On taxes, I certainly think there is room for taxing wealthy individuals more, but I also think that's not enough. I think we need tax increases across the board. By the way, everything I'm mentioning are political non-starters, but that's exactly where we need to go. The things that are so-called — all these third rails you're not supposed to touch. We need to start grabbing them and addressing them because otherwise, we're just speechifying. Those would be two places to start.

I'll just mention one other thing, everybody. There will be in a few years that Social Security's going to go broke. Well, that is sort of really not true because the trust fund may run out of money, but you think Congress is going to allow Social Security payments to decline by 25 percent? Which is what they would have to do if Social Security "went broke." They'll just transfer funds from the general fund to the Social Security trust fund as they have done in the past and as they do now with the Medicare trust fund.

That's not a real problem, but it's sort of a political flashpoint because if you walk into a room of senior citizens and tell them the Social Security trust fund is going to go broke in a few years, it gets people's attention. That might be a trigger for some action.

David D. Stewart: Well, Marty, even though it does sound like doom and gloom, I thank you for helping keep us grounded on all these subjects. Thank you for being here.

Martin A. Sullivan: Thanks for having me.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Senior Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper B. Smith: Thanks, Dave. In Tax Notes Federal, Raymond Placid and Daniel Acheampong explain the complex stock attribution rules under section 318. Jeffrey Pennell and Alex Zhang propose a new administrative process for recognizing tax exemption.

In Tax Notes State, three EY practitioners discussed the impact of New York's apportionment rules for investment managers. Karl Frieden rebuts the idea that business does not pay its fair share of state and local taxes.

In Tax Notes International, Arlene Fitzpatrick provides context for various proposals to address the Taiwan-U.S. tax relationship. Three PwC practitioners examine the evolution of the treatment of transferable tax credits for pillar 2 purposes.

And finally, in featured analysis, Marie Sapirie examines the debate over how the proposed hydrogen tax credit regulations should handle renewable natural gas and fugitive methane.

David D. Stewart: That's it for this week. You can follow me online @TaxStew. And be sure to follow @taxnotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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