Did Tax Cuts Cause Rising Deficits?

Adam N. Michel

The current federal budget deficit and the accumulated debt result from Congress spending more than they are willing to raise in taxes. Ultimately, the question of which is more to blame—steady taxes or ballooning spending—will depend on our priors: should the government consume an ever‐​increasing share of private resources, or should its growth be constrained?

However, the recently updated CBO long‐​term budget outlook makes clear that the causes of the future budget deficit is not a question of normative judgment. Tax increases cannot fix the underlying growth of health and retirement spending. Even if tax revenues permanently increased to the levels collected when the United States had a budget surplus in 2000, projected deficits would still rise above 9 percent of GDP by 2053. Tax cuts are not to blame for the demographic and benefit‐​formula‐​fueled growth in mandatory spending.

This short piece will begin with context on U.S. fiscal trends and then discuss the two distinct issues in budgetary sustainability—the growth rate of future spending and the desired level of government spending. Fixing the unsustainable growth rate of federal spending is necessary regardless of the desired level of government spending and preferred tax rates. However, without spending restraint, any tax relief will necessarily be short‐​lived.

Spending Consistently Outstrips Revenue

Federal spending has been systematically higher than tax revenue for the last half‐​century. Revenues have fluctuated around an average of 17.4 percent of GDP, while spending has followed much larger swings around an average of 20.9 percent. For a brief time between 1998 and 2001, Congress ran a surplus when revenue was high during the strong economy, and outlays dipped due to a temporary political consensus against deficits that limited defense spending, discretionary appropriations, and entitlement growth. Since then, spending has steadily ratcheted up, punctuated by the Great Recession and COVID-19.

Figure 1 shows historical and projected revenue and outlays from 1970–2053. In 2022, federal revenue as a percent of GDP was at a two‐​decade high, and this year’s revenue as a share of the economy is projected to be 18.4 percent of GDP, a whole percentage point above the historical average. Over the next three decades, revenues will remain above the historical average, climbing to 19.1 percent by 2053. After recovering from the pandemic spike, outlays are projected to climb past their current highs, rising from more than 24 percent of GDP in 2023 to 29.1 percent of GDP in 2053.

The CBO projections are subject to some well‐​known flaws. First, it is based on current law, which assumes unrealistic things, such as Congress allowing all the temporary 2017 tax cuts to expire and discretionary spending growing slower than the economy. Second, it cannot account for new spending Congress will authorize in the future, whether due to an emergency—war, recession, pandemic—or politically expedient spending on student loan forgiveness or additional energy subsidies. Third, the projections are based on speculative assumptions about economic growth, inflation, interest rates, and healthcare costs. None of these flaws change the critical takeaway from the CBO projections: even with assumed significant tax increases and conservative spending projections, the federal budget is unsustainable.

Congress has been much better at constraining projected revenue growth than they have been at constraining spending. Spending grows as benefits increase faster than inflation and more people become benefit‐​eligible. Baseline tax revenue grows as temporary tax cuts expire, and inflation slowly pushes people into higher tax brackets. The largest source of additional tax revenue over the next 30 years is inflation‐​caused real bracket creep, accounting for almost twice as much additional revenue as the expiration of the 2017 tax cuts in 2053.

Periodic tax cuts have kept revenue as a share of the economy flat rather than increasing while spending growth remains on a consistent upward path.

Taxes and Fiscal Sustainability

Some commentators have claimed that “without the Bush and Trump tax cuts, debt as a percentage of the economy would be declining permanently.” However, CBO budget projections from before the 2001 Bush tax cuts tell a different story. In 2000, when the U.S. was running budget surpluses, the first line of CBO’s long‐​term budget outlook begins by noting that “projected growth in spending on the federal government’s big health and retirement programs—Medicare, Medicaid, and Social Security—dominates the long‐​run budget outlook.” Even in its most optimistic scenario—in which the federal government saves the temporary surpluses—CBO still notes that “the growing expenditures projected for health and retirement programs would quickly push the budget back into deficit,” and debt would again begin to grow exponentially.

There are some more recent years, such as 2012, when CBO projected declining deficits and debt, but these years are flukes of the current law scoring process in which the CBO assumed both significant automatic tax increases and large automatic spending cuts that Congress never intended to allow. The 2012 alternative baseline, which more realistically assumed Congress would extend the 2001 tax cuts and halt automatic payment cuts to Medicare providers, among other spending increases, showed a more realistic scenario with deficits growing to 17.2 percent of GDP by 2037.

Focus on Unsustainable Spending First

Ultimately, focusing on revenue distracts from fixing the existential fiscal problems faced by the U.S. The growth rate of health and retirement spending is not a problem that can be fixed with higher taxes. As Jeff Miron wrote in 2013, “If higher taxes have even a modest negative impact on growth, tax increases have no capacity for restoring fiscal balance. That finding leaves expenditure cuts—especially to Medicare, Medicaid, and ACA subsidies—as the only viable avenues for significant reductions in fiscal imbalance.”

CBO has similarly warned every year for the past several decades that spending on health and retirement programs cannot continue to grow faster than the economy forever; eventually, something has to give. These major entitlement programs are responsible for almost all of the non‐​interest spending growth over the next three decades and, as a share of the economy, are projected to increase by 36 percent over the same time. Such rapid health and retirement spending growth is neither caused by nor fixable with the tax code.

If Treasury collected as much revenue as it did in 2000 when it had a record 2.3 percent budget surplus, the U.S. would still have a 2022 budget deficit of about 5.1 percent of GDP (compared to the actual 5.5 percent deficit). Figure 2 shows an illustrative estimate of federal deficits if tax revenue increased permanently to 20 percent of GDP, the high revenue mark from the early 2000s. The only slightly larger deficits under CBO’s current law projections show that even significant tax increases cannot compensate for fundamentally unsustainable spending growth.

Debate the Level

After policymakers address the unsustainable growth rate of mandatory spending, they can debate the appropriate size and scope of government. Reasonable people can disagree over the appropriate level of government spending and, thus, the level of revenue.

As I’ve written before, big government is expensive, and advocates of larger government should be clear that by blaming deficits on tax cuts, they are calling for significantly higher taxes on middle‐​class Americans. Additional taxes only on the rich are not a sustainable or mathematically feasible way to fund a European‐​style social welfare state. Paying for the current level of government spending—let alone what some Democrats have proposed—will require an unprecedented tax increase.

Broad‐​based tax increases are also no guarantee of lower deficits and debt. Historically, new or increased taxes to remedy fiscal imbalances deepen and prolong economic recessions, do not reduce debt‐​to‐​GDP ratios, and are associated with new spending in excess of the revenue raised.

As Congress prepares for the 2025 fiscal cliff when the 2017 tax cuts expire and taxes automatically increase on basically every American, legislators should be clear that by keeping taxes low, they are also committing to constraining the level and growth of federal spending. Without spending restraint, any tax relief will necessarily be short‐​lived.

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