December 11, 2010

CBO’s Wish List For Santa

Doug Elmendorf, the director of the Congressional Budget Office, published an interesting assessment of Trends in Federal Tax Revenues and Rates. This is timely information considering the heated debates over a tax compromise that includes extending the Bush-era tax cuts.  The CBO’s report concludes among other things:

Even with the projected substantial increase in revenues, under current law deficits between 2015 and 2020 will range between 2.6 percent and 3.0 percent of GDP. If the Congress extended most or all of the 2001 and 2003 tax cuts and made no other changes to taxes and spending, revenues would be lower and deficits would be significantly larger.

In an ideal world, the leaders of a country would understand the implications of poor financial management the way every business owner does. And perhaps, the long-term solution to fiscal deficits would be a requirement for all elected officials to pass a set of Business Management and Economics classes. Sadly, this seems even more illusive than getting a grip on the ever-growing public debt. 

Maybe we need to take a kid’s financial literacy approach to this tax debate to make our financially illiterate politicians understand the dilemma.  Economics is all about scarcity. As a whole, society has unlimited wants but very limited resources. You can drive home this fundamental principle by taking your children to a toy store and giving them a limited budget and a choice of only one toy they are allowed to buy.  Your kids learn very fast that they can only get a few of their unlimited wants satisfied within clearly set constraints. Clearly set constraints however have not been applied by US administrations for decades and it has only been getting worse culminating in last week’s tax compromise.

Given two choices, cut spending on the one hand while extending the Bush-era tax cuts or continue spending while raising taxes, a reasonable person would understand the constraints and choose one of the two.  Our political leaders however behaved like kids in a toy store while the parents gave them a blank check.  Translate this into the ongoing tax debate where some politicians still believe that more spending and lower taxes can miraculously fix the economic problems.  As the CBO graph below indicates, the optimistic scenario still means that revenues are trailing outlays (I love that word because it somehow makes expenses sound more like a temporary thing) by a considerable margin. In essence, this is more akin to wishful thinking.


If that is the optimistic case, how much more devastating could it get by increasing spending while lowering tax revenues? 

Granted, nobody wants to pay higher taxes and the word austerity is not part of the American dictionary. But as gloomy as it may sound, in order to get US public finances under control, we actually don’t have a choice anymore.  We must cut spending AND increase government revenues.  We’re no longer allowed to go to the toy store and choose one toy. We have to stay home and build our own toys from now on…

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