We’re at the end of the federal fiscal year with the likelihood of yet another government shutdown. I assume that will happen or whether the Dems will conclude at the eleventh hour that a shutdown is in neither their political nor the nation’s interests.1
Back in March, I assume they concluded that a shutdown would simply make more of the DOGE rampage through the federal government legal. That was so because a shutdown gives the executive wide discretion to determine what is an essential function and can continue despite the lack of appropriations. That concern has lessened a bit with the tempering of DOGE, probably increasing the likelihood of a shutdown.2 The messages out of DC confirm that a shutdown is highly likely. I see no good coming of this, no matter which course the Dems take.
The Dems are going to hold out for health care funding – reversing some or all of OBBBA’s health care cuts.3 Given that tax increases are surely off the table – as a matter of principle for Republicans and as a matter of politics for Democrats – that presents a classic Hobson’s choice (at least for me).4 Is it better to:
Increase an already unsustainably growing federal deficit by spending more on ACA tax credits – a serious long-term fiscal and economic risk of unclear dimensions; or
Make individual health insurance much more expensive for lower-middle income households who rely the tax credits – effectively throwing millions of folks off health coverage because they can’t afford it?
It might be fun to speculate about the political pros and cons of the Dems’ choice of whether to shutdown government to preserve health care coverage for a swath of folks in the individual market (a policy good) or to allow that to happen so the public can see the real impact of the Republican’s OBBBA decisions (a Dem political good possibly).5 Weighing in on such questions is NOT my comparative advantage. I’ll leave it to politicos and pundits.
Instead, I think a little thought experiment is useful. In a world where tax increases are not an impossibility, could the Dems’ fund their health care demands with reasonable tax increases that:
Are progressive and apply overwhelmingly to households with incomes north of $200k;
Do not increase rates – corporate or individual (As an aside, it’s still a political mystery to me that the Dems were unable to increase the corporate rates at all when they had Congressional majorities, given that neither Manchin nor Sinema were unlikely to and ultimately did not run again. They must really believe that the corporate rates matter a lot.); and
Leave untouched the idiotic “small business” break (i.e., QBI or the 20% exclusion for pass through entities)?
At the request of the Dems, CBO has estimated the 10-year cost of their health care proposals (i.e., enacting them permanently). The numbers are in the table below. Descriptions of what is involved with the various spending is in the CBO memo. Note that this addresses only the ACA related provisions, not the full Medicaid cuts in OBBBA, a much bigger fiscal nut to crack.
Provision
Cost ($ billions)
Increased # of insureds (millions)
Expanded premium tax credit permanently
$350
3.8
Nullify final admin rule
40
0.3
Repeal OBBBA’s ACA provisions
272
2.9
TOTAL
$662
7
Thus, the total cost is a little less than $700 billion. It’s worth noting that repealing the OBBBA provisions are the provisions that deny ACA benefits to various immigrant groups (not unauthorized aliens FWIW), such as those on temporary protected status, with pending asylum claims, and so forth. They do not take effect typically until 2026 (one provisions is delayed until 2028).
It is easy to assemble a list of tax increases meeting my three criteria above. The table below shows some possibilities that can be justified on a policy basis.6 The numbers for reversing OBBBA’s provisions are from the JCT estimates, the other two are per CFRB.
Provisions
Revenue in billions
Reverse TCJA/OBBBA estate and gift tax expansion
$212
Revert to TCJA’s SALT deduction
142
Limit charity deduction to cash > 2% of AGI
500
Apply NIIT to PIT income not subject to SECA
490
TOTAL
$1,344
The total from this limited list of high-buck options is almost twice the cost of the health care provisions, providing plenty of room to soften their impact by phasing them in, raising the dollar limits, lowering percentage inclusions, and so forth. Many small dollar options are also available, such as taxing carried interest of hedge fund and private equity investors as ordinary income rather than capital gains.
The estate and gift tax reversal would still provide a lifetime exemption for married couples that exceeds $16 million, indexed for inflation. That is sufficiently generous. The current antipathy for estate taxation is one of life’s imponderables, given its historic popularity. It must be a political messaging problem. The tax only affects a tiny percentage of the population.
OBBBA’s quadrupling of the SALT deduction limit to $40K is both regressive and unnecessary. (Disclosure: it will save me a material amount of tax. It’s still a bad idea.) The revenues from the SALT deduction limit could be further increased by reversing the IRS’s administrative decision to allow deduction of income taxes directly imposed on pass through entities. (That decision was probably contrary to the statute, but no one has both standing and an incentive to challenge it.) When OBBBA was under consideration, the congressional committees considered various options for limiting deductibility, one of which was in the House passed version but was ultimately dropped. Getting rid of it would treat wage earners and investors in stocks and bonds more equally with owners of pass-through business entities.
OBBBA already imposes a 0.5% AGI floor on charitable contribution deductions, starting for contributions next year. Ratcheting that up and imposing some sort of limit on the ability to deduct the fair market value of appreciated property makes both policy sense and can raise a lot of revenue. This is a favorite hobby horse of mine.
The final option – imposing the Net Investment Income Tax on (mostly) S corporation distributions – would close the John Edwards/Newt Gingrich loophole and treat S corporation shareholders similarly to partners. It only applies at incomes above $200k (single and head of household) and $250k (married joint).7 The amount of revenue involved never ceases to amaze me.
Bottom line: there are plenty of tax increases that should be politically acceptable to offset the cost of the Dems’ heath care proposals. In the current environment where any tax increases (except tariffs) are toxic, none of this will be considered. The more likely outcome is a compromise that increases the deficit by temporarily extending some of the Dems’ health care demands.
The administration is trying to reanimate it by threatening mass firings of federal employees. Past practice would counsel Dems to take the administration seriously on stuff like this, not just to assume it’s a negotiating bluff. ↩︎
Technically, OBBBA did not cut the ACA tax credit enhancement that was enacted during the pandemic. It allowed it to expire. OBBBA did make some ACA related cuts, terminating credits for immigrant groups, in addition to its major Medicaid cuts. ↩︎
I assume that when push comes to shove, the issue will be whether to temporarily extend the enhanced ACA tax credits. The cuts in the out years are just too far off and too large to address. My amateur guess at the politics. ↩︎
The latter option is occasionally referred to as touching the hot stove – essentially helping Trump voters realize the real-world consequences of Republican policies that are inconsistent with the populist campaign rhetoric they may have thought they were voting for. ↩︎
My first preference would be simply to repeal QBI. That would more than solve the problem if the repeal were effective for tax year 2027. It’s been made absolutely clear that despite QBI’s lack of any policy basis both parties support it, fairly strongly. Sigh. ↩︎
Here’s how Penn-Wharton succinctly describes it: “Under current law, individuals with high wage or self-employment earnings are generally subject to a 0.9% additional Medicare payroll tax on top of the 2.9% Medicare payroll tax. Similarly, individuals with high investment earnings are subject to a 3.8% net investment income tax (NIIT). However, certain pass-through business income of limited partners and S corporation shareholders escapes both of those forms of high-income taxation. This policy would expand the NIIT base to ensure that all pass-through business income would be subject to the NIIT.” ↩︎
After two months, I see two overarching themes to Trump’s economic policies:1
Tariffs obviously
Chaotic cuts in discretionary spending with a heavy emphasis on eliminating federal employees.
This is based on the unilateral executive actions he has taken. Some of those were almost certainly extralegal because they required congressional action.2 SCOTUS will need to sort out which ones, but only a modest subset will likely make it that far. In the final analysis, it may not matter that much: all the King’s men and horses (or the Court) probably cannot put Humpty back together again in some or many cases.
Tariffs
Trump is obviously entranced by tariffs as some sort of magical policy instrument – both economically and politically.
On the economic front, he seems to be living in a mercantilist time warp that ignores both economic theory and reality, including the modern economy with its interconnected global supply chains and interdependencies, highly susceptible to disruption. The securities markets obviously do not share his view. They go down when more tariffs appear likely and partially recover when he relents. But only partially. So, it’s not just pointy-headed economist types with their fancy theories and empirical studies.
On the political front, he perceives that tariffs are politically acceptable. The 2024 election result following Trump’s strenuously promoting them confirms that, at a minimum. A cadre of people are favorably disposed. Two major groups, both big parts of Trump’s voting constituency, are (1) old fashioned laborites, like the UAW and many union members, who think tariffs protect high-paying jobs3 and (2) xenophobes who perceive, as Trump misleading keeps saying, that tariffs mainly adversely affect foreigners and foreign interests.
So, away we go with tariffs. Nobody can fairly claim that this is a surprise, including all the business types who supported him and oppose tariffs (e.g., WSJ editorial page), assuming it was just political rhetoric or that he would back down when the markets pushed back. No sign of that. When Trump claimed he was Tariff Man, they should have believed him.
This graph, posted on Twitter, is striking in showing this isn’t the first term:
A longer run view – w/o the handpicked time period – provides a more balanced view. We aren’t anywhere close to Smoot Hawley territory, but it does show how dramatic a deviation Trump’s policies are from immediately preceding generations.
Tariffs are Trump’s all-purpose billy club that he uses to bully foreign countries that aren’t doing what he wants. Examples include the threats against Mexico and Canada regarding fentanyl. The most recent nonsensical use is his threat to impose tariffs on Russia to bring it to heel in the negotiations for a ceasefire in Ukraine War. He obviously thinks that all the sophisticated efforts to impose economic sanctions on Russia were ineffective because they forgot about the possibility of using maximum tariffs of our imports from countries that buy Russian oil (e.g., China and India). Seems like an obvious bluff, which is the typical reaction of the targets, because it’s unclear who would be hurt more – the U.S., our trading partners, or Russia.4
Peter Navarro, a longtime Trump economic advisor,claims the tariffs will raise $6 trillion in revenues over a decade. This does not square with the estimates made by government economists, the Tax Foundation, or CRFB, all of which are half or one-third of that amount for higher tariffs. (Navarro comments appear to be for Trump’s proposed tariffs, not the universal tariffs estimated by the credible sources I linked to.) None of this takes into account the likely retaliation. It’s magical thinking like this that helps explain the radical and risky actions Trump is taking.
I doubt that Trump thought his tariffs would stimulate China, South Korea, and Japan to work on negotiating a free trade agreement, but that appears to be in works jarring lose negotiations that had been at an impasse for over a decade. The world is not static. Classic retaliatory tariffs are only one possible response.
This post by Noah Smith, an econ blogger, is worth reading for context. He points out indirect effects that most people likely don’t think about. Some examples:
Auto tariffs will drive up the auto insurance costs as the prices of auto parts and, thus, repairs rise.
Higher steel tariffs make it harder for “drill baby drill” proponents by raising oil industry’s equipment costs (e.g., pipes and drilling equipment).
The demand effects have hit the Iron Range, as Strib coverage has pointed out.
It’s always useful to look for possible bright spots, Reagan’s pony that must have produced all the manure in the room. One thought is that imposition of Trump tariffs might offer the opportunity to transition to a broad-based consumption tax to fix a disastrous economic and fiscal policy in a post-Trump world. Tariffs are largely a consumption tax on foreign goods. Their revenues could be replaced and augmented by a VAT. That would eliminate their distortive economic effects, while simultaneously could cut the deficit depending upon rate and base. This seems unlikely but plausible. It’s the only pony I can think of.
DOGE spending cuts
I don’t have much insight into the dramatic and chaotic cuts in the discretionary spending. But I’ll still make a few random points:
It’s a truism that discretionary spending is such a small proportion of the budget, that cutting it cannot be a material factor in dealing with the budget deficit. But it’s good theater/PR for the uninformed who want stuff done, resent public employees, etc.
Consider the net result so far of the termination of probationary employees. They were fired for poor performance, which was not supported factually. A few courts have ordered them to be rehired. Most of them have been rehired and put on paid administrative leave. So, they’re getting paid for not working. Move fast and break things. I guess it doesn’t matter if you think their services were totally worthless. That is absolutely not true for the largest category in this group, IRS employees.
If the goal is to reduce fraud and mistakes in entitlement payments, firing federal employees who could uncover mistakes and fraud is going in the wrong direction. Hiring investigative staff (or contractors) and applying resources in a concerted and thoughtful way is what’s needed. Medicaid and Medicare mistakes and fraud are likely a big deal and should be targeted. But it will take a long-term commitment and is not a quick budget fix.
Don’t expect immediate negative effects of these cuts on a macroeconomic level. The cuts in staff compensation, contractor payments, and grants are relatively small compared to the overall size of the economy. Moreover, the effects of tariffs will overwhelm. However, the layoffs and cuts do reinforce the negative effects on expectations that are occurring and the drop in spending.
Also do not expect the general public to perceive much degradation in federal services. Some anti-Trump former Republicans are asserting that if the public does not see the decline in services, that is a damning indictment, given the wholesale and chaotic cuts DOGE has made. In short, little outcry about disastrous effects implies we could have been cutting these expenditures all along. (Sarah Longwell at the Bulwark has repeatedly suggested this. That perspective reflects her roots in limited government, quasi-libertarian ideology, as she admits.) I think that is unlikely and a wrongheaded way to think about it. Most federal agencies and employees provide very few services directly to public. Rather, what they do is like an element of the economy’s basic infrastructure. Cutting their services have long run and often not obvious effects (slight degradations in the quality of weather forecasts, slower approvals of drugs and medical devices, less basic research, fewer college and grad students, etc.). The general public will not notice. Yes, the feds do provide some direct services, such as social security, and that is why the administration keep backing off of making dramatic changes. (Martin Malley’s claims of an imminent collapse of agency probably will not come to pass IMO. Of course, he hedged it as “could.”) The cuts to VA staff may be an exception. The effects in a few geographic places with big federal footprints will also be noticable.
It’s the long run effects that are corrosive – reducing spending on basic research, laying off FDA staff, etc. These are public goods that the private sector will not do (ROI is 0) and that have provided some of the dynamism of the US economy, in combination with its reliance on private market incentives. Attracting foreign talent to America with higher education and research institutions has been a big deal. This Axios story (America Progress in Peril) provides some sound bites on that: e.g., “40% of U.S.-affiliated Nobel Prize winners in the sciences — physics, chemistry and medicine — between 2000 and 2023 were immigrants.”
DOGE has confirmed a part of Paul Ryan’s old hypothetical budget plans that I thought were implausible and that never gathered much attention – massive cuts in discretionary spending in the out years. I assumed that his inclusion of them was akin to David Stockman’s magic asterisk – a politically easy way for Ryan to cover up untenable math in his plans to fund tax cuts – but it turns out to be one of the things he got right about where the Republican Party was going. I had always thought that a sober conservative would not have wanted that; it was just a sleight of hand. Wrong or at least wrong for current iteration of the party (not sure about Ryan’s real policy preferences). Reconciliation may also prove that his Medicaid cuts are another thing he was right about politically – can definitely see conversion to block grants with big cuts tilted toward blue states as a strong possibility to finance tax cuts. Or not, given the slim majorities in Congress. We’ll see.
Footnotes
I’m not counting immigration as primarily an economic policy, although there likely will be important economic effects in the long run. Changes in noneconomic policies are IMO more alarming with the descent into authoritarianism (knee capping law firms, police state-like grabs of people off the streets, shipping people to foreign prisons w/o due process, and similar). ↩︎
In terms of talk and plans for legislative action, it’s all about massive, deficit-increasing tax cuts, partially offset by cuts in the safety net, largely Medicaid and SNAP. Whether this closely divided Congress can pull that off or exactly what it looks like, if it can, remains to be seen. ↩︎
I think this is backward thinking. It’s based on the idea that manufacturing jobs are “better” (i.e., higher paying), which was based on a former reality when they were more heavily unionized and allocated oligopolistic profits to labor. That is simply no longer true. Manufacturing and service sector wages are converging. ↩︎
The simpler and more straightforward approach would be to tell Putin that we are going to give Ukraine more and better weapons with fewer restrictions on their use, if he does not start making concessions. I guess that’s too complicated, dangerous, expensive, or something. But it would be more credible and might work. Secondary tariffs, not a chance. ↩︎
I recall Reagan castigating liberals’ spending practices as impugning drunken sailors, implying the sailors’ reckless spending was restrained by comparison. Reading the quote (thanks to the Reagan Library), I see that it was really an antitax message. What Reagan said was that their spending would
place higher and higher taxes on small businesses, on family farms, and on other working families so that government may once again grow at the people’s expense.
In other words, he was not tagging liberals for deficit spending but for the taxes that their spending would require. In 1984, it would have been hypocritical for Reagan to harp on the deficit, since his tax cuts and increased defense spending drove the deficit higher than the Democrats had ever done, aside from financing WWII.
The current iteration of the Republican Party appears poised to borrow money like a proverbial drunken sailor going ashore with an unlimited credit card:
Most indications are that they will treat extension of TCJA, a $4 T tax cut over the next decade, as deficit neutral under a “current policy” baseline theory.1 This CBO analysis (3/25/2025) says that a full extension would increase the national debt to 214% of GDP by 2054. When CBO assumed interest rates would rise by 1 percentage point as a result, deficits would exceed 250% of GDP by 2054. It’s worth recalling that the Penn Wharton Budget Model assumes budget deficits are unsustainable when they hit 200% of GDP. See also the CRFB discussion of the new CBO analysis. Any of Trump’s additional tax cuts not offset by spending cuts – e.g., exempting tips, overtime pay, more social security benefits, etc. – will add more debt.
DOGE’s IRS cuts are likely to lead to material reductions in revenue collections. This WaPo story (reprinted on the front page of last Sunday’s Strib) quotes “Treasury Department and IRS officials” as predicting a 10% reduction in tax receipts or $500 million compared to 2024 by April 15th because of the IRS cuts and layoffs. I personally don’t think the effect will be anywhere close to as bad as that, but maybe that’s just my inherent Pollyana nature. My experience says that changes in taxpayer behavior take longer than that, especially if requires going against longstanding compliance norms.2 I would guess it will take two or three years for such a larger reduction to occur. But in the long run, the revenue reducing effects of DOGE (assuming the IRS layoffs and cuts stay in place and grow as planned) are likely to swamp any of DOGE’s spending cuts.
Reagan’s concerns – i.e., about higher taxes affecting private economic activity – probably still apply to drunken sailors recklessly cutting taxes and increasing deficits because doing almost inevitably will drive up interest rates.3 Higher interest rates function like taxes, driving up the cost of business investment and consumer spending such as buying houses and cars. For example, the CRFB analysis cited above suggests a modest 1 percentage point increase in interest rates as a result of growing the debt will reduce GDP by 1.8 percent (albeit three decades from now).
Tax data and immigration enforcement
In other IRS news, according to another WaPo article the IRS is poised to enter an agreement to provide IUC with confirmations of the addresses of undocumented individuals. This is a partial compromise, i.e., IRS is only confirming an address ICE provides, not matching an address for a name provided by ICE.
IMO that is a very bad idea. The law requires noncitizens, whether they are in the country legally or otherwise, to pay taxes on their incomes. To facilitate that, the IRS provides ITINs (Individual Taxpayer Identification Numbers) in lieu of social security numbers for these folks and implicitly (probably explicitly in some cases) promised not to turn their tax information over to ICE. The idea was that it was more important to encourage tax compliance by these folks, only a few of whom would ever be deported, than to use tax data to enforce immigration laws. That would likely deter tax compliance, and government would have neither the taxes nor the data. In short, it would be self-defeating.
There are 10 to 15 million undocumented individuals in the US, many of whom work and pay taxes. In the last 20 years, the highest number of deportations was about 400,000 (during the Obama administration). If one focuses on interior removals, as opposed to border removals, who are more likely to have ITINs, the highest number is much lower (a little over 200,000 and typically well under 100,000 in most years). Let’s assume Trump is successful and doubles or triples deportations, which is probably a heroic assumption. That would mean only maybe two or three percent of the undocumented population. But when the word gets out in the community, it will send a negative message about the risks of filing and paying taxes. It seems exceedingly stupid to undercut the incentive to pay taxes by a large population, given the likely small benefit of deporting a few more taxpaying undocumented immigrants.
I could see doing it, if ICE provides documentation that the individual was convicted of a crime or similar. But then they probably don’t need their addresses. People who have taken the step of getting ITINs are likely law abiding (at least tax compliant). Why target them?
Footnotes
See this NYTimes article for a comic collection of metaphors to describe this gimmick. ↩︎
Counter example is how quickly people figured out how to rip off the pandemic tax credit programs. ↩︎
Nothing in economics is simple. That’s a mistake too many people make in applying simplistic econ 101 rules of thumb to policy problems and programs. Real human behavior is much more complex than the assumptions and must be tested empirically. Despite that caveat, it is hard to believe that multitrillion increases in federal borrowing can be accomplished without raising interest rates. Of course, if foreign investors are willing to keep pouring capital into the US, it might be avoidable. But Trump seems determined to alienate foreign investors in various ways – trade policy, erratic fiscal policy, etc. Higher tariffs, if they are successful in reducing trade deficits as Trump contends they will, as a matter of simple accounting will reduce investment/capital flows into the US. Those capital flows are an indirect and inevitable result of the higher trade deficit and they help hold down US interest rates. ↩︎
For those of us concerned about the federal debt, recent news has been consistently bad. Optimistic signs are sparse.
Status Quo: Bleak
Debt relative to GDP. The usual way to measure the level of debt is as a percentage of GDP. i.e., relative to the economy’s output. In 2020, it reached an all-time high; it’s a little lower now, about what it was at the end of WWII. This is gross or total debt (including that held in federal trust funds, like the social security trust fund). Debt held by the public, per FRED, is a bit lower than WWII levels.
Implicit debt. The federal government is in the business of making promises. The old saw is that the federal government is largely an insurance company (retirement and health benefits plan might be more accurate) with an army. No competent finance professional would evaluate the fiscal health of an insurance company or pension fund by only looking at its outstanding debt and annual PL, ignoring its legal obligations to pay future claims. The same should be true in evaluating the fiscal health of the federal government.
Put another way, federal policy promises to pay Social Security and Medicare benefits. These commitments cannot realistically be changed quickly as a political and equitable matter. That’s why Trump has pledged not to cut them; it’s politically unpopular. These commitments are implicit debt and need to be considered in evaluating the economic burdens of the debt. The folks who created and maintain the Penn Wharton Budget Model estimated these broader measures of debt and they don’t look good. Complete Measures of U.S. National Debt (1/25/2025). Considering the need to fund Social Security and Medicare benefits at current levels increases the explicit debt (i.e., outstanding treasury securities) by 35%. That reflects the demographic reality of an increasingly aging and dependent population; the relative burden of paying those benefits will increase. Estimating other commitments – VA benefits, military and civil service pensions, etc. which are not included in those estimates – would likely further increase implicit debt.
Cost of paying the debt. A better budget measure of the debt’s economic effects is how much it costs the government to pay the interest. How much does the debt crowd out other spending – public or private? During a low-interest environment (e.g., last decade with interest rates at or below inflation), that cost is manageable. When interest rates rise, as they have recently, the economic burden of debt becomes more significant.
I’ve made this point before, citing CFRB, by pointing out how interest outlays have surpassed spending on the military and Medicaid. This graph compares interest outlays to GDP illustrates just how far this has gone, per FRED through 2023:
The all-time high was reached in 1990. 2023 was close. It would be worse if a lot of the outstanding long-term T-bonds had not been issued during the extremely low-interest rate environment in the aftermath of the Great Recession. It’s only recently that Treasury has had to borrow at more typical rates. The exact opposite was true in the late 1980s, when there was an overhang of long-term debt issued during Paul Volcker’s high interest, inflation-fighting.
As a bit of international context, the US pays a higher percent of its GDP in interest than any other developed nation (see graph of OCED estimates below that I cribbed from Bruce Mehlman’s Substack), even though out debt is lower, relative to GDP, than some nations. For example, Japan has more than twice our level of debt relative to GDP but pays much less in interest because of its low interest rates.
What happens if the budget is put on autopilot (i.e., Congress simply continues existing policy)? It looks worse because we keep spending more than we take in, by a lot. CBO’s latest forecast (table on page 2) shows that interest outlays for 2024 are 3.1% of GDP, higher than shown in the FRED graph above at about the 1990 level. But CBO forecasts that they will rise to 3.9% of GDP in 2034, an all-time high. CBO’s forecast (page 61) assumes that interest rates (10-year T-notes) will drop in the next two years and be stable afterward. If they don’t, the debt burden will be even higher.
Shades of black. Those who want to go even darker can read Gene Steuerle’s post, Our Fiscal Situation Threatens Democracy, Not Just The Economy(2/25/2025), which points out that federal revenues are now less than mandatory spending (SS, Medicare, Medicaid, interest on the debt, etc.) or this Penn Wharton Budget Model estimate that the point of unsustainability is reached in 20 years under a best-case scenario (e.g., a counterfactual assumption that Trump and Congress don’t make things worse). When the debt and the cost of paying it is growing faster than the economy, you’re on an unsustainable path and that’s where we are.
That doesn’t mean things can’t be turned around; they can with the necessary political will and sustained commitment. For a less dark view, see this Brookings Report by Bill Gale and Alan Auerbach.
Bottom line. If the status quo continues, things will get worse not better. Bleak.
Prospects: Bleaker
What really matters is what Trump and Congress do. Budgets do not operate on autopilot, especially not after a national election that put one party into full control with (arguably) a mandate to make big changes.
Looking at interest outlays relative to GDP, the 1990 high water mark was quickly reversed, thanks to a combination of 1989-93 budget actions and stellar economic growth in the mid to late 1990s. If our leaders thought it was a big problem and had the necessary political will, they could put us back on a more sustainable path (deficit growing more slowly than GDP), if not to an actual balanced budget (probably not necessary). That is what Bush 41, Clinton, and their respective congresses did in 1989 through 1993, one was bipartisan (1991) and the other purely Democratic (1993).
Is there any chance of similar actions being taken now? Or are we doomed to descend to even deeper depths? Judging that requires a fraught exercise, political forecasting. Put more frankly, a fool’s errand. Since I’m a known fool, my informed guess follows. They’re not really predictions of what I think will happen. Just my assessment of two things:
A comparison of the current political and budget environment to that in 1989-93, when the federal government turned the ship of budget state away from the debt iceberg; and
The budget messages and actions coming out of DC.
Current climate unfavorable
For Congress to take meaningful actions on debt/deficit, three factors are crucial:
Recognition that it’s a serious problem
Political will to act
Favorable budget options that make fixing it politically possible
All three key factors were present in the 1889-1993 period, which is why they succeeded in closing the deficit. I was reminded of that by recently reading two books, Mike Graetz, The Power to Destroy and John Ganz, When the Clock Broke, both of which cover (among many other things) the political and budget history of the late 1980s and early 1990s. My media diet and common sense now tell me each of three factors is less favorable now than back then.
Recognition of the gravity of the problem. It’s obvious that if public officials and the public do not recognize it as a big problem, nothing will be done. Any solution will be painful – cutting spending and/or raising taxes is never pleasant or easy. The budget speak equivalent of the aphorism, “Nature abhors a vacuum” is “Human nature abhors a budget constraint.” We like free stuff, unfunded tax cuts and spending.
In 1989-1993, the gravity of the problem was widely accepted, as recounted in the second section of Graetz’s book. Examples: Reagan admitted the growing deficit was the big failure of his administration. Congress enacted the draconian Gramm-Rudman-Hollings Balanced Budget Act to fix the problem automatically if Congress didn’t. It was a core theme of the 1992 presidential election. Ross Perot made it a central theme of his third-party candidacy (remember his long TV infomercials with charts and graphs) and he got nearly 19% of the vote, more than any other third-party candidate except TR.
By contrast, nothing like that is now the case. Deficits and debt are politically passe. Both candidates in the 2024 presidential election proposed major deficit-increasing policies. Donald Trump has never, in his personal or public life, been concerned about debt. Sure, he claimed he would balance the budget with magical tariffs and by cutting waste and fraud (a fraudulent claim itself). The Republican Party long ago stopped believing the debt is a serious issue, but rather a rhetorical cudgel to bludgeon Democrats and their spending proposals with. Yes, a variety of groups and pundits express concerns, but they are regarded as scolds, and the issue has not grabbed public attention or concern – by a critical mass of the media and other elites. The current fragmented media environment, compared with the 20th century version, makes doing anything much more difficult. It’s simply harder to focus the public’s attention on anything because people get their news from so many diffuse sources. Concerns about deficits now are much more defuse and of a second or third order, insufficient to motivate painful political choices.
Political will to act. The political will to act flows from public recognition of the severity of the problem, a function of widespread concern by voters. That was present in the late 1980s and early 1990s – spurred by the markets (the bond market especially), the media, and elites. Nothing like that exists now.
Reasonable budget options. The third key factor is a budget environment that provides somewhat palatable budget options. Cutting spending and raising taxes is never easy, but there can be wide variations in the degree of difficulty of doing so. The budget balancing path in 1989-1993 was smoother and rosier than now.
Then. In 1989-1993, there was more room to make budget cuts without cutting politically sensitive entitlements. Demographics were favorable. The baby boom was entering its prime earning years, and the 1983 social security fix was bulking up the social security trust funds. The end of the Cold War allowed major cuts in defense spending. Discretionary spending and pure welfare (i.e., AFDC) were relatively larger budget categories and both were cut. Both parties were willing to raise taxes and that, along with modest cuts and economic growth, was how the budget was balanced in the late 1990s.
Now. There is much less room now to cut spending. The Ukraine War and the increased belligerence of China suggests (unlike the 1990s) we may need to increase military spending, if only to rebuild the nation’s capacity to make conventional weapons (artillery shells, e.g.) and drones (we should not be dependent on China to produce them). Demographic factors are not on our side. We have an aging and increasing dependent population as the baby boomers retire and more of them need care. Fertility rates are lower and dropping. Thanks to political considerations immigration will decline and deportations may rise. That combination makes entitlement spending grow faster and harder to cut, while reducing its revenues (e.g., social security taxes paid by undocumented immigrants who collect no benefits).
In short, the background environment for reducing the deficit and debt is not good. The political and budget reality is much more difficult than in the 1989-1993 period, the last time Congress enacted serious budget balancing legislation. A best-case scenario, unlikely as that is politically, would be to continue the status quo. More likely politically, as the next section suggests, is we pile on more debt, burrowing deeper into the hole we’re in.
Direct Messages from Politicos
Here’s where I’m on the thinnest ice – making inferences from the actions and public communications by politicians and their ilk. These messages are typically ambiguous, garbled, and too often calculated to mislead. Moreover, they typically have short shelf lives as discussions go on, positions shift, resolutions pass, and compromises are made. So, take this snapshot with a grain of salt.
In any case, the explicit messages from the critical actors – Trump, Republican congressional leaders, and Elon Musk – are uniformly bad, in my view, if your concern is the growing debt. In fact, they suggest things will get worse, not better.
Campaign positions
The Trump campaign – to the extent one relies on campaign rhetoric – suggested something on the order of $5 to $10 trillion in tax cuts not offset by spending cuts or other tax increases. The menu includes full extension of TCJA, including already expiring business tax cuts like R&D expensing and bonus depreciation, exempting tips, overtime pay, social security benefits and so on. All of this is to be offset by tariff revenues and reducing fraud and wasteful spending.
Bottom line based on campaign rhetoric: Some indeterminate, but substantial, increase in the deficit.
Congressional Budget Proposals
The 2025-26 Congress is going to deal with extending or making TCJA permanent and myriad other budget issues through reconciliation. The first step in that process is to pass a budget resolution that sets the target deficit effects by congressional committee for a ten-year period (2025-2034). The heavy lifting, actual legislation with changes in the law that effectuate the budget, will follow later.
The Senate so far is on a two-bill track, the first of which is a slimmed down bill to deal with the border and military spending (NY Times story) for the first ten-year period. (Each congress can pass two reconciliation bills.) So, we don’t know what they will do about the bigger issues, like tax cuts. We do know what the chair of the Senate Finance Committee thinks and it will definitely grow the deficit by ignoring the $4+ trillion cost of making TCJA permanent as part of the baseline budget. According to quotes in Politico, the senate is now willing to switch to the one-bill track.
The House is on a one bill track and has passed its budget resolution. It didn’t look likely to pass until Trump intervened and convinced just enough no votes to convert to yes. NY Times; Politico. It calls for large, deficit-increasing tax cuts (i.e., extending TCJA etc.), along with big budget cuts. Republicans generally succeed at enacting unfunded tax cuts (e.g., Reagan, GWB twice, and Trump 1). What’s different about this cut is that it is also funded by at least $1.7 trillion in spending cuts. That they have never done, and I remain skeptical that they can actually do so. Of course, that may mean they simply skip meaningful spending and either reduce the size of the tax cut or increase the deficit. Stay tuned.
The text of the resolution is available, here, Penn Wharton Budget Model’s analysis, here, and a Tax Foundation summary, here. The resolution would increase the deficit by $2.8 trillion over ten years. The really bad news (assuming this is the final plan) is that $1.7 trillion dollars of spending cuts are used not to reduce the deficit, but to reduce the amount of deficit-increasing tax cuts.
The table below is my simplified summary of the resolution. Positive numbers are billions of dollars of increases in federal deficit spending over the 10-year period. The amounts are by committee (the resolution directs congressional committees to take budget actions, such as cutting or increasing spending or taxes). I combined committees with smaller amounts. The Ag cuts will likely come largely from SNAP (formerly food stamps) and Energy and Commerce cuts from Medicaid, I’d think.
The unallocated cuts number reflects a provision that will increase or decrease the size of the tax cut, if the spending cuts reported by the committees with directions under the resolution to cut spending do not equal $2 trillion. (The sum of the cuts specified by committee is $1,502 billion. So, there are orphan cuts of $498 billion.) If the cuts are more than $2 trillion, the tax cut increases by the overage. If the cuts are less, the tax cuts decrease by the shortfall. So, that means that the deficit reduction factor is baked in and it’s only the size of the tax cut (not the deficit effects) that is at issue.
I guess that’s intended to incent the spending committees to cut more, allowing Way & Means to cut more taxes, potentially including Trump’s ideas to exempt tips, overtime pay, social security benefits, etc. It also confirms the obvious regarding the GOP’s priorities: tax cuts are more important than deficit reduction. The adjustment factor uses all spending cuts over the $2 trillion marker to fund tax cuts with zilch for deficit reduction.
Bottom line: based on congressional actions so far, we’ll see a big increase in the deficit because of congressional action, likely at least $2.8 trillion. The Senate will probably push up the House amount, based on this Politico story:
Immediately after the House approved its plan Tuesday, [Senate Majority Leader] Thune called for any Republican tax bill to include a permanent extension of the 2017 Tax Cuts and Jobs Act. That was an implicit criticism of the House budget blueprint, which allows for $4.5 trillion in net tax cuts — which tax writers in both chambers say won’t be enough to allow for TCJA permanency along with Trump’s other tax priorities.
“I know my Senate colleagues are committed to, as is the president, permanence in the tax situation. And we don’t have yet in the House bill so we’re going to work together in a cooperative way,” said Sen. John Barrasso (R-Wyo.), the No. 2 Senate Republican.
Trump’s efforts and success at getting reluctant House members to vote yes on the budget resolution suggest that he will be more engaged this term than last. Bad sign. There is no precedent for a Republican Congress making material budget cuts to finance tax cuts. So, I make no predictions in that regard. A $2.8 trillion increase in the deficit is a best-case scenario and I’d take the over on that.
DOGE to the rescue?
Meanwhile and notwithstanding Congress’s constitutional power of the purse, the Department of Government Efficiency (DOGE) is carrying out extensive executive actions with budget implications. The best way to characterize these actions are intentional chaos – terminating numerous federal employees some for pretextual reasons (e.g., nearly all probationary employees for poor performance but not based on assessing that performance), pausing spending, axing programs, etc. – much of which is of borderline legality or outright illegality. That’s consistent with Silicon Valley’s business MO – Move Fast and Break Things – and a general willingness to not worry a lot about legality (especially Musk and bright line SEC requirements per Matt Levine).
It’s hard to make sense out of chaos (the fog of war and all that), but a few things seem clear:
DOGE is proving a determined executive can unilaterally cut spending, notwithstanding the constitution vesting the appropriation power in Congress. Yes, court actions will reverse some of the cuts, but some will be upheld, others won’t be challenged, and some cannot be practically reversed. Only one thing is certain: it will be a boon for lawyers who represent employees in federal employment matters.
There will be material reductions in outlays, even if DOGE’s claims of savings must be discounted (Politico, NBC, NYTimes).
Since most entitlement spending is off-limits, other than mistaken or fraudulent payments, real progress to pay for tax cuts or reduce the deficit is unlikely. They’re even talking about giving back some of the savings as Doge dividend checks, demonstrating a lack of fiscal seriousness.
Adverse effects on revenue collection may exceed spending reductions.
Revenue effects may swamp spending cuts. On the lateral point, DOGE’s administrative actions are hurting IRS’s ability to collect revenues.
Some unknown number of IRS probationary employees have been laid off (6,700 per NYTimes story, 6,000 per WSJ, 3,500 per Tax Notes). Most of these employees (more than 5,000 according to the Times story) were working in enforcement and compliance. These newer employees were likely hired under the IRA’s increases in funding, including many attempting to improve the Service’s IT resources. Newer employees are likely less productive as they move up the learning curve, but in the long run this must undercut compliance, collections, and enforcement.
An executive order, which applies to IRS, mandates that for each four federal employees who quit or retire, only one may be replaced. If that sticks, it will further hobble the Service.
While laying off employees, they’re distracting the IRS from its core mission of administering the tax system and collecting revenues by seeking to use its employees to enforce immigration law and combating fraud in unrelated government programs. Some of the latter may make sense, but it needs to be debated by Congress and funded.
If the goal is to balance the budget, IRS cuts are short-sighted to put it charitably. To illustrate the idiocy of what they’re doing consider these quotes from the Times article:
The Commerce secretary, Howard Lutnick, said on Fox News on Wednesday that Mr. Trump wants to replace the I.R.S. with an “External Revenue Service” that would be funded by tariff revenue.
“His goal is to abolish the Internal Revenue Service and let all the outsiders pay,” Mr. Lutnick said.
…
“I live in D.C.,” Mr. [Kevin] Hassett [Director of Trump’s National Economic Council] said. “Nobody’s going into the buildings, people aren’t commuting because people aren’t doing their jobs.”
“We’re fixing that and the I.R.S. is a small part of that picture.”
It’s like DOGE dispatched people to save a sinking ship that is taking on water. Some of them start bailing, while others go below and throw stuff overboard to reduce the ship’s weight. The guys below unbolt and throw overboard the bilge pumps. The net result is the ship sinks faster.
That very well may be what they’re doing by laying off IRS employees. Dumb. Of course, it is what Trump and many Republican congressional candidates said they would do during the campaign. So, I can’t say I’m surprised.
Here’s how seven former IRS commissioners (appointed by Reagan, Bush1, Clinton, Bush2, Obama, and Trump), put it in a NY Times op-ed:
Every year, the government receives much less in taxes than it is owed. Closing that gap, which stands at roughly $700 billion annually, would almost certainly require maintaining the I.R.S.’s collection capacity. Depleting it is tantamount to a chief executive saying something like: “We sold a lot of goods and services this year, but let’s limit our ability to collect what we’re owed.”
Perhaps only the company’s competitors would approve of such an approach. Yet here we are. Aggressive cuts to our nation’s accounts receivable function will reduce the amount of tax revenue coming in, which will in turn increase our nation’s deficit and add to our $36 trillion in debt.
Bottom line: I expect DOGE to create more chaos and little real deficit reduction. DOGE actions might make the deficit worse.
Ray of Light
It’s important to keep this all in perspective, of course. Unlike some other stuff going on in Washington (Ukraine, cutting USAID funding of food and medical aid, etc.), this is not an immediate and existential crisis. It’s more like a chronic disease with unknown but adverse effect off in the long run. It’s like the hypertensive going off his meds and diet. It won’t result in immediate death and there likely will be time to fix it. But the degree of difficulty in doing so will increase as the public increasingly assumes it’s not a real problem. We keep engraining the public’s expectation that they can buy government services at a substantial discount.
SALT Effects
All of this is bad news for state budgets, including Minnesota’s. The IRS cuts will undermine the state’s ability to collect corporate franchise and individual income taxes, especially over the long run – both because of the DOGE layoffs and the almost certain unwinding of the IRA increased funding by Congress. This will not create an immediate crisis but will gradually erode the tax base by enabling more noncompliance.
If enacted, the Medicaid cuts implicit in the House budget resolution likely would put immense pressure on the state budget. To realize such large savings (almost $900 billion over 10 years), more responsibility for paying benefits almost inevitably will be shifted to states. That’s easier than cutting benefits – it’s now the states’ responsibility, we’re giving them flexibility to be more efficient, etc. A Republican congress is sure to do that in ways that disadvantage blue states more than red states. There are myriad ways to skew the effects to blue states with clever formula writing, time limit phase-ins (partially protecting red states that opted into ACA later), etc.
Prime candidates for large cuts include reducing the ACA’s 90% reimbursement rate back to the otherwise applicable rate (NY Times story) and/or reducing the regular rate below 50% for states with higher incomes (like CA, NY, MN, and other mainly blue states). This KFF report details the state-by-state effects of the first option. It would save $626 billion nationally over ten years (NYT story says $550 billion). Minnesota’s share of that is $1.4 billion. Nothing that dramatic is likely to be enacted but Medicaid cuts in the form of lower state payments almost surely are coming.
Republican legislators understand how vulnerable Minnesota is to Medicaid cuts, which is why some of them warned their colleagues in Congress about it. Many of their voters are enrolled in MA, Minnesota’s Medicaid program. And the rural districts, nearly all of which are heavily Republican, are especially dependent on MA reimbursements for the financial health of their hospitals, nursing homes, and health care providers.
I’m sure that Republican members of Congress fully appreciate this (w/ or w/o letters), as evidenced by this Politico story on the politics of Medicaid cuts. That will make it exceedingly difficult to pass the cuts contemplated in the House budget resolution.
As an aside, the House budget resolution also has a half trillion in unallocated budget cuts – i.e., cuts they were unwilling or unable to specifically identify the general category in which they would be made. Where are they going to find the additional half trillion in unallocated cuts is unclear, if Medicare, Social Security, and the military are
off limits? Medicaid already comprises two-thirds of the allocated cuts, but it’s the only big budget category on the table, it seems to me. All that suggests more of the tax cuts, including increases demanded by Senate, will likely be financed by debt.
Disclosure: I subscribe to CFRB’s emails, which I typically scan and sometimes read. Last week, they emailed a link to a WaPO op-ed by Mitch Daniels, GWB’s OMB director and fiscal conservative type (supposedly). The ugly combination of Chicken Little rhetoric and declining to own up to his and his party’s ongoing role in the crisis in the piece triggered me. I usually take a breath and move on or type a few paragraphs and delete them the next day after recognizing that political commentary is not my comparative advantage. In this case, I decided to post it. Caveat emptor.
It’s become increasingly clear with the return of real interest costs for federal borrowing (i.e., Treasury no longer is paying interest at or below the inflation rate), that the country is on an unsustainable deficit and debt path. The federal government now spends more paying interest than for the military budget, for Medicare or for Medicaid. The power of compound interest and all that. Projections show the debt growing faster than the economy.
I think this is mainly a tax problem, fueled by the acute tax aversion that has infected one of our two major parties. The one domestic policy Republicans agree on is opposition to any tax increase and support for deficit financed tax cuts in good times (e.g., 2001 and 2017) and bad (e.g., 2003). Their spending increases of various flavors (e.g., Iraq War and Medicare Part D) did not help matters, as did insisting on cutting tax increases that paid for Democratic spending (e.g., goading the Dems into supporting repeal of the medical device and Cadillac insurance taxes that were to help to fund the ACA). The Trump campaign is a case of this on steroids (see below).
The debt situation has led to handwringing by normie Republicans who claim to be fiscal conservatives, like Mitch Daniels. In his op-ed, Daniels hypothesizes the nation is on the verge of a fiscal disaster. A situation sufficiently dire, in his mind, to justify characterizations like (as fodder for an Aspen Ideas or similar confab):
“Preparing for Armageddon”; “Climbing Out of the Ashes”; “The Day the Dollar Died.”
Never once does Daniels admit to his or his party’s complicity in creating this crisis. He was George W. Bush’s director of OMB during the formulation of the 2001 and 2003 tax cuts. Moreover, his op-ed only once mentions, in passing, the possibility of increasing taxes. Assets sales, renegotiating debt obligations (translation: partial default), invoking the Insurrection Act to quell a rebellion (presumably from cutting social welfare benefits resulting from depleted trust funds) get more ink, in addition to partisan shots. Really w/o even discussing reversing some of the tax cuts? Tax collections are now between 3 and 4 percentage points of GDP lower than when GWB (and Daniels as OMB director) took office.
I get that this is just rhetorical attention grabbing, and I would shrug it off it were coming from Ted Cruz, Rand Paul, or similar unserious folks. It’s hard to take from Mitch Daniels, who isn’t going to be running for anything and has to know better.
Back to 1997?
I think that Daniels is likely right that we do have an impending national debt crisis. But it’s a crisis of (a lack of) political will, radical tax aversion, polarization, and abandonment of real fiscal conservatism by the likes of Daniels. Fidelity to your party and its implacable opposition to tax increases and support for tax cuts is more important than recognizing reality.
Over the last quarter century, the country (Republicans really) ran a bold economic and political experiment. That is, they tested whether dramatically cutting income, corporate, and estate taxes would, in some combination: (1) induce growth that would offset the cuts (the economic experiment) or (2) lead to restraining or cutting spending, as the lesser evil of rescinding the tax cuts (the political experiment). Daniels’ op-ed reveals that experiment was an abject failure on both counts. If growth was stimulated, it was modest at best (estimates show it was less than the tax cuts). Spending was not restrained. Instead, we have a debt crisis.
So, where does that leave us? Selling federal assets, giving bondholders a haircut, cutting social safety net programs, etc. per Daniels? As an alternative frame of reference, two academic economists suggest rolling back the federal tax system to 1997. Recall the economy was booming in the late 1990s, so the tax system was not stifling growth. Things were pretty good.
Doing so would not eliminate the federal deficit. But the supposed crisis would largely evaporate with more manageable deficits. You can read the full article here: Owen Zidar and Eric Zwick, A modest tax reform proposal to roll back federal tax policy to 1997 or a short summary by Noah Smith, an economist blogger who I often read, here (the second of his five interesting things) or Neil Weinberg, The Case for a Retro Tax Code (Chicago Booth Review).
Zidar and Zwick claim that their proposal would increase progressivity and raise revenues by $5 trillion over the 10-year budget window, based on analysis done using the Penn Wharton Budget Model. Their proposal deviates from a mechanical return to 1997 law and the revenues they claim are misleadingly high as I briefly explain below. My intuition is that an actual return to 1997 law would raise more revenue.
Bottom line
In my opinion, a true fiscal conservative would not be raising the prospects of a federal fire sale of assets, haircutting bondholders, reducing social security or Medicare that modest income seniors are counting when returning taxes to ordinary levels would mostly fix the problem. The Daniels op-ed reveals just how radical (not conservative) Republican orthodoxy has become, the antithesis of actual prudential and cautious conservatism. In my view, a democracy depends upon its conservative party to play that role, to be the voice of reason and fiscal probity. We don’t have it now.
Until normie Republicans like Daniels, Rob Portman, Paul Ryan, and others of similar ilk can forthrightly say (what I’m sure they know) that major tax increases are necessary and enacting them is not a big deal economically, we have a crisis of political leadership. If that means advocating for a national consumption tax to replace two decades of income tax cuts, fine. (See this NYT article implying that is where Trump’s tax proposals may be leading. I’m not buying it. He’s selling pure populist snake oil.) But let’s be forthright about the ineffectiveness of the “Starve the Beast” strategy of limiting government. The size of government stayed the same or grew modestly, funded by debt.
Would it actually make a difference if the likes of Daniels, Ryan, and Portman now leveled with the public about the need for major tax increases (well, rollbacks of tax cuts)? Of course not. Decades of rhetoric and mainstream media coverage have lulled the public into assuming the current imbalance between taxes and spending is normal and fine. Reversing it will take at least a generation or a cataclysm. But speaking actual truth (as opposed to Chicken Little columns like Daniels’) would at least be a start. (What’s perplexing to me is he is well beyond his political sell buy date. And guys like him have no future in a Trump GOP. So, his temerity cannot be rationalized by preservation of his political career. It must be reflexive partisanship triumphing over conservative principles and/or concern for the fiscal health of the Republic. Same for Portman and Ryan. Very disheartening.)
The political problem is likely getting worse. If the last 25 years have inured the populace to government benefits funded by debt, the two presidential campaigns, but especially Trump’s, is willfully leading them to think their taxes can be cut even more without affecting the government they’re accustomed to receiving.
To list Trump’s tax proposals reveals the fiscal incongruity and tax policy idiocy (numbers from either CFRB or Tax Foundation):
Extending TCJA – about $4.6 T
Restoring the SALT deduction (a major TCJA “payfor”) – $1.2 T
Exempting social security benefits – $1.6 T
Exempting tips – $250 B
Exempting overtime pay – $1.4 T
Paying for it all with tariffs and disallowing parts of the IRA – economic ill effects will exceed the revenue
He’s like a car salesman who’s trying to close a sale: “Okay, in addition to undercoating, floormats, and fuzzy dice, I’ll throw in a set of snow tires and a 100,000-mile warranty.” Sheesh.
This Brookings paper by UC Berkley economists, Alan J. Auerbach and Danny Yagan, Robust Fiscal Stabilization (9/25/2024), provides a long and nerdy and neutral description (not pointing the finger, as I do, at tax aversion) of how we got here and the economic risks, complete with all the usual equations. My take is that it requires a bipartisan commitment and willingness to compromise (including on taxes) that has departed. Let’s hope not permanently.
Quibbles
I found the Zidar and Zwick proposal did not meet its billing in two respects.
Projected revenues
Their claimed revenues of $5 trillion are misleadingly high because of the 10-year budget window they picked, 2021-30. Obviously, we’re now at the end of 2024 (9/30 is federal year-end), so four of those years are already history. That is misleading because a large portion of their claimed revenues come from repealing features of TCJA that expire, i.e., QBI and its individual rate cuts. Those revenues comprise $1.6 trillion of the $5 trillion total and are in the CBO budget baseline going forward. Thus, most of that money is out the door and the rest is one-time. Using their projected 2030 revenue increase as a benchmark, the 10-year total increase is about $2.7 trillion or half what they claim.
To put the best construction on this, I assume their benchmark is a full TCJA extension. But that makes the deficit bogey higher than the official CBO baseline.
New tax provisions
Their claim that this is really just rolling the tax code back to 1997 is a canard, because they add major new features. These are all progressivity enhancing and are mainly good changes, but they were not in effect in 1997 (or ever in most cases):
Eliminating stepped-up basis – not only would gains on death of the owner be taxed, but gifts of appreciated property would trigger taxation of gains, and charitable contributions of untaxed appreciation would be disallowed (all good policy but not in effect in 1997)
The ability of S corporation owners to avoid FICA (mainly the uncapped Medicare tax) would be eliminated, treating them like partnerships (They refer to this as the Gingrich-Edwards loophole based on two of the more high-profile politicians that used it. Again, a good policy change, but not something in effect in 1997.)
Large PTEs would be taxed as C corporations
On the other hand (and contrary to Noah Smith’s summary), they do not rollback TCJA’s corporate rate cut, a permanent TCJA feature. Doing that, even partially, could raise substantial revenues and is more politically palatable than their proposal to roll the estate tax rates and exemption back to 55% and $1 million.
Another big revenue loser that no one talks about are the myriad of expansions in the retirement rules since 1997. Those were enacted in bits and pieces, parts of both big tax cuts and bipartisan stand-alone bills with no-cost funny accounting. In combination the massive increases in the amounts that can be put into retirement accounts result in a lot of lost revenue and shift the income tax to something closer to a hybrid income-consumption tax. The current tax expenditure estimates (2027) are $660 billion up from $84 billion in 1997. That is about a 7X increase. Inflation between 1997 and 2024 was about 2X. This reflects the story told by Professor Doran in The Great American Retirement Fraud. That horse is out of the barn, but cutting back contributions to the 1997 levels (indexed for inflation obviously) and capping the maximum amount that can be held in accounts at a reasonable amount (say $5 million) would raise billions in revenue without hurting anyone’s retirement security.
In short, there are reasonable ways to get Zidar and Zwick’s permanent revenues back up to $5 trillion and some of them (i.e., corporate rate increases) are politically feasible. But without major bipartisan buy-in, it will be impossible and if the likes of Mitch Daniels can’t forthrightly advocate for it (in exchange for spending growth slowdown), we’re toast. Support for major tax increases from normie Republican fiscal conservatives is just a first necessary baby step. I guess it’s too much to expect or hope for.
SALT Speak - Joel Michael's Blog 