Extending JGTRRA and EGTRRA under the CBO’s March 2008 Baseline

There are many moving parts to McCain’s budget policy (see McCain site on the economy, [0]), so I can only undertake a partial analysis. That being said, extension of JGTRRA and EGTRRA is the most concrete, and easy to score, component, exactly because the CBO has already done it.

Figure 1 depicts the impact of making permanent the Bush tax cuts of 2001 and 2003, relative to the March 2008 CBO baseline.

consequences1.gifFigure 1: Unified budget balance to GDP ratio (blue), baseline (teal), and counterfactual under extension of JGTRRA and EGTRRA (red), by fiscal years. Incremental debt service approximated by prorating the total increments listed in Table 1.3. Balance to GDP ratio incorporating extension of JGTRRA/EGTRRA and growth of discretionary spending with nominal income (green box). Ten-year-out impact ($280 billion) of growth of discretionary spending with nominal income rate from August 2006 Outlook. Source: CBO, CBO’s Estimates of the President’s Budget for Fiscal Year 2009 (March 2008) Table 1.3, and CBO historical data, and author’s calculations.The most important aspect of this graph is the shift in the budget position relative to the baseline (which incorporates the expiration of the 2001 and 2003 tax cut provisions). That’s because the 2008 baseline is probably already a bit optimistic regarding the budget deficit. Since March, most observers have extended the period of anticipated slow growth, and hence resulting depressed revenues. In addition, while the CBO baseline incorporates adjustment of discretionary spending with the CPI, growth with nominal income is more the rule. While CBO did not report the alternative path when discretionary spending grows with nominal income, I can use the August 2006 10 year end-point impact to gain a (lower bound) estimate on the impact on the budget balance to GDP ratio (the green box). What this suggests to me is this part of the McCain plan would push the deficit to at least 2 ppts of GDP. Of course, these are not the only tax cuts in the plan.

What are the implications for Federal debt held by the public, expressed as a ratio to GDP? Figure 2 depicts the March 2008 baseline (teal), with discretionary spending increasing with the CPI, and GDP growing as in the baseline.

consequences2.gifFigure 2: Debt (held by public) to GDP ratio (blue), baseline (teal), and counterfactual under extension of JGTRRA and EGTRRA (red), by fiscal years. Incremental debt service approximated by prorating the total increments listed in Table 1.3. Ten-year-out impact ($280 billion) of growth of discretionary spending with nominal income rate from August 2006 Outlook. Source: CBO, CBO’s Estimates of the President’s Budget for Fiscal Year 2009 (March 2008) Table 1.3, and CBO historical data, and author’s calculations.Once again, what is most relevant is not the actual paths, but the gap between the baseline and the counterfactual. By FY2018, the debt/GDP ratio is a full 10 ppts higher as a consequence of extending the tax cuts. (By the way, I haven’t shown the impact of higher discretionary spending growth, in line with nominal income, but you can get an idea of how that looks in this post).

Now, it is true that I’ve only examined revenue side implications for one component of the McCain plan, although this is sometimes considered the centerpiece (spending cuts that McCain has referred to are not specified, so seem akin to the old “magic asterisk” of days gone by). One can see a more comprehensive examination based upon what the staffs or speeches indicate in a Tax Policy Center analysis (the Tax Policy Center is a joint Urban Institute-Brookings Institution center). That analysis highlights the difficulty of doing an independent scoring of the many other provisions both McCain and Obama have forwarded.

Both the Obama and McCain campaigns have proposed tax cuts relative to current law; according to the Tax Policy Center; the Obama tax cuts amount $2.9 trillion over the FY2009-2018 period (approximately equal to the amount associated with extending the JGTRRA and EGTRRA). Hence, in purely budget revenue terms, the Obama plan has similar implications as extending the JGTRRA/EGTRRA provisions (although clearly the distributional implications are much different, as illustrated by Figure 2 in the Tax Policy Center report, shown at the end of this post).

Interestingly, using the McCain campaign’s own numbers, the McCain plan implies a $4.2 trillion reduction in tax revenues. In other words, both tax plans imply a deterioration of the debt/GDP ratio relative to baseline, but the McCain plan implies a substantially larger deterioration [i.e., $1.3 trillion (45%) bigger]. For those who view the budget deficit as a short and long term challenge, this is an important factor.

Do deficits matter? Should we care? Here are my takes on those questions: [1], [2], [3], [4], and [5].

The CBO’s Budget and Economic Outlook will be released September 9th.

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Originally published at Econbrowser and reproduced here with the author’s permission.