The $4.2 Trillion Drop in Revenue Projections

As we explained last week, health care spending is growing more slowly, which is great news for the federal budget. Spending has been revised downward by $900 billion through 2021 since CBO's March 2011 budget outlook. Unfortunately, not all parts of the budget tell as positive a story. Revenue projections have tumbled, falling $4.2 trillion through 2021 since March 2011. And while most of this drop is due to the passage of tax cut legislation, even economic and technical revisions have lost enough revenue to cancel out the savings from the health care revisions.

The graph below shows that projected revenue has fallen significantly as a share of GDP since March of 2011. Back then, revenue was projected to exceed 20 percent of GDP by 2021, compared to 18 percent under current projections. The gap is even larger (almost 3 points) if the 2011 numbers are adjusted for the fact that GDP is now measured in a different way. The bulk of the difference is due to the fact Congress has extended most of the 2001/2003/2010 tax cuts. But interestingly, today's revenue projections are lower (in most years) than the March 2011 projections assuming the extension of all of the tax cuts.

Of the $4.2 trillion reduction in revenue, nearly $3.3 trillion – or almost 80 percent – come from legislative changes. Almost all of those legislative changes come from American Taxpayer Relief Act (ATRA), which extended most of the 2001/2003 tax cuts and reduced revenue by $3.1 trillion through 2021. In addition, the two payroll tax cut extensions for 2012 and minor revenue changes such as the increase in federal employee retirement contributions in the Bipartisan Budget Act are involved in the total.

The remaining one-fifth, or $950 billion, comes from economic revisions to GDP, employment, and inflation – and consequently salaries, wages, and profits. Technical changes – such as the incorporation of data like actual tax collections and new methodologies – basically net to zero, although individual years sometimes have sizeable changes (particularly in the short term). Thus, even excluding the legislative changes which were largely expected to occur at the time, the downward revision of revenue is slightly larger than the downward revision of health care spending over the same period; and about $250 billion larger than the economic and technical (as opposed to the legislative and judicial) changes to health spending.

Overall, the individual income tax accounts for the bulk of the downward revenue revision at $3 trillion, or nearly three-quarters of the total changes. Payroll taxes were revised down by nearly $900 billion, or about one-fifth of the change. "Other" revenue – including excise taxes, fees, and fines – was revised down by $350 billion, or just under 10 percent of the change. Finally, corporate income tax revenue went up slightly by $50 billion.

It is not surprising that individual income taxes played the largest role, given that most of the 2001/2003 tax cuts ($2.8 out of $3.3 trillion) were from that source. Downward revisions from economic changes, meanwhile, came both from the individual income tax and from payroll taxes. Those two combined for a $1.25 trillion drop, with much of that coming from CBO's revisions in February to economic growth and the labor market. Corporate income taxes actually were revised upward by $370 billion as actual profits and, consequently, profit projections have exceeded CBO's original expectations. Technical revisions, meanwhile, worked in opposite directions – increasing individual income taxes by $565 billion, reducing corporate income taxes by $250 billion, and reducing payroll taxes by about $310 billion.

Relative to the size of their projected revenue, individual income taxes experienced the largest change with a 15 percent drop. Both other revenue and payroll taxes saw substantial drops as well, while corporate revenue got a small increase. Importantly, most of the 15 percent drop in individual income tax revenue can be explained by legislative changes. The largest technical and economic downward revisions were centered in the payroll tax.

In short, while reduced health care spending may be the prime triumph of the budget in the past few years, there is no reason to celebrate. The federal government has lost more revenue than it saved via the health care slowdown. And partially as a result, our debt problems are still far from solved.