The importance of revenue revisited: Minimizing the drag of austerity

Via Ezra Klein comes a must-read leaked memo from Senate Budget Committee Chairwoman Patty Murray (D-Wash.) to Senate Democrats ahead of fashioning a Senate Budget Resolution. It’s an excellent chronology of the deficit reduction enacted in the 112th Congress—a hefty $2.4 trillion expected to take effect and $3.6 trillion if sequestration goes into effect—and the looming phases of the Beltway budget fights following the American Taxpayer Relief Act (i.e., the lame-duck budget fight, or ATRA for short).1

Klein hones in on tables depicting the fundamentally unbalanced nature of deficit reduction in the 112th Congress: Ignoring sequestration, 70 percent of policy deficit reduction measures (i.e., excluding additional debt service savings) enacted came from spending cuts as opposed to revenue, and if sequestration takes effect as scheduled, the share of spending cuts ratchets up to 80 percent. Murray’s memo contrasts these ratios with a 51 percent revenue share proposed by the Simpson-Bowles Co-Chairs’ report and 52 percent in the Senate’s bipartisan “Gang of Six” proposal. Hence Murray’s conclusion:

Revenue Must be Included in Any Deal. Tackling our budget challenges requires both responsible spending cuts and additional revenue from those who can afford it most.”

She’s absolutely right, but the memo hits only on the budgetary half of why compositional balance is important. Accepting on face value that the 113th Congress will pursue more deficit reduction measures (more forthcoming from us on this premise)—at the very least replacing sequestration in chunks or entirety—including progressive revenue is critical for minimizing the economic drag of austerity. As we’ve explained before, revenue increases on upper-income households and corporations are, per dollar, the least economically damaging policy option for deficit reduction—see the table below. (Again, why policymakers are abandoning what works and fixating on damaging an economy already depressed nearly $1 trillion—or 5.6 percent below potential output—with bleak prospects for emerging from depression, is a question for another post.) Some simple math helps underscore the benefit of increasing the revenue share in hitting a fixed deficit reduction target.

Replacing the blunt, intentionally unpalatable sequester, which would require annual cuts of $109 billion totaling $984 billion over nine years, will be the next budget fight, so offsetting this austerity is an illuminating framework. The government spending multiplier—meaning the economic impact of a dollar of government spending—is estimated at 1.4, so $109 billion in spending cuts would knock $153 billion off gross domestic product (GDP).2 For a $15.9 trillion U.S. economy (Congressional Budget Office’s latest projection for 2013), that would amount to a hit of just less than 1.0 percent of GDP. But the fiscal multiplier for a permanent increase in the corporate income tax rate is just 0.32, and we impute an even lower multiplier of 0.25 for tax increases on upper-income households. (Murray’s letter emphasizes curbing tax expenditures for upper-income households and corporations, which if anything would have slightly lesser impacts on demand per dollar.)

So if this sequester cut were to be contemporaneously replaced with revenue from corporations or upper-income households, the economic drag would fall to $35 billion or $27 billion, respectively—just 23 percent or 18 percent, respectively, of the drag imposed by an equivalent dollar amount of spending cuts. The more you shift the composition of any sequester offset toward progressive revenue, the less austerity will retard growth in 2013 and beyond. At a 1:1 ratio of spending cuts to revenue from upper-income households, the damage from $109 billion in policy savings falls to $90 billion (0.6 percent of GDP), or just 59 percent of the drag from an equivalent dollar amount of spending cuts. This result holds especially valid while the economy remains depressed—the next four years as currently projected by CBO, though likely longer if fiscal policy remains deeply contractionary. (Relatedly, maximally delaying offsets or inevitable deficit reduction until the economy is back to full health would also be highly advisable.)

In other words, balanced deficit reduction is critical not just for protecting the basic functioning of government, social insurance (Medicare, Medicaid, and Social Security), public investment, and more broadly the progressivity of the tax and transfer system—it’s critical for minimizing the economic damage of the premature austerity that Congress misguidedly remains hell-bent on enacting.

In a sane world, the sequester would simply be repealed without offsets—which would still leave real GDP growth in the ballpark of an anemic, inadequate 1.6 percent for 2013—and deficit-financed spending would be used to boost demand and ensure a return to full employment. We previously estimated that $700 billion of deficit-financed spending would be needed in 2013 and sustained for several years to return full employment—the equivalent of roughly three more Recovery Acts. But given the misguided obsession with austerity at hand, maximizing the share of progressive revenue in expected subsequent deficit reduction measures is a decent second-best option. To that extent, Murray’s emphasis on balance and progressive revenue is encouraging, albeit from a very low bar in economic policy management.


1. As a side note, it’s important to remember that the Affordable Care Act enacted in the 111th Congress was perhaps the most substantial piece of deficit reduction in decades, lowering the projected deficit in the decade following conventional 10-year budget windows by more than $1 trillion and prompting massive downward revisions to long-run projections of public debt.

2. Sequentially for this paragraph:

($109) x (1.4) = $153

($153) / ($15,899) = 1.0%

($109) x (0.32) = $35

($109) x (0.25) = $27

($35) / ($153) = 22.9%

($27) / ($153) = 17.6%

(($109/2) x (1.4) + ($109/2) x (0.25)) = $90

($90) / ($153) = 58.9%

Note that we use Moody’s Analytics Chief Economist Mark Zandi’s fiscal multipliers, which have the advantage of being policy specific, but are robust to estimates by CBO, the Council of Economic Advisers, and the International Monetary Fund, among others (see my colleague Josh Bivens’ blog post for more on robustness of multipliers).

Appendix Table A2

Fiscal multipliers of various spending and tax provisions

Spending increases
Temporary increase in food stamps 1.70
Temporary financing of work-share programs 1.64
Emergency unemployment insurance benefits 1.52
Increased infrastructure spending 1.44
General government spending 1.40
General aid to state governments 1.31
Low-income home energy assistance 1.13
Refundable tax credits (mix of spending and tax cuts)
Child Tax Credit, Recovery Act expansion 1.38
Earned Income Tax Credit, Recovery Act expansion 1.23
Refundable lump-sum tax rebates 1.22
Making Work Pay tax credit 1.19
American Opportunity Tax Credit, Recovery Act expansion* 1.09
Temporary tax cuts
Payroll tax cut for employees 1.25
Hiring tax credit 1.20
Payroll tax cut for employers 1.04
Nonrefundable lump-sum tax rebate 1.01
Across-the-board tax cut 0.98
Housing tax credit 0.82
Accelerated depreciation (bonus depreciation) 0.29
Loss carryback 0.25
Permanent tax cuts
Extend alternative minimum tax patch 0.53
Make capital gains and dividend tax cuts permanent 0.39
Make Bush tax cuts permanent 0.35
Make corporate income tax cut permanent 0.32
Make upper-income Bush tax cuts permanent* 0.25

* Imputed from Zandi multipliers as detailed in Bivens and Fieldhouse (2012a)

Sources: Zandi (2011a), Zandi (2011b), and Bivens and Fieldhouse (2012a)

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