Center for American Progress

Should Advocates of Domestic Investments Worry About Tax Cuts?

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Millions of individuals and thousands of organizations throughout the country advocate each year on behalf of a greater commitment of federal resources to a variety of domestic investment programs. These programs range from the support of scientific research to efforts to ensure that low-income preschoolers are ready to learn when they arrive in the first grade. It includes our support of local public health activities, libraries, local schools, students struggling to pay the cost of college tuition, and the remaining programs we maintain to help troubled youth and dislocated adult workers get the training and counseling they need to enter or re-enter the work force.

Domestic investment programs cover a wide range of activities but all of these activities have one thing in common. Rather than paying for the cost of supporting people, these are all efforts to improve the health, skill, and productivity of our nation.

Increasingly, it has appeared that the conservative tax cut agenda comes at the expense of such investments.

But most organizations that favor these investments have a membership base that is both bipartisan and representative of a wide range of policy beliefs. Further, these organizations fear that taking a position on proposed tax cuts would alienate legislators whose support for their spending proposals might become critical when decisions are made on which portion of the domestic investment budget is to fall victim to spending cuts.

Only the organizations themselves, based on the views and values of their members, can determine how they as a group will cope with these questions and what their collective posture will be on the question of tax cuts.

This presentation is merely aimed at trying to inform the decision-making process by examining the effect tax cuts and budget deficits have on decisions about domestic investment funding levels.

During the course of the past six years we have had one of the greatest fiscal reversals in the history of the country. On Friday, the Congressional Budget Office (CBO) announced that we were going to have a deficit of only $300-billion and anymore, that passes as good news. How did we go from a $236-billion surplus in 2000 to a $300-billion deficit in 2006?

This graph explains what happened.

The blue line represents federal spending, which has for many years equaled around 20 percent of the Gross Domestic Product (GDP).

During the first Gulf War federal spending was higher. It has risen since the end of the Clinton administration because of the war in Iraq, creation of the Department of Homeland Security (DHS), and the global war on terror that eats up about $150-billion a year.

But that does not begin to explain how we went from a $200-billion plus surplus to a three-billion plus deficit.

That is what the red line shows us. In 2000, our revenue code caused us to collect 20.9 percent of GDP in taxes. By 2004, we were collecting only 16.3 percent. This is a decline of four and a-half percent, which is the equivalent of about $600-billion in lost taxes to the U.S. Treasury.

So, we have gone from record surplus to record deficit.

OK, you ask, what does that have to do with Head Start, Pell Grants, Childhood Immunization, or Bilingual Education?

All of these programs, and all of the other programs that you advocate on behalf of, are in a portion of the budget we in the budget world refer to as “discretionary spending.”

It is less than two-fifths of the federal budget.

And the other three-fifths are off-limits in terms of any real form of budget discipline.

Take Social Security for instance — the biggest single federal program.

This is how inflation adjusted spending for Social Security has increased over the past 45 years and is projected to increase over the next five. It is driven by demographics. It is remarkably consistent regardless of the fiscal condition of the federal government — no matter how big the annual budget deficit.

The rest of mandatory spending is pretty much the same.

Most of it is medical payments and, as everyone is aware, they are going up faster than other costs in the economy.

So “other mandatory” spending is going up at a rate much faster than Social Security.

As you can see from the contours in the upward slope, there are periods when the “other mandatories” go up more rapidly than others. These are generally caused by recessions or economic downturns when there are huge increases in unemployment payments. These downturns also affect government revenue; and, so, when deficits are growing, spending on this group of programs tends to rise more rapidly.

Interest on the debt has to be paid if we are to protect the good faith and credit of the federal government. Interest payments also go up as deficits force the debt higher.

Larger deficits force an increase in the public debt, and the larger the debt — the higher the interest payments. As this chart shows, interest on the debt in real or inflation adjusted dollars was relatively stable during the 1960s and early 1970s. In the late 1970s, interest payments started to climb as a result of both high interest rates, and the mega deficits of the 1980s pushed payments on the debt in the late 1980s and early 1990s to levels about five times greater than those we faced in the early 1970s.

The movement of the federal budget to surplus in the late 1990s, and the decline in interest rates that accompanied those surpluses, resulted in a dramatic decrease in interest payments on the debt.

The return to deficits and the resulting shift in interest rates has now reversed the direction of maintaining our public debt, and interest payments are absorbing a larger and larger share of total spending — crowding out other spending priorities.

As a result, we have three-fifths of the budget that only gets more expensive when we have deficits.

That leaves only two-fifths of the budget that can be the target of budget cutters — the part that is included in the annual appropriation bills.

But most of the “discretionary spending” is made up of:
• Defense
• International Affairs
• Homeland Security

And as anyone who reads the newspapers knows, these particular areas are not currently the targets of budget cuts.

This graph shows real spending for defense during the past 30 years. The red bars represent years in which the deficit was more than three percent of GDP. The orange show years of one percent to three percent deficits, and the turquoise and aqua show years of small deficits or surpluses.

As you can see, defense spending is about as likely to go up during periods of large deficits as it is in periods of small deficits. In any case, Congress will always vote for defense when we have troops in the field.

And, so, all budget-cutting is targeted at a small portion of the budget.

That leaves the entire budget-cutting aimed at about 10 percent of the budget. A portion so small that if it were eliminated entirely, it would not offset a $300-billion deficit.

That does not mean we can’t succeed in increasing federal investment as the growth in federal support for elementary and secondary education has demonstrated.

During the past 30 years, federal funds for elementary and secondary education have more than doubled.

But when during that period did the progress occur?

This is the same coding that we used for defense. High deficit years are in red and orange. Low deficit or surplus years are in turquoise and aqua. But this time we see a very high correlation between deficits and restraint. In fact, almost all of the growth is in surplus years and high deficit years are often years of decline.

During the past 30 years, education funding has grown at an average rate of $140-million a year when deficits were higher than two percent, and by more than $3.2-billion a year when deficits were less than one percent, or in years when we had surpluses.

In other words, over the course of the last three decades, annual increases in federal funding for education have on average been 24 times bigger in years in which the budget is in surplus or deficits are smaller than 1% than in years with larger deficits.

What about a domestic investment that we have not done well with, such as employment and training?

We have seen a 75 percent decline in real spending on those programs since 1980.

But nearly that entire cut has taken place during periods of high deficits.

As I mentioned earlier, not all categories of domestic discretionary spending follow this path. Disaster assistance obviously fluctuates at the dictates of nature. But it is striking, how spending in many of these program areas linked to future investments are driven by the size of the deficit.

Real dollar spending for the budget category labeled “General Science” and “Basic Research” has increased by 270 percent during the past thirty years. Two-thirds of that increase occurred in just five years, and those five years were the ones in which we had surpluses or small deficits.

One other major component of federal science spending, biomedical research shows a similar pattern.

Restoring the ability of the federal government to collect enough revenue to cover current operating expenses provides advocates of public investment with a level playing field. It makes it possible for policy-makers to judge such arguments on their merits and without undue pressure to eliminate a huge deficit by extracting cuts in spending from a tiny fraction of the overall federal budget. As a result, restoring the revenue base is not only an important part of any strategy to restore domestic investment; it is the key part of such a strategy.

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