WASHINGTON - February 2 - In a paper released today by the Washington, DC-based Center for Economic & Policy Research (CEPR), economist Dean Baker shows that the federal budget deficit will be as much as $600 billion greater over the next ten years than estimated by the Congressional Budget Office (CBO). Baker, co-director of the Center, attributes this error to the CBOs failure to include in its calculations the impact of the large, persistent current account (trade) deficit on the federal budget.
The United States is running a current account (trade) deficit of approximately $550 billion, or 5 percent of Gross Domestic Product (GDP). This deficit corresponds to a transfer of $550 billion in U.S. financial assets, such as stocks, bonds, and short-term deposits, to foreign wealth holders. The interest, dividends, and capital gains earned on these assets in subsequent years will accrue to foreigners and will therefore largely escape domestic taxation.
According to Baker, CBO economic projections assume, either explicitly or implicitly, that the current account deficit will remain near its present level but fails to calculate the consequent reduction in taxable income.
This error is similar to the failure of CBO to recognize the inconsistency between its projections of capital gains tax revenue in 2001 and its projections for profit growth. The projections for capital gains tax revenue implicitly assumed that stock prices would continue to rise, even from the record price to earnings ratios that existed at the time. However, CBOs projections also assumed that profits would grow at a very slow pace. As a result of this error, the 2001 CBO projections of capital gains tax revenue over the period 2001-2011 were $526 billion higher than the most recent projections.
The failure to incorporate the impact of the current account deficit is likely to lead to an overstatement of revenue of approximately the same amount. The paper shows that if the annual current account deficit remains near $500 billion for the next decade, then the deficits will be considerably larger than the projections indicate. The gap will increase each year. In 2014, the last year in the projection, the deficit will be nearly $85 billion, or 0.5 percent of GDP, higher than the current CBO projections show. Over the full ten-year horizon, the current account deficit will add $587 billion to the debt, an amount a larger than the cost of the Medicare prescription drug benefit.
CEPR Paper Available at www.cepr.net