OPED18 EGTRRA - Whither the surplus?

OPED18 EGTRRA - Whither the surplus?

Fiscal Year (FY) 2000, which ended September 30th 2000, resulted in a $236 billion surplus. Even the non-Social Security portion of the budget showed a surplus of $84 billion. Federal spending (at 18.4% of GDP) was at its lowest percentage level since 1966, while federal revenues (at 20.7% of GDP) were at their highest percent since 1944. This was the third year of surplus, and the Congressional Budget Office's Jan 2001 forecast showed growing surpluses over the next decade. (chart at right)

EGTRRA - the Economic Growth and Tax Relief Reconciliation Act of 2001 passed the Congress and was signed into law June 7th 2001. It provided broad income tax relief to individuals.

EGTRRA reduced marginal tax rates - in 2001 the lowest rate of 15 percent was partially replaced by a 10 percent bracket. The 28, 31, and 36 percent brackets are each reduced by 3 percent and the top bracket of 39.6 percent is reduced to 35 percent. These reductions are to be phased in, with the full effect not taking place until 2006 (see chart).
EGTRRA gradually lowers and then repeals the estate tax.
EGTRRA also effects a number of other taxes - it doubles the child credit by 2010, improves various education and savings incentives, ends up repealing the itemized deduction limit, reduces the 'marriage penalty', etc.

EGTRRA was estimated to reduce federal revenues by a cumulative $1.35 trillion over ten years. To stimulate the economy the law required that the IRS distribute the savings from the ten percent bracket change in the form of rebate checks between July and September of 2001. $38 billion of rebate checks were sent out and personal disposable income jumped in the July to September time period. However consumer spending did not keep pace, and plunged in September following 9/11 before subsequently recovering.

In January 2002 the CBO released new budget projections. These projected that the budget would go into deficit in 2002 and 2003 before going back into surplus in 2004 (see first chart). The revised projections show federal debt being totally retired around 2014, five years later than the January 2001 projection. FY 2001, ending September 30th 2001, ended with a $127 billion surplus as federal revenues slipped to 19.6% of GDP while federal spending stayed steady at 18.4% of GDP

Critics of EGTRRA's rate cuts have blamed them for the huge drop in the projected unified surplus (initially projected at $5.6 trillion over 2002-2011, now projected to be reduced to $2.6 trllion over the same period) and have called for 'freezing' or delaying EGTRRA's marginal rate changes. President Bush, on the other hand, is calling for more tax cuts in the budget he submitted to Congress. So, is EGTRRA to blame??

Several factors are responsible for this decrease. The economy was already slowing down as EGTRRA was being debated (hence the Congress' inclusion of the tax rebate that was hoped to stimulate the economy by increasing consumer spending). The terrorist attacks of 9/11 further weakened the economy. They also led to increased Congressional spending (e.g. the $40 billion spending package, $5 billion in aid to the airlines, federal compensation for attack victims, etc.) Thus, approximately half of the (projected) change is due to EGTRRA, approximately 20 percent is due to the recession, approximately 21 percent is due to increased spending due to the terrorist attacks, and the rest by increased spending unrelated to the attacks.

There are also a couple of 'gotchas' in EGTRRA. First, the law is set to expire 12/31/2010, when all the rates automatically go back to their pre-EGTRRA values! Presumably Congress will act before this to avoid these hikes... Second, EGTRRA did not effect the individual alternative minimum tax (AMT). The AMT was adopted in 1978 to ensure that taxpayers could not avoid paying income tax by having sufficient tax deductions to offset their income. A taxpayer calculates their tax liability as well as the AMT, then must pay the higher of the two. Since EGTRRA did not effect the AMT the 1 million taxpayers already on the AMT will receive very little benefit from the law. Also, since EGTRRA decreases the tax burden, the result will be that more people will find themselves responsible for the AMT. Though AMT rates are low the AMT is not indexed for inflation and does not allow many deductions and credits (e.g. for dependents, for state and local taxes, etc.). An estimated one third of all taxpayers will find themselves paying the AMT by 2010, assuming no Congressional action.

Of course the numbers are fluid and will change. The Congress is likely to exceed President Bush's requested increase in the military budget, while not holding to the 2% increase he has called for in non-military discretionary spending. And the economic recovery may be 'U' rather than 'V' shaped as hoped for...