Congressional Budget Office Report Paints Overly Rosy Picture

February 18, 2013

The Congressional Budget Office's (CBO) latest economic projections for the next decade predict an economy that grows, albeit slowly, throughout the next decade. However, the economic model that the CBO uses to make its predictions is flawed, says William McBride, chief economist at the Tax Foundation.

  • The CBO projects the budget deficit to shrink for the fourth year in a row in 2014 to an estimated $845 million, which represents just 5.3 percent of gross domestic product (GDP).
  • Despite dropping as low as 2.4 percent of GDP by 2015, CBO expects publicly held debt to reach 77 percent of GDP by 2023, which could trigger an interest spike or even a default.
  • McBride says that it will likely be worse than the official prediction and puts credence in the CBO's alternative scenario, which predicts that the debt-to-GDP ratio will reach 87 percent by 2023, assuming automatic spending cuts through sequestration do not take place.

The CBO also predicts that individual income taxes will provide a substantial increase in tax revenue that affects the U.S. economic outlook to 2023. While individual tax revenue remained flat in 2012 at 7.3 percent, the CBO expects that to grow to 7.9 percent in 2013 and to 9.8 percent by 2023 as new higher tax rates on high-income earners and investors are instituted.

  • McBride points out that the evidence shows higher tax rates reduce income and tax revenues.
  • Historical data on the capital gains tax rate indicates that capital gains realizations and tax revenues decrease when the tax rate rises.
  • The new economic projections do not account for lower revenue under a higher capital gains tax.
  • The new projections also fail to account for a long-term slowdown in capital gains tax revenues resulting from less overall investment.

The CBO model is driven by capital and labor. McBride says that if the CBO's long-term model of economic growth reflected the effect of taxes on capital and labor, then economic growth would be slower and high unemployment and low tax revenue would persist longer than the CBO predicts.

Souce: William McBride, "CBO Overly Optimistic about Economic Growth and the Federal Debt," Tax Foundation, February 12, 2013.

 

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