If current spending and revenue trends are allowed to continue without intervention, crisis management may replace sound policy as the driver of reform.
In the United States, the structural gap between federal spending and federal revenues continues to widen, and the scheduled expiration of a host of popular tax provisions at year's end has spawned talk of “Taxmageddon.”
In the short term, policymakers are concerned that spending cuts or tax increases (commonly referenced as the risk of a “fiscal cliff”) could stifle the fragile economic recovery.1 In the long term, policymakers face a dilemma that is every bit as challenging — that of an unsustainable fiscal path.
Annual federal spending has remained around 20% of GDP for the past three decades and is projected to climb to almost 38% of GDP by 2041.2 Federal revenue, historically about 18% of GDP, is running at 15.7%, depressed by economic weakness and fiscal stimulus.
Federal debt held by the public3 is projected to be 73% of GDP at the end of 2012 and is expected to reach almost 90% of GDP by the end of 2022, assuming certain current policies are extended.4 Currently, the US national debt amounts to approximately $50,000 per US citizen — and this figure continues to grow.5 This increasing debt load poses significant risks to the US economy.6
While the $1.2 trillion of spending reduction mandated by the Budget Control Act of 2011 (BCA) helps the federal government's fiscal situation somewhat, growth in entitlement programs, particularly Medicare, will continue to drive up spending. Sooner or later, lawmakers will have to confront the fiscal imbalance and the challenge grows more difficult with time.
Gap between US spending and revenues widening
Source: An Update to the Budget and Economic Outlook: Fiscal Years 2012–2022, August 2012; CBO, The 2012 Long-Term Budget Outlook, June 2012; Office of Management and Budget, The Budget for Fiscal Year 2012, Historical tables, February 2012.
Resolving these issues in a way that secures the future requires large-scale solutions. Inevitably, the necessary changes will require compromise, sacrifice and long-range thinking. However, if current spending and revenue trends are allowed to continue without intervention, crisis management — such as that currently taking place in Europe — may replace sound policy as the driver of reform.
Federal debt and spending continue to grow
Federal debt held by the public, which stood at 36% of GDP in 2007, had ballooned to 68% by the end of 2011. Under current policies — such as continuation of the 2001/2003 tax cuts, alternative minimum tax (AMT) relief and Medicare payment rates for physician services — the trajectory of the federal debt is on an unsustainable path.
Fiscal challenges — confronting unparalleled US debt
Source: An Update to the Budget and Economic Outlook: Fiscal Years 2012–2022, August 2012; CBO, The 2012 Long-Term Budget Outlook, June 2012.
Increased dependence on foreign lenders
The US has also become increasingly reliant on foreign lenders to hold its debt. Over time, concerns about the long-term fiscal imbalance in the US could cause these lenders to require higher interest rates to hold US government debt, raising the United States' cost to borrow money.
United States' rising dependency on foreign lenders
Note: 2011 data reflects debt levels through September 2011.
Source: Data for 1970 and 1990 from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget, Analytical Perspectives, February 2010. Data for 2011 from Department of Treasury,Daily Treasury Statement (30 September 2011) and Treasury International Capital Reporting System, September 2011.
US tax competitiveness
Many believe the United States' worldwide system of taxing multinationals adversely affects its ability to attract capital and business investment relative to other developed economies. Globalization has made capital more mobile, magnifying the significance of international tax differences.
Capital investment may also shift elsewhere as other countries continue to reduce corporate tax rates relative to the US.7 At 39%,13 the US has the highest corporate income tax rate among the 50 largest economies. It's also one of only three countries in the top 25 economies with both a worldwide system and a top corporate tax rate over 30%.
Over the past year, US tax competitiveness has emerged as a high-profile political issue, though lawmakers differ over how to address it. House Ways and Means Committee Chairman Dave Camp (R-MI) and Senate Finance Committee member Mike Enzi (R-WY) have released international tax reform plans that would move the US toward a territorial tax system. Similar territorial tax proposals are expected to follow.8
The Obama Administration, meanwhile, proposes to address global tax competitiveness by reducing the US corporate tax rate to 28%, with a 25% effective rate for manufacturing.
Call to action
Most economists and policymakers agree the US is on an unsustainable fiscal path. The US will reach a critical juncture soon after the 2012 elections when: the 2001/2003 Bush tax cuts are due to expire; important tax elements of the Patient Protection and Affordable Care Act go into effect; the payroll tax holiday is due to sunset; $1.2 trillion in automatic spending cuts are scheduled to take place; the United States hits the national debt ceiling; and the currently expired AMT patch causes the AMT to affect more than 31 million taxpayers when they file returns for 2012.9
Now is the time for policymakers to begin to address the underlying issues that have led to this challenging scenario. Putting the United States on a sustainable fiscal path will require multiple policy shifts. Within this context, spending reform and tax reform would appear to be inevitable, as policymakers seek to restore fiscal order and maintain international competitiveness. The key questions, we believe, are how and when reform will occur, and what form it will take.
Too many times in recent years, ideological differences and insufficient political will have hindered bold action by the nation's lawmakers. Policymakers must not continually defer tough policy choices in the hopes of gaining a more favorable political climate.
The data demonstrate the need for US leaders to commit to concrete action — action that breaks the cycle of debt and deficits, secures the nation's future in the global economy and reinstates the promise of a solid economic foundation for future generations.
1In its latest budget update, the Congressional Budget Office (CBO) states that the “fiscal tightening” that would come from a continuation of scheduled policy changes (including items such as expiration of the 2001/2003 tax relief, spending cuts under the Budget Control Act of 2011, expiration of unemployment benefits and payroll tax relief and scheduled reductions in Medicare physician payment rates), “will lead to economic conditions in 2013 that will probably be considered a recession. . . .” However, CBO also notes that extending the policies, while likely resulting in a stronger economy in 2013 and 2014, would result in continuing large deficits and debt. CBO, An Update to the Budget and Economic Outlook: Fiscal Years 2012–2022, August 2012.
2CBO, The 2012 Long-Term Budget Outlook, June 2012.
3Debt held by the public refers to all federal debt held by sources outside the federal government that is needed to finance government operations. It does not include borrowing from federal trust funds such as Social Security. According to the CBO, debt held by the public the most meaningful measure for assessing the relationship between federal debt and the economy because, unlike debt held by the trust funds, it competes with other elements of the credit markets.
4CBO, The Long-Term Budget Outlook, June 2012. Table 1–2. Also see CBO, supra at note 1, Table 1–6.
5“Monthly statement of the public debt of the United States,” The Bureau of the Public Debt, www.TreasuryDirect.gov, and “State & County QuickFacts,” US Census Bureau, www.census.gov, both accessed 31 May 2012. The $50,000 figure was derived by dividing the total public debt outstanding — $15.7 trillion as of 30 April 2012 — by the US population, which the Census Bureau estimated at 311.6 million for 2011.
6It is generally thought that debt of 100% of GDP is destructive — and debt at or more than 120% of GDP risks default.
7See e.g., Tom Neubig and Thomas Kinrade, Landscape changing for headquarter locations: an update, Ernst & Young LLP Center for Tax Policy, September 2011, for a discussion of the shift in headquarter locations by Global Fortune 500 companies.
8For example, Sen. Rob Portman (R-OH) has indicated he plans to put forward a revenue-neutral tax reform plan with a top 25% corporate tax rate and a territorial tax system. For information on Chairman Camp's plan, see Chairman Camp's territorial tax plan: five things businesses should know, Ernst & Young LLP Center for Tax Policy, December 2011. For more on Sen. Enzi's plan, see Senator Enzi introduces an international tax reform bill, Ernst & Young LLP Tax Alert 2012–435, 1 March 2012.
9 “Tax Topics: Alternative Minimum Tax (AMT),” Tax Policy Center website, www.taxpolicycenter.org/taxtopics/AMT.cfm, accessed 23 January 2012