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Federal Budget Proposal Reflects Record-Low Tax Revenue

First Posted: 02/14/11 03:41 PM ET Updated: 05/25/11 07:30 PM ET

Obama Budget Taxes

As President Barack Obama unveils his plan for the coming year's federal budget, he confronts a revenue stream that is the weakest its been in decades.

With the recession’s legacy dragging down payrolls and with a federal deficit ballooning, the Obama administration is trying to accomplish two difficult tasks: jump-starting economic growth while simultaneously cutting spending.

Federal tax revenue, measured as a percentage of economic output, is the lowest it has been since the mid-1970s, according to a new report from Credit Suisse. That figure, 15.1 percent, is slightly recovered from what it was during the recession, but it’s still more than two percentage points below the 50-year average of 17.5 percent. In mid-2009, when the economy had been shrinking, tax revenue was the lowest it had been in at least half a century.

“There were very severe job losses and income losses associated with the recession,” said Neal Soss, chief economist at Credit Suisse and an author of the report. “If you don’t have income, then you don’t have tax revenues.”

Obama’s proposed budget, which outlines cuts to programs that help the working poor and the middle class, reflects a move to trim the federal deficit, which has reached a record high. Currently, federal expenditures outpace revenue by more than $1.3 trillion. The White House expects that figure to increase beyond $1.5 trillion in the coming year.

The nation cannot simply grow its way out of debt, Atlanta Fed president Dennis Lockhart said last week, according to Reuters. As the government continues to borrow money to pay for its obligations, lawmakers and economists worry that accumulating too much debt could harm the economy.

“What I am concerned about is the structural imbalance between taxes and spending, which means the U.S. government is out there borrowing hundreds of billions of dollars every year,” said Gus Faucher, an economist at Moody’s Analytics. If interest rates rise, he added, “it’s going to make the government’s problem even worse.”

Much of the tax drought stems directly from the recession. On the state and local level, the real estate slump has strained government budgets, as property tax collection in some cases has fallen. In cities across the nation, governments have had to slash spending to compensate.

But on the federal level, it’s the jobs crisis that has taken a devastating toll on revenue. As nine percent of the workforce is unemployed, and as millions more workers have given up looking for jobs, fewer employees are paying personal income taxes. Since the December 2007 peak in revenue, this taxpayer base has dropped by about 7 million workers, the Credit Suisse report notes.

Moreover, a drop in personal tax revenue accounts for about two-thirds of the total decline in tax revenue since the recent peak.

“The economy is a lot smaller than it ought to be, given the capacity to produce,” said Gary Burtless, a former Labor Department economist and a current fellow at the Brookings Institution, in Washington. “There’s an automatic decline in the revenues going to the federal government.”

Even as some sectors of the economy show signs of recovery, U.S. companies have demonstrated continued reluctance to hire workers. Apparently padding their defenses against future losses, corporations are hoarding cash to a historic degree. In the third quarter of last year, corporations increased their cash holdings 7.3 percent, setting a new record with $1.9 trillion in liquid assets, according to Federal Reserve data.

Relative to their short-term liabilities, U.S. corporations haven’t been sitting on this much cash since 1956. In a speech this month before the Chamber of Commerce, the nation’s most powerful business lobby, president Obama urged the business world to use that money to increase payrolls, encouraging businesses to “get in the game.”

Coupled with a lackluster employment situation, the recent series of tax cuts has further eroded revenue. After two pieces of tax cut legislation were passed during George W. Bush’s first term as president, Americans received a tax rebate in 2008. Under president Obama, most Americans saw their taxes shrink in 2009, and again in 2010. In less than a decade, a budget surplus turned into a trillion-dollar deficit.

These tax cuts inflicted a revenue drop that was “above and beyond those tax reductions that would have occurred just because the economy shrank,” Burtless said.

With the economy in the grips of recession, dwindling corporate revenues also affected federal tax income. Wounded bottom lines translated into depreciated taxes, contributing about 28 percent of the drop in tax revenue, the Credit Suisse report notes.

As the economy recovers, these sources of revenue will likely improve. But a robust economy on its own might not be enough to resolve the deficit.

“The long-term budget problems require massive spending cuts. There’s no other way around them,” Glen Hubbard, dean of Columbia University Business School, said. “You couldn’t raise taxes enough to cover that, without completely killing the economy.”

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