Revenues, as a percentage of the economy, have stayed relatively constant since 1978. In fact, revenues have been remarkably stable in these terms over the past 40 years, never falling below 17 percent of GDP and only once (in 2000) exceeding 20 percent of GDP, despite many changes in tax policy and economic ups and downs. Missing from most discussion and representations of revenues is “tax expenditures,” revenues not received; see Box 1-5.
The downturn that began in 2008 has at least temporarily caused major changes in both spending and revenues, especially for fiscal 2009. Spending rose sharply as the federal government stepped in to stabilize the financial sector and stimulate the economy. As incomes and business profits fell, so did revenues. The resulting very large increase in the deficit was financed with additional borrowing.
Few economic experts would forgo strictly temporary increases in federal spending, deficits, and debt in an economic downturn as severe as this one. Such deficits are countercyclical—they help moderate the societal effects of a recession that might otherwise be far harsher, and they may speed
An invisible component of charts like Figure 1-6—because no one has figured out how to depict negative slices of pie—is tax expenditures. Also dubbed tax breaks, preferences, or loopholes, “tax expenditures” refer to departures from normal tax law that favor certain types of income or economic activity. Tax expenditures reduce the amount of money that the government collects from specified sources. Analysts debate how best to measure tax expenditures, but one commonly used measure is the annual loss of revenue resulting from each provision (assuming other parts of the current tax code are unchanged).
The Joint Committee on Taxation (2008a) lists more than 200 tax expenditures, led by preferential rates on dividends and capital gains ($150 billion in 2008), favorable treatment of pensions and other retirement plans ($120 billion), the exclusion of employer contributions to health insurance and similar plans ($117 billion), the deductibility of mortgage interest on owner-occupied housing ($67 billion), and the deductibility of state and local income, sales, and property taxes ($48 billion). This list of the top five tax expenditures omits the tax rebates paid as part of the economic stimulus effort, which the Joint Committee estimated at $95 billion in 2008, because those rebates are not a permanent feature of the tax code. Although tax expenditures reduce federal revenues and thus make government’s role appear smaller by that measure, they have the same effect on the deficit as would equivalent spending for the same activities. If they were classified as federal spending instead of tax benefits, federal expenditures would have been about 30 percent higher in 2006 than OMB reported—slightly over 26 percent of GDP instead of 20.3 percent (Burman, Toder, and Geissler, 2008).