The shrinking deficit

The Wall Street Journal

We hate to be the bearers of good news, but someone's got to do it: The Congressional Budget Office has released its preliminary estimates for Fiscal year 2007 that ended Sept. 30, and the federal budget deficit fell again, this time by 35 percent to $161 billion.

There's more to applaud, if you can stand it: Since 2004, deficit spending has tumbled by $251 billion, which is one of the most rapid three-year declines in U.S. history. The deficit as a share of the economy is down to 1.2 percent, or about half the average of the last 50 years. This improvement is especially remarkable given the $150 to $200 billion a year of post-Sept. 11 expenses for homeland security and the wars in Iraq and Afghanistan.

Americans coughed up a record $2.568 trillion in taxes to the IRS in 2007, or 6.7 percent more than in 2006. This means federal receipts have climbed by $785 billion since the 2003 investment tax cuts, the largest four-year revenue increase in U.S. history. Income, dividend and capital gains tax rates were all cut in 2003, but individual income tax receipts have soared by 46.3 percent in four years, with payments by the wealthy accounting for most of the windfall. Last year's increase in individual income payments was 11.3 percent, or more than double the rate of growth in nominal GDP. Don't worry, class warriors: Hannah Montana and others among the "new rich" are paying their taxes.

Overall federal revenue is now 18.8 percent of GDP, compared with the 18.2 percent average of the past 40 years. The nearby table shows how far off CBO was, as usual, in its static-revenue estimates that failed to anticipate the impact of taxes on incentives and growth.

The biggest surprise in fiscal 2007 was the slower growth in federal spending. CBO reports that federal outlays crept up just 2.8 percent last year (2.5 percent after adjusting for timing in payments), which was "well below the 7.3 percent average over the previous five years." The decline was largely due to lower disaster-related payments compared with Hurricane Katrina's aftermath the year before, plus the budget deal last winter that kept domestic spending stable as Congress changed hands.

This is a one-year wonder. Congress is already gearing up to splurge again, with its $35 billion expansion in the children's health program, a $286 billion five-year farm bill, $23 billion in water projects, and $22 billion more in non-defense discretionary spending. Combine this blowout with slowing revenue growth due to the housing recession, and the deficit may not fall again in 2008. This is all the more reason for President Bush to finally use his veto pen on spending bills.

The overriding lesson here is that the best antidote for deficits is faster growth, not tax increases. The budget deficit has declined more rapidly this decade in the wake of the Bush tax cuts than it did in the 1990s in the wake of the Clinton tax increases. CBO is still forecasting a balanced budget in 2010, but if Congress gets its way on spending and taxes, all of this progress will be short-lived.