Thursday, February 4, 2010

The Federal Budget - Spending Projections

This is one of a series. For the other parts click on the links below:

The Federal Budget - An Introduction
The Federal Budget - Federal Debt
The Federal Budget - Social Security and Medicare
The Federal Budget - My Budget

Projections of receipts and outlays are usually done for five years (plus the current year in progress) for each budget report. There are some hunches that I have about the projections based on my theory of government and bureaucracy. For this, I gathered together the projections from the last 10 years of budgets (2000-2009).

1) The receipt projections will be higher than actual receipts.

This is relatively easy to show. On average, the 5, 4, 3, 2, and 1 year estimates were 4% to 6% higher than the actual amounts. The current year estimate is about 0%. This makes sense, during the current year, you have a much better idea of the economic situation and revenue (tax receipts) is a fairly good correlation to the economic situation since 90% of receipts are from corporate and individual income taxes or social security taxes. Whereas it is difficult to predict booms and busts 5 years and even 1 year in the future.

2) The outlay projections will be lower than actual outlays.

This is also relatively easy to show. Estimates of outlays start at 10% under actual 5 years out and slowly decrease to 2% above actual in the current year. In other words, politicians get cold feet on a small portion of their spending during the current year as they are hammered about deficit spending.

An additional tidbit is that politicians tend to be overly optimistic on both ends, but consistently so on outlays. For the 50 estimates (10 years x 5 year outlook), 28 receipts were optimistic (predicting more receipts than actual). The difference is in the magnitude though. Optimistic predictions averaged 14% (i.e. they estimated 14% more receipts than actual) while pessimistic predictions averaged only 7%. On the flip side, only 3 of 50 estimates for outlays were optimistic (i.e. less outlays than actual) with an average of 3%. The pessimistic estimates were off by 8%.

The graph below shows the average receipt and outlay differences and their cumulative effect on the deficit predictions. Negative values indicate that the estimate was less than actual.

Now that I have a rough idea of how the projections have worked historically, I can make my own estimates of how the future budgets will look. So, I added up the FY11 budget deficits (the difference between receipts and outlays) and found that for 2010 through 2015 there is a projected total deficit of $5.8 trillion. Compare that to my guesstimate of $7.7 trillion without a year below $1 trillion. This is done by adjusting the budget estimate by the average difference that was found for the previous 10 years. Its not rocket science.








One last point is to look at the rosiness of the projections. Politicians don't want to say that the economy is going to be in the dumps for 5 years, so every budget that comes out may have it declining for a year if we are in a recession, but then it snaps back better than ever. 2009 saw a year over year change in receipts to the federal government of -17%. 2010 is projected to change by 3% and then 2011 is estimated to increase by 19% (i.e. 2011 will bring in 1/5 more money into federal coffers than 2010) and then by another 14%in 2012 . How realistic is this? Well, in the last 50 years it has happened once 1977-78 (19% and 12%) and 1969 it went up by 22%. This time, the budget expects it to happen during the same time as a major tax increase (or the expiration of the Bush tax cuts). How has the receipts of the country faired with major tax increases to dramatically increase revenue? Well, 1993-94 revenue increased an average of 7.5% each year, 1991-92 revenue increased an average of 4.5%, 1942-43 revenue increased an average of 66%, 1936-37 revenue increased an average of 23%, 1932-33 revenue decreased 21%, and 1917-18 revenue increased an average of 135%.

So, it appears that in times of a World War, raising taxes will increase revenue (of course if you look at the size of the tax increases during those times, they far outstripped any tax hike we have now). However, other issues were in play as well. In World War I, the income tax was new and it was relatively easy to include a whole bunch of the population that previously had not been paying taxes into the tax system under the guise of patriotism. In World War II, the Social Security taxes were just ramping up and people are more willing to pay taxes to finance a war. Other than that, major tax increases have only had moderate effect (nothing close to the 16.5% average that is estimated in 2011-12). In fact, based on the 1932-33 numbers, this tax increase could result in a large decrease in revenue.

In conclusion, the spending projections (and accompanying receipt projections) are a fantasy. They only faintly resemble reality, but that is what is used to make promises of "X billion invested over the next X years." In the end, a current Congress cannot bind a future Congress to do anything.

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