Why the Deficit Soared in 2018

Plus, the Pentagon's next big budget battle By Yuval Rosenberg and Michael Rainey 2018 Deficit Jumped to $782 Billion – and It’s Only Going to Get Bigger You might have missed this with everything else going on in the world, but the Congressional Budget Office said Friday that the deficit for fiscal year 2018 rose to $782 billion, a big jump from the $666 billion shortfall recorded in 2017. Revenues for the fiscal year, which ended on September 30, were up less than 1 percent on a year-over-year basis, CBO said, while spending was about 3 percent higher. The deficit rose to 3.9 percent of gross domestic product, up from 3.5 percent in 2017. Where’s the revenue? Heather Long of The Washington Post [said]( a bigger deficit “isn’t supposed to happen” with GDP growing as rapidly as it is. A booming economy that’s adding millions of new jobs should produce higher tax revenues and shrink the deficit, if not eliminate it entirely. Long pointed out that the last time unemployment rates were down near current levels, in 2000 and in 1969, the federal government produced budget surpluses. The Wall Street Journal’s Nick Timiraos summed up the 2018 shortfall in a [tweet]( “Federal revenues aren't keeping up with economic output. Receipts rose 0.4% in fiscal 2018, compared to 5.4% nominal GDP growth in Q2.” The big drop: CBO said that individual tax receipts rose 4 percent in 2018, driven in large part by higher-than-expected payments received in April for the 2017 tax year. Corporate taxes, however, fell by 31 percent, with half of that drop occurring after June as the full effects of the corporate tax cuts kicked in. Taxes vs. spending: Budget expert Stan Collender revisited the perpetual debate on the fiscal effects of spending compared to taxes, [writing]( that, “It would be easy — but very very wrong — to conclude that the increased spending was the reason the budget deficit rose from 2017 to 2018. After all, revenues were about the same both years while spending was higher.” But if you compare the actual 2018 numbers to the CBO’s projections for what would have happened if the GOP tax cuts had not been enacted, it becomes clear, Collender says, that “the real reason the budget deficit grew from 2017 to 2018 was because revenues were substantially less than what they would have been without the tax bill. Had it not been enacted, the deficit would have dropped below $600 billion instead of rising to close to $800 billion.” What comes next: The deficit is expected to keep rising, hitting nearly $1 trillion in the current fiscal year and rising above that level starting in 2020. [Share this story →]( The Post-Election Outlook: ‘Debt, Debt and More Debt’ The 2018 elections are looking like a lose-lose proposition for the U.S. bond market, according to [Bloomberg’s Liz McCormick and Alex Harris]( “If Democrats take the House, it raises the odds that congressional leaders will propose an infrastructure-spending bill similar in scope to President Donald Trump’s original [trillion-dollar]( proposal. And if the GOP defies expectations and holds on in Congress, tax cut 2.0 becomes more likely. In either case, the result will be debt, debt and more [debt]( With the federal budget deficit high and rising, and the Treasury already increasing its bond issuance even as the Federal Reserve scales back its bond holdings, “any dropoff in investor demand for the burgeoning supply of U.S. Treasuries could mean tens of billions of dollars in additional interest -- all of which taxpayers would ultimately have to pay,” McCormick and Harris write. The key quote: “Here’s a certainty: It doesn’t matter who wins [in November], we’re going to be issuing debt forever,” Thomas Simons, an economist at Jefferies, tells Bloomberg. “There will be a push toward more expansionary fiscal policy. Be ready.” [Read the full piece here.]( [Share this story →]( Chart of the Day: Election Ads The Democrats are hammering home a health care message ahead of November’s midterm elections, while Republican ads “are barely mentioning” the issue, [The Wall Street Journal reports]( (paywall), citing data from Kantar Media/CMAG. In the wake of the Republicans tax cut plan passed last year, taxes are the top issue mentioned in GOP ads, though the Journal’s Brian McGill and Julie Bykowicz note that “Republicans seem reluctant to talk explicitly about the tax legislation; just under 12% of all Republicans’ television ads mention it.” Democrats have stepped up their tax-related advertising recently. The Pentagon's Next Big Budget Battle Late last month, President Trump signed into law a [$670 billion defense spending bill]( for fiscal 2019. Now, Travis J. Tritten writes in the [Washington Examiner]( the fight over the next such bill is already ramping up: “The Pentagon and lawmakers are now facing the imminent return of the same thorny budget issues that have snarled on-time funding and hobbled the Pentagon for years, as well as a wild card with the November midterms and a ballooning deficit.” Under Trump, Congress agreed to lift spending caps in order to boost both defense and non-defense spending for two years. But the caps imposed by the Budget Control Act of 2011 remain in place for 2020 and 2021, meaning that the military faces a $71 billion drop in funding at a time when military leaders like Defense Secretary James Mattis and their allies in Congress are looking to put more money toward the implementation of a new National Defense Strategy. “Mattis and the Pentagon have indicated the military will need about 3-5 percent budget growth over the coming years to stay competitive against adversaries such as Russia and China, which the new strategy puts at the top of U.S. national security priorities,” Tritten writes. The outcome of the looming defense budget battle may depend on November’s midterm election — and the deteriorating deficit outlook. If Democrats win control of the House, Rep. Adam Smith (D-WA) would likely become chairman of the House Armed Services Committee. “Smith believes the growing U.S. debt is making large Pentagon budgets untenable,” Tritten writes. “Smith has made clear in recent weeks that his vision as Armed Services chairman would be a scaled-back military role in the world, fewer nuclear weapons, and a hard look at shaving defense spending.” [Share this story →]( How the Army ‘Found’ $25 Billion The U.S. Army has been combing through its existing programs to identify potential sources of funding that can be applied to its ambitious modernization program, and according to Secretary Mark Esper, the effort has already paid off to the tune of $25 billion. Esper said Monday that Army leadership has spent dozens of hours conducting what he called “night court” to assess programs and evaluate them against six modernization priorities the service defined a year ago. (For more on those priorities — long-range precision fires, next-generation combat vehicles, future vertical lift, Army tactical network, air and missile defense capabilities, and soldier lethality — see [this strategy review]( Although Esper didn’t specify which programs were identified for possible reduction or elimination, he did say that a significant part of the potential savings relate to equipment procurement. Army Under Secretary Ryan McCarthy [told]( Defense News that the review effort is driven in part by the awareness that unless Congress acts, defense budgets could shrink starting in 2020 due to mandatory spending reductions imposed by the Budget Control Act. We're looking forward to the Red Sox-Yankees matchup tonight. What are you watching? Email yrosenberg@thefiscaltimes.com or connect with us on Twitter: [@yuvalrosenberg]( [@mdrainey]( and [@TheFiscalTimes](. And please tell your fiscally minded friends they can [sign up here]( to get their own copy of this newsletter. Tell your friends who aren't fiscally minded, too, for that matter. This stuff is important. 529 Plans Are Growing — and So Is Their Cost to the Government Education savings accounts called 529 plans have grown dramatically since 2010, both in terms of the number of accounts and total assets, according to research by [The Pew Charitable Trusts](. And they’re set to continue growing after the 2017 tax law expanded the expenses they can cover, with other proposals potentially expanding their use even further. The growing popularity of 529s means that the cost to the federal government in foregone revenue has risen about 25 percent since 2010, Pew reports: “To date, the forgone federal revenue from 529 plans has been modest compared with other forms of federal support for higher education. In 2017, the costs totaled $2 billion, about 6 percent of all federal [tax expenditures on higher education](. But these costs have grown, rising by about $389 million—nearly 25 percent—since 2010, after adjusting for inflation. The [Treasury Department]( projects that by 2027, the total will more than double to $4.1 billion in nominal terms and rise to 10 percent of higher education tax benefits. The department made those estimates before Congress expanded 529s to allow for certain K-12 expenses; the projection reflects the law as of July 2017.” The Pew report says that information on the state-level costs of 529 plans is limited, but data from some states suggest that the lost revenue “appears to mirror patterns at the federal level.” Big Changes Ahead for Key Tax-Writing Committee No matter what happens in November’s elections, the tax-writing House Ways and Means Committee will see some big changes, [Politico’s Morning Tax]( says: “Four committee members are retiring, three ran for other political offices, one was picked off in a primary election and several are in tight re-election races.” Some staff members who worked on last year’s tax overhaul are also moving on. The tax law may not be helping some committee Republicans seeking re-election. The Wall Street Journal’s Richard Rubin [highlights]( the fight that Rep. Erik Paulsen (R-MN) faces in selling the tax law and fending off criticism of it, calling Paulsen “the most endangered Republican member” of the committee. But three other Ways and Means Republicans “are in tossup races as they try to sell their biggest achievement,” Rubin says: Peter Roskam of Illinois, Mike Bishop of Michigan and Carlos Curbelo of Florida. Why it matters: That all adds up to a potentially significant brain drain when it comes to tax policy and other areas. “The panel's other jurisdictions — health care, Social Security, trade, numerous family support programs and oversight — are also highly specialized,” Politico’s Toby Eckert notes. If Democrats win control of the House, Rep. Richard Neal of Massachusetts would likely take over the committee chairmanship and would likely lead efforts to “chisel away” at elements of the GOP tax law that largely favor the wealthy, Politico adds. Lawmakers at some point will probably have to deal with technical corrections to the tax law as well. News - [Ryan Predicts ‘Big Fight’ Over Trump’s Border Wall, Says He Doesn’t Know How It Will Be Resolved]( – Washington Post - [Ryan Says 'Medicare for All' Shows Democratic Party Has 'Gone Off the Rails']( – The Hill - [Senate Dems to Force Vote This Week to Overrule Trump Obamacare Change]( – The Hill - [Fact Check: Trump Distorts Democrats' Health Care Ideas]( – Associated Press - [Trump Officials Plan Maintenance Downtime for Healthcare.gov during Obamacare Sign-Ups]( –The Hill - [Trump Says Fed Moving Too Fast With Interest Rate Increases]( – Bloomberg - [Rising Yields Could Be a Big Problem for Booming Corporate Profits]( – CNBC - [The Hidden Money Funding the Midterms]( – Politico - [Affordable Care Act Insurers Are Doing Just Fine]( – Axios - [Republicans Fought Obamacare. Now They’re Campaigning to Save It]( – Bloomberg - [For Millennials, a Regular Visit to the Doctor’s Office Is Not a Primary Concern]( – Washington Post - [Pensions Get Bolder in Challenging Private Equity on Investments’ Human Cost]( – New York Times - [Questions About Funding and Purpose Loom Over a Foundation Congress Created to Help the FDA]( – STAT - [Meet the 2018 STAT Wunderkinds]( – STAT - [Mike Pence's NFL Walkout Cost Taxpayers $325,000 and Was Likely Staged, Report Says]( – Los Angeles Times Views and Analysis - [‘Trumponomics’ Takes a Heavy Toll on the World]( – Ferdinando Giugliano, Bloomberg - [Republicans Hand Democrats an Election-Year Gift on Health Care and It's a Winner]( – Andrew Sprung, USA Today - [Good News About Obamacare Premiums Can't Hide Long-Term Pain Donald Trump Is Trying to Fix]( – Sally Pipes, USA Today - [How Republicans Lost the Health Care Debate]( – Robert Robb, Arizona Republic - [The CVS-Aetna Merger: When Bigger Is Better]( – Lanhee J. Chen, Washington Times - [Industry's Strong Players Merging in Age of Healthcare Disruption]( – Merrill Goozner, Modern Healthcare - [Don’t Let the Fed Scare Us into a Recession]( – Doug Carr, The Hill - [The Next Financial Crisis Is Staring Us in the Face]( – Barry Ritholtz, Bloomberg - [Stop Kicking the Federal Workforce]( – Fred Hiatt, Washington Post Copyright © 2018 The Fiscal Times, All rights reserved. You are receiving this newsletter because you subscribed at our website, thefiscaltimes.com, or through Facebook. Our mailing address is: The Fiscal Times 712 Fifth AvenueNew York, NY 10019 [Add us to your address book]( If someone has forwarded this email to you, consider signing up for The Fiscal Times emails on our [website](. Want to change how you receive these emails? You can [update your preferences]( or [unsubscribe from this list](