San Francisco Fed Projects 1 Percent Lower GDP Growth Due To Higher Income Tax Rates On Rich And Obama Health Care Taxes

Posted by Milton Recht:

From Federal Reserve Bank of San Francisco, Economic Letter, "Fiscal Headwinds: Is the Other Shoe About to Drop?" by Brian Lucking and Daniel Wilson, June 3, 2013:

The CBO projects that the federal deficit as a share of GDP will drop 1.4 percentage points per year over the next three years. This projection would ease slightly to 1.2 percentage points per year if sequestration spending cuts were reversed. By contrast, our calculation of the historical-norm deficit decline through 2015 is 0.4 percentage point per year based on the CBO’s output gap projections. This implies that the excess drag from the rapidly shrinking deficit would reduce real GDP growth annually by between 0.8 and 1.0 percentage point, depending on whether sequestration is reversed. Thus, with or without sequestration, fiscal policy is expected to be a much greater drag on economic growth over the next three years than it has been so far.

Surprisingly, despite all the attention federal spending cuts and sequestration have received, our calculations suggest they are not the main contributors to this projected drag. The excess fiscal drag on the horizon comes almost entirely from rising taxes. Specifically, we calculate that nine-tenths of that projected 1 percentage point excess fiscal drag comes from tax revenue rising faster than normal as a share of the economy. As Panel B shows, at the end of 2012, taxes as a share of GDP were below both their historical norm in relation to the business cycle and their long-run average of about 18%. However, over the next three years, they are projected to rise much faster than our estimate of the usual cyclical pattern would indicate. The CBO points to several factors underlying this "super-cyclical" rise, including higher income tax rates for high-income households, the recent expiration of temporary Social Security payroll tax cuts, and new taxes associated with the Obama Administration’s health-care legislation. [Emphasis added.]

Source: Federal Reserve Bank Of San Francisco

[HT: Political Calculations]