This week the nonpartisan Congressional Budget Office (CBO) published its final monthly budget review for FY 2021. While the Treasury Department will publish the official numbers in its next Monthly Report, CBO’s end-of-year report provides an accurate preview of the final numbers.
According to CBO, the cumulative deficit for FY 2021 was $2.8 trillion, $362 billion smaller than the FY 2020 deficit, and approximately $230 billion less than what CBO projected in its July baseline. In explaining the late-breaking miss, CBO said its outlay projections were on target, but revenue collections were substantially higher in the final months of the fiscal year than it expected.
While a $2.8 trillion deficit would normally trigger headlines, the revenue number is attracting all the attention. CBO’s preliminary estimate reveals the Treasury collected $4.047 billion in FY 2021, an 18.3 percent increase over the prior year—the largest revenue jump since 1977. CBO has been revising its revenue projection all year based on collection patterns, but even as late as July (less than 3 months before the end of the fiscal year), the agency was projecting a 12 percent revenue bump. Naturally, budget experts want to know: what’s going on with revenues?
The short answer is: We don’t know, and we may never know. Several factors are influencing revenue collections and all at the same time: the calendar, the economy, changes in tax law, and the behavior of taxpayers—and it may not be possible to separate one effect from the other.
The calendar. Revenue collection patterns are quite volatile on a month-to-month basis. While some taxpayers remit their payments to the IRS monthly, others operate on a quarterly system. As a result, the monthly collection pattern looks like a seesaw (up, down, up, down…) and can be very hard to predict. When CBO released its revised revenue baseline in July, the last quarterly due date of the federal fiscal year lay ahead on September 15. Armed with historical collection patterns and economic data, CBO made its best estimate of the last few months but missed.
The economy. One surprise of the COVID-induced recession in 2020 was how swiftly it was over and how fast the overall economy regained strength. While the employment numbers continue their head-scratching ways, real GDP surpassed its pre-recession peak by the end of the second quarter of 2021. Consumer spending, which fuels two-thirds of the US economy, stumbled in 2020 then took off with increased public access to COVID vaccines. Consumer demand combined with sectoral labor shortages have given rise to real wage increases, fueling higher income tax collections.
Changes in tax law. COVID-related legislation enacted in 2020 allowed many employers to delay payment of their payroll taxes between March and December 2020 and helped businesses preserve cash. As a result, some tax collections were pushed from FY 2020 into FY 2021, depressing the first year and artificially inflating the second.
Behavior of taxpayers. When faced with a prospective tax increase, taxpayers will often proactively shift income from a high-tax year into a low-tax year, based on the probability of those tax increases becoming law. When President Biden submitted his Build Back Better budget to Congress in late May, it was largely paid for with tax increases on wealthy individuals and corporations. With unitary Democratic control of the legislative and executive branches of government, it is logical to conclude that those same taxpayers assumed some or all of those tax increases would become law and reacted accordingly by moving realized gains and income from 2022 into 2021 to avoid paying higher taxes.
In any given year, it would be possible to tease out one effect from the baseline, but with all four affecting revenues at the same time, Treasury may be unable to assess the contribution of each factor individually—ever.
Whatever reasons exist for the large revenue jump in 2021, the federal government still logged a $2.8 trillion deficit. Moreover, many of the factors affecting revenues this year are transitory. It would be foolhardy to expect multiple consecutive years of double-digit revenue growth. Even before COVID struck there was a yawning gap between revenues and expenditures fueling increasingly dangerous levels of deficits and debt—and we are far from closing that shortfall. That is the missing headline.