Wall Street and Washington got jolted this month by government warnings that the U.S. could become unable to pay all its bills as soon as June 1. That crunch came months sooner than expected, raising the specter of a default on federal obligations unless Congress increases the debt ceiling.
The reason: the expected annual gusher of tax-season payments didn’t flood into the Treasury. When the Congressional Budget Office analyzed tax collections for the current fiscal year through April, the tally fell about $250 billion short of predictions from just a few months ago.
The immediate impact is that the U.S. may run out of cash before mid-June tax payments roll in, and that is spurring urgent talks between the Biden administration and congressional Republicans on how to lift the debt ceiling.
Independent of debt-ceiling dynamics, the tax shortfall continued a wild boom-and-bust cycle for federal receipts over the past three years.
This may be a one-off shock related to the coronavirus pandemic or a sign that federal revenue is becoming more volatile and unpredictable, potentially wreaking havoc in already-tense fiscal-policy debates.
The U.S. runs regular budget deficits because it spends roughly $4 for every $3 in tax revenue, the result of choices made by Congress about tax rates and federal programs. That requires regularly raising the debt limit.
But the system that generates that revenue is a relatively well-oiled machine, steadily drawing income taxes and payroll taxes out of the economy. That machine, combined with the ease of issuing Treasury debt, means the U.S. can normally finance daily operations without wild swings. The value of that predictability only becomes apparent when it disappears during periodic debt-ceiling showdowns.
Typically, when economic activity and wages rise, so does federal revenue. When activity goes down, so does revenue. Now, though, the economy is growing but the federal tax take is shrinking without any significant change in tax laws. That is the reverse of a year ago when soaring income-tax revenue decoupled from modest economic growth.
These sorts of unpredictable revenue fluctuations are long familiar to states, especially California, which relies heavily on high-income taxpayers and capital gains. States, constrained by balanced-budget requirements, routinely adjust spending and tax policies as revenue bounces around.
Analysts attribute the latest boom and bust largely to capital gains, which don’t get deducted from each paycheck but typically show up in government coffers through quarterly estimated taxes or April payments with tax returns.
In 2021, prices of stocks, homes, and cryptocurrency all soared as the economy emerged from the Covid pandemic. Some of the resulting capital gains started showing up in 2021, but the big flood came in April 2022, when the government collected a record $864 billion, 61% higher than the same month in 2019.
CBO forecasters expected individual income-tax revenue to decline this year, but nonetheless, April revenues came in 26% below last year, a much bigger fall than expected, mostly due to a drop in the non-withheld individual income taxes that include business profits and capital gains. That forced officials and analysts to revise the so-called X date—when the government runs out of cash and may have to default on some of its obligations—to early June instead of late July.
Inflation likely had an effect, too, said Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget, a fiscal watchdog group. Tax brackets get adjusted for inflation but with a lag. As a result, the surge in incomes and wages associated with higher inflation generated a one-time sudden tax increase in 2021 that will moderate over time. That likely affected business taxes, too, he said, because companies deducted pre-inflation costs and received post-inflation revenue, boosting profits before those effects reversed.
Then the Internal Revenue Service delayed the tax payment deadline for almost all residents and businesses in California because of weather disasters, pushing income-tax payments normally due in January, April, and June to mid-October.
California projects that the date change will shift $42 billion in state revenue to October from earlier in the year. Based on earlier state data, the Bipartisan Policy Center estimates roughly $100 billion of federal revenue could be shifting, contributing to the earlier debt ceiling crunch point.
“Because early June is such a close call, it is materially impacting the timing,” said BPC’sShai Akabas.
Going forward, the big unknown is whether, and when, the close correlation between economic growth and federal taxes returns to its pre-2020 trends, or if they stay decoupled.
“We had a pandemic and several really crazy years,” said Alexander Arnon, director of business tax and economic analysis at the Penn Wharton Budget Model. “To the extent that we are past that…things are going to return to something at least more like the pre-pandemic normal.”
On the other hand, capital gains are concentrated among high-income households, so more inequality means capital gains are more important to federal revenue, and that means more volatility. Forecasters have limited visibility into capital gains generated inside partnerships or the decisions that lead people to sell assets. And corporate revenues may drop sharply, too, because many of the energy tax credits in last year’s Inflation Reduction Act can be transferred to companies outside the energy industry.
“You never know how much of this is temporary, how much of this is permanent, and how much of this is going to take a while to fade away,” Mr. Goldwein said.
That requires modesty for forecasters but also for politicians, he said. Some Republicans pointed to the revenue surge as proof that the 2017 tax cuts were working. In fact, in the immediate aftermath of the law’s enactment, there were modest increases in business investment and strong wage gains, but trying to divine any effects of that tax law now, after an intervening pandemic, is dicey at best.
President Biden crowed about deficit reduction that happened during his administration but the jury is still out on the big picture as the boom-and-bust returns to normal.
“Being a little bit more humble when you see a one-year spike in revenue would be good because that can lead to more dangerous policy,” Mr. Goldwein said.