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Time is Running Out for a Debt Ceiling Deal

President Biden and Speaker McCarthy are running out of time. That’s what the numbers are telling us in the months since January, when the Treasury said it could employ “extraordinary measures” to remain under the ceiling for five months.

The most important “measure” is income tax collections. They look likely to fall significantly short of Washington’s expectations this filing season, dragged down by plunging receipts from capital gains taxes.

Capital gains taxes are likely to come in below the Congressional Budget Office projection of $315 billion for the full fiscal year of 2023. CBO’s forecast is down only $63 billion, or 17%, from last fiscal year’s record high of $378 billion that was produced by the eye-popping rise in stocks of 27 percent in 2021, as measured by the S&P Index .

Such a modest decline seems unlikely given that the stock market in 2022 had a dramatic reversal of fortune and plunged almost 20%. That’s a greater annual decline than in any year since 2008, when the S&P plunged 38% and capital gains taxes fell about 50% the next fiscal year, according to CBO.

Related Content: Falling Markets Will Crush Government Budgets — Wall Street Journal

The CBO forecast for fiscal 2023 does not appear to recognize the volatility of capital gains, including volatility in recent history. Before fiscal 2021, capital gains taxes never exceeded $200 billion, suggesting that $378 billion in fiscal 2022 and the forecasted $315 billion in fiscal 2023 are significantly above long-term trend.

Ironically, CBO focuses upon long term trend in its February 2023 policy paper outlining its approach for projecting capital gains over the next ten years. CBO states that it expects capital gains realizations (and, thus, taxes) to return to “their historical average relative to the size of the economy,” down from “8.7% in 2021 to a long-run average of 3.7% of GDP by 2033.”

While acknowledging that capital gains “fluctuate more than other economic variables,” CBO’s forecast of a very modest decline in fiscal 2023 belies that statement. Indeed, the combination of the forecasted return to a significantly lower long-term trend line and this acknowledgment of the inherent volatility of capital gains would suggest a significant decline in capital gains tax receipts in fiscal 2023, not the modest decline CBO has forecast. 

Capital gains taxes are part of “other receipts” in federal reports. Last fiscal year, 40% of total individual income tax receipts were composed of “other receipts,” including the $378 billion of capital gains taxes, which amounted to 33% of total other receipts.

By comparison, in fiscal 2019, other receipts accounted for only 32% of that fiscal year’s total individual income taxes, of which, in turn, capital gains taxes were just 27% by CBO estimate.

In the critical month of April in 2022, the IRS received $642 billion, or 23% of last fiscal year’s total individual income taxes, and other receipts in April accounted for a whopping $515 billion, or 80% of the total paid that month.

In April 2019, the IRS received only $397 billion, or 20% of the fiscal year’s total, and other receipts were just $283 billion, or only 71% of the month’s total. Manifestly, capital gains taxes are both volatile and determinative of tax collections in the critically important month of April.

IRS rules magnify the volatility from fiscal year to fiscal year. Estimated payments of non-withheld income are due and payable in April, June and September in one fiscal year and the last estimate in January, and final payments (or refund claims) are due in the next fiscal year.

If taxpayers underpay with their estimated tax payments, they are liable for penalties, unless they have followed IRS “safe harbor” rules, the determinative one of which says they won’t be penalized if they make estimated payments equal to 110% of their prior year’s actual taxes due (100% for lower income taxpayers).

The effect is that taxpayers with capital gains tend to overpay their first three quarterly estimates if the stock market in the prior year was higher than in the current year. This results in refunds of the overpayments when final tax returns are filed primarily in February, March and April.

This past February and March, months when many taxpayers claim refunds, reflected this dynamic dramatically. Among taxpayers who file estimated taxes, many more claimed refunds than paid taxes, according to data in the CBO Monthly Budget Review and the Monthly Treasury Statement. Net other receipts were a negative $70 billion.

In any event, Treasury had a mere $87 billion in cash in its General Account on April 12th, according to the Daily Treasury Statement. That’s down from $178 billion at the end of March and $545 billion a year ago on April 12, 2022.

Related Content: Debt, Not the Debt Limit, is Real Crisis – Wall Street Journal and Debt, Not the Debt Ceiling, is the Real Crisis – Two Months On

The upshot is that the United States Treasury may not be able to employ “extraordinary measures” for many more months, and President Biden and House Speaker McCarthy may have less time to negotiate a debt ceiling deal than they may think.


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