It’s That Time of Year Again!

By Loren Adler, Shai Akabas

Tuesday, January 31, 2012

The Congressional Budget Office (CBO) released its annual Budget and Economic Outlook this morning. CBO’s first summary paragraph captures precisely the complicated uncertainties of fiscal policy and economic outcomes in the future:

“The federal budget deficit—although starting to shrink—remains very large by historical standards. How much and how quickly the deficit declines will depend in part on how well the economy does over the next few years. Probably more critical, though, will be the fiscal policy choices made by lawmakers as they face the substantial changes to tax and spending policies that are slated to take effect within the next year under current law.”

The summary of the CBO report: Deficits and debt are likely to worsen in the next decade, and worsen still more in the years after.

Fiscal years (FY) 2012-2022 face two major uncertainties— the policy choices that confront policymakers in January, 2013, and the impacts on the real economy of those choices.  Thus, CBO projects deficits and debts using not only its “current law” baseline, as it is required by law to do, but also using an Alternative Fiscal Scenario (AFS) that attempts to accommodate a possible outcome of congressional decisions.

Under current law, the projected deficit for FY2012 is estimated to be almost $1.1 trillion, declining dramatically to $585 billion in FY2013, and as low as $196 billion projected in FY2018.  Those projections assume the following, among other assumptions:  that the “Bush Tax Cuts” of 2001 and 2003 completely expire for all taxpayers starting in calendar year 2013; that across-the-board spending cuts (“the sequester”) of $1.2 trillion over the next decade begin in January, 2013, without any amelioration;  that all expiring tax provisions (“the extenders”) are allowed to expire; that the Alternative Minimum Tax (AMT)  will not be  indexed for inflation after 2011;  and, that current Medicare payments for providers are, as current law dictates, allowed to decline by 27 percent in March, 2012, and decline further thereafter.

In the AFS, which we believe is vastly more likely to occur after congressional action, the Bush Tax Cuts continue for all taxpayers; all expiring other tax provisions (other than the payroll tax holiday now in conference between the House and Senate) are extended; the AMT is indexed for inflation; Medicare reimbursement rates are frozen at their current rate; and, above all, that the sequester enacted by Congress as part of the Budget Control Act (BCA) in August, 2011 is completely over-turned by congressional action and presidential approval.

The AFS results in what we believe are much more realistic outcomes: an increase in cumulative deficits of $11 trillion over the next decade, or an average of a little more than $1 trillion annually.

If the AFS occurs, deficits would average 5.4 percent of Gross Domestic Product (GDP) over the next decade, and by 2022, the deficit would equal 6.1 percent of GDP. As CBO details, these numbers worsen in the following decade.

More important, perhaps, is the fact that the AFS yields debt held by the public of 94 percent of GDP in 2022, the highest level in almost three-quarters of a century. For legislators, of course, the important figure is gross debt because that number is what compels action by Congress to raise the debt limit.  The present debt limit is $16.4 trillion.  If CBO’s AFS occurs, the debt limit would need to increase to nearly $30 trillion by FY2022.  Using CBO’s economic forecast, GDP in FY2022 would be approximately $24.7 trillion.  In short, the nation faces the possibility of having gross sovereign debt equal to more than 120 percent of GDP in FY2022, and well more than 200 percent of GDP in FY2035.

To its credit, CBO underscores the difficult forecasting landscape that economists have faced over the past three years and the uncertainty of future forecasts.  While CBO’s recent medium-term deficit forecasts have been significantly lower than actual deficits, this largely stems from almost unprecedented actions by policymakers to address the Great Recession and the very slow economic recovery from it that has taken place.  

The drivers of the looming fiscal disaster remain unaddressed by Congress and the Administration. Entitlement costs, especially those associated with health care and pension entitlements, will soar in the next two decades, driven by the retirement of the Baby Boom generation. Also, we remain stuck with an arcane tax code that raises too little revenue. For the past decade, congresses and presidents have failed to take any significant action to rein in these soaring costs or enact comprehensive tax reform. Indeed, even with all the furor over last year’s debt ceiling increase and the passage of the BCA, Congress failed to do anything about these two elephants in the room.

The CBO document released today makes three things abundantly clear:

  • Federal deficits and debt could reach dangerously high levels if policymakers behave over the next ten years as they have the past ten;
  • The current remarkably low interest rates likely will revert to their historical mean during the upcoming decade, increasing total interest costs to the federal government dramatically;
  • Attempts to slow deficits and debt in recent years have concentrated on that part of the federal budget (discretionary spending) least responsible for the looming crisis.

Please see our upcoming detailed posts on the CBO report for further analysis. Related Posts

2012-01-31 00:00:00
Deficits and debt are likely to worsen in the next decade, and worsen still more in the years after