On February 4, the Congressional Budget Office (CBO) released its latest set of ten-year budget and economic projections. Serving as CBO’s annual report to Congress, as well as the baseline against which the budgetary effects of proposed legislation are estimated, there are several high-level takeaways:
- In the short term, federal deficits are projected to continue their downward trend this year (to $514 billion for Fiscal Year (FY) 2014, as compared to $1.4 trillion in FY 2009) and again next year (to $478 billion for FY 2015). But this decrease will be temporary. By 2022, annual deficits will again exceed $1 trillion, according to CBO estimates.
- Lower deficits in the near term have been driven by increased revenues, mostly due to the recovering economy. CBO expects revenues to increase by 9 percent this year and another 9 percent in FY 2015. After that point, revenues are projected to grow in line with the economy, averaging 18.1 percent of gross domestic product (GDP) after 2015.
- Spending growth is expected to be driven by the continued aging of the population, increased health care costs, and growing interest payments (as interest rates on government debt return to more typical levels), while annually appropriated discretionary spending is expected to drop as a share of the economy. By 2024, outlays are projected to equal 22.4 percent of GDP (compared to 20.5 percent for FY 2014).
- Debt, which is already at a historically high share of the economy (72.1 percent of GDP at the end of FY 2013), is expected to exceed 79 percent of GDP by the end of FY 2024 and to continue to rise thereafter.
CBO’s budget projections are not substantially different from those issued last year. The continued, slow recovery from the Great Recession, combined with growth in major federal health care programs (expected to increase from 4.8 percent of GDP in FY 2014 to 6.1 percent of GDP in FY 2024) and growth in net interest payments (expected to increase from 1.3 percent of GDP in FY 2014 to 3.3 percent of GDP in FY 2024) has resulted in a forecast showing declining deficits in the near term but a sustained, increasing path in the long term. While this trend is clearly visible in CBO’s estimate through 2024, it is only a modest preview of what is to come if current law remains in place. CBO warns:
But the pressures of aging and the rising costs of health care will intensify during the next few decades. Unless the laws governing those programs are changed—or the increased spending is accompanied by corresponding reductions in other spending relative to GDP, by sufficiently higher tax revenues, or by a combination of those changes—debt will rise sharply relative to GDP after 2024.1
Further, these projections assume that current law remains in place, including reductions in defense and non-defense discretionary spending to a smaller share of GDP than at any time in the last 40 years and that scheduled cuts to Medicare providers and plans either remain in place or are replaced in a deficit-neutral manner. CBO’s baseline also assumes that per-capita health care cost growth remains at historically low levels. CBO’s current law baseline must incorporate certain assumptions; these may turn out to be unrealistic, which could result in deficits that are higher or lower than expected. Furthermore, any budgetary projections (including CBO’s) are uncertain and strongly affected by unexpected changes in economic growth and activity.
CBO also has updated its estimate of the labor effects of the Affordable Care Act (ACA) and now expects the ACA to reduce aggregate labor compensation by 1 percent over the period from 2017 to 2024. This updated estimate is almost entirely driven by fewer workers seeking jobs – rather than fewer jobs existing in the economy. This effect is largely the result of the phase-out of tax credits and subsidies as income increases, which reduces the incentive for some individuals to work. CBO notes that these estimates are subject to substantial uncertainty, as many ACA provisions are new to widespread implementation and estimates of the response of workers to these incentives vary in the research literature.
Once revenues return to more typical levels, the key drivers of changes to the deficit will be net interest costs and entitlement programs:
- Interest rates on government debt have been at historic lows as investors sought safe assets and the Fed maintains extremely low interest rates in the aftermath of the financial crisis. CBO expects rates on the 3-month Treasury bill to increase from 0.1 percent in FY 2013 to an average of 3.7 percent in the period FY 2018 – FY 2024. The 10-year Treasury note’s interest rate is similarly projected to increase from 2.4 percent to an average of 5.0 percent over the same period. The higher levels projected in the latter part of the ten-year window are much more typical than current levels.
- Growth in spending on major federal health programs is expected to be driven by growth in Medicare enrollment and growth in Medicare costs per beneficiary and the start of the new coverage expansion from the Affordable Care Act (ACA), which will cause increased spending on Medicaid and subsidies for individuals purchasing coverage through insurance exchanges. It is important to note that, once the coverage expansion is fully implemented, CBO expects ACA coverage-related spending to remain a small proportion of total federal health spending, growing from 0.2 percent of GDP in FY 2014 to 0.6 percent of GDP in FY 2024; whereas, spending on all other federal health programs (mainly Medicare and non-ACA related Medicaid spending) is projected to grow from 4.5 percent of GDP to 5.4 percent of GDP over the same ten year period. CBO expects Medicare spending to increase by an average of 6 percent annually from FYs 2014 through 2024, with about half of the growth due to increased enrollment and half due to increased cost per beneficiary. The most rapid growth in future Medicare and Medicaid spending is expected to occur beyond the 2024 end of the ten year CBO scoring window, because the bulk of the Baby Boom generation will enter Medicare and begin to rely on Medicaid-paid long-term services and supports in future decades. In previous years, CBO has substantially decreased its expectation for growth in Medicare spending; its current estimates assume that much of the slowdown in health care cost growth will persist. Budget projections are very sensitive to this assumption; if CBO is off by one percentage point in its estimate of per-capita cost growth, Medicare and Medicaid spending would change by $800 billion over ten years.
In a positive sign for the economy in the near term, CBO estimates that inflation-adjusted GDP will see solid growth rates of over 3 percent through 2016, but after that, the expectation is that growth will weaken to an average of 2.2 percent from 2018 to 2024, below the average from recent decades. Although CBO predicts that the economy will gradually move closer to full capacity – with unemployment finally dipping below 6.0 percent in 2017 – the slower growth estimates in the report are partially driven by decreasing labor force growth because of the aging population.
The main news in the 2014 CBO baseline is that the fundamental fiscal position of the United States government has not changed. The decreasing deficit is a trend that will not continue. In the next ten years, revenue will grow with the economy, but spending will grow faster than the economy. This sets the stage for ever-increasing deficits and ever-growing debt. The key drivers of this spending growth are a return to more typical interest rates as well as per-capita spending growth and enrollment growth in federal entitlement programs, especially Medicare and long-term services and supports, which represent a significant percentage of Medicaid spending. These challenges will only get worse in the decades after 2024, when the bulk of the members of the Baby Boom generation will enter and move through retirement. Policymakers may not be ready to address these challenges this year, but they will need to be addressed at some point, and will be easier to confront sooner rather than later. We conclude with a warning in CBO’s own words:
Such large and growing federal debt could have serious negative consequences, including restraining economic growth in the long term, giving policymakers less flexibility to respond to unexpected challenges, and eventually increasing the risk of a fiscal crisis (in which investors would demand high interest rates to buy the government’s debt).2
BPC will continue to review CBO’s outlook and have additional analysis on particular aspects in the coming days.