Yesterday, the Congressional Budget Office (CBO) released the first of its two major annual reports on the federal budget and expectations on the next decade’s worth of spending, tax revenues, and publicly held debt.
Here are some of the highlights:
In its current law (baseline) estimate, CBO assumes all tax increases and spending cuts on the books are implemented. According to CBO, this means the following would take place:
• $7 trillion in new publicly held debt would be added to our already existing debt.
• Assuming a certain level of economic growth and tax increases, the amount of our economy taken by federal taxation will be above the average for the last 40 years from 2015 to 2023, at approximately 19% of GDP.
• Federal spending will continue to rise, but slow as compared to the size of Gross Domestic Product (GDP) until 2017.
After that, America is in trouble. From the report:
The aging of the population, increasing health care costs, and a significant expansion of eligibility for federal subsidies for health insurance will substantially boost spending for Social Security and for major health care programs relative to the size of the economy. At the same time, rising interest rates will significantly increase the government’s debt-service costs. In CBO’s baseline, outlays reach about 23 percent of GDP in 2023 and are on an upward trajectory.
In other words, despite having above-average tax revenues and the effects of sequestration, the federal debt is still going to go up. As will the budget.
Of course, the baseline estimate makes a number of unreasonable assumptions, per existing law. CBO thus publishes its alternative fiscal scenario (what I call the political reality scenario), which makes assumptions about which policies the politicians will choose to further delay. In that scenario, the fiscal situation is a bit different:
• $9.5 trillion will be added to the current level of publicly held debt.
• Tax revenue will be slightly above the 40-year average, at 18.5% of GDP.
• Spending will be very high, at 22.9% of GDP, higher than the 40-year average and only one-tenth of one percent of GDP below that expected in the baseline expectations.
In other words, CBO expects certain tax increases to not happen, and certain spending cuts to not take place. Looking at the baseline expectations, however, even with unlikely-to-happen cuts and tax increases, spending and debt skyrocket.
As is true with any long-term estimates, both the baseline and alternative fiscal scenarios have significant flexibility. One major caveat to the report should be noted: CBO does static analyses of tax policies, not dynamic analyses. In other words, CBO generally expects a dollar of tax increases to mean one dollar more to the government coffers, and a dollar of tax cuts leaves the coffers empty. This method this ignores important considerations with regards to incentives provided by tax policy – considerations which are the core of dynamic analyses of tax policy, which account for changes in spending, saving, investing, and other habits by people as tax incentives change.
In another report released yesterday, CBO analyzed the future economic growth under three potential paths of deficit reduction (not including interest payments and their impact on annual deficits). They are:
Path 1: A $2 Trillion Increase in Primary Deficits. With economic effects and debt service included, the cumulative increase in the deficit would total $2.5 trillion and debt would reach 87 percent of GDP in 2023, compared with, respectively, 73 percent at the end of 2012 and 77 percent projected for fiscal year 2023 under current law (see Figure 1).
Path 2: A $2 Trillion Reduction in Primary Deficits. The total cumulative decrease in the deficit would amount to $2.4 trillion and debt would drop to 67 percent of GDP in fiscal year 2023.
Path 3: A $4 Trillion Reduction in Primary Deficits. The total cumulative decrease in the deficit would amount to $4.8 trillion and debt would drop to 58 percent of GDP in fiscal year 2023.
Here are CBO’s expectations on economic growth in each of the scenarios:
Path 1: A $2 Trillion Increase in Primary Deficits. Real (inflation-adjusted) GNP would be higher, by 0.3 percent, in the fourth quarter of 2014 and lower, by 0.9 percent, in 2023 than it would be under current law (see Table 1).
Path 2: A $2 Trillion Reduction in Primary Deficits. Real GNP would be lower, by 0.3 percent, in the fourth quarter of 2014 and higher, by 0.9 percent, in 2023 than it would be under current law.
Path 3: A $4 trillion Reduction in Primary Deficits. Real GNP would be lower, by 0.6 percent, in the fourth quarter of 2014 and higher, by 1.7 percent, in 2023 than it would be under current law.
In other words, cutting government spending will cause economic growth to slow in 2014, but within a decade be stronger. In other words, CBO recognizes the basic reality Tea Party activists have been promoting and pushing for years.
Partisans constantly spin CBO reports as they see fit, but the simple truth is we need to cut spending, and soon. Keep an eye out for more analysis as the week goes on.