Perspectives on the Budget Outlook

Peter R. Orszag and
Peter R. Orszag
Peter R. Orszag Chief Executive Officer - Lazard
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

February 3, 2003

The release of the Congressional Budget Office’s
new baseline budget projections on January 29 offers
the opportunity to reassess the fiscal status of the
federal government as Congress and the administration
consider a new set of budget proposals. This
article examines the current budget outlook, the magnitude
and sources of changes in the outlook since
January 2001, and adjustments to the official data that
more accurately reflect the continuation of current
policy and the government’s underlying financial
status. Based on this analysis, we also provide a very
preliminary and brief assessment of the administration’s
new budget proposals. We reach the following

CBO now projects a 10-year baseline unified
surplus of $1.3 trillion for fiscal years 2004 to
2013. But the budget outside of Social Security
faces a baseline deficit of $1.2 trillion, and outside
of the Medicare and Social Security Trust
Funds, the baseline deficit is $1.6 trillion. (None
of the figures in this article include recent tax
proposals, a Medicare prescription drug benefit,
or the cost of a war with Iraq. Incorporating
these items would make the budget outlook
look less promising.)

These figures represent staggering declines
from the baseline forecasts made two years ago.
The projected unified budget outcome for 2002
to 2011 deteriorated from a projected surplus of
$5.6 trillion (4 percent of GDP) in January 2001
to essentially zero ($20 billion) in January 2003.
The budget outcome for 2002 alone declined by
$471 billion (4.6 percent of GDP).

The short-term changes are due primarily to
worsening economic conditions, which account
for about two-thirds of the decline in 2002 and
about half of the projected change for 2003. The
longer-term changes are due as much to the 2001
tax cut—which accounts for 40 percent of the
deterioration in the budget outlook for 2010—as to economic and technical changes, which
account for 37 percent.

The official projections significantly misrepresent
the government’s underlying fiscal
position because of unrealistic assumptions
regarding the continuation of current policy and
because retirement programs are merged with
other programs in the budget.

Making realistic assumptions about how current
policies will be maintained—in particular,
that expiring tax provisions are extended, a
moderate AMT fix is provided, and real per
capita discretionary spending is held constant—we estimate that the adjusted unified budget
is in deficit for each of the next 10 years and will
cumulate deficits of $1.1 trillion over the decade.
These deficits emerge just from efforts to maintain
the policy status quo. The differences between
the official and our adjusted projections
for the unified budget grow over time. In 2013
alone, the difference exceeds $600 billion (3.6
percent of GDP).

The unified budget figures above include large
cash-flow surpluses accruing in trust funds for
Social Security, Medicare, and government pensions
over the next 10 years. But in the longer
term, Social Security and Medicare face significant
deficits. The adjusted budget outside of
these trust funds faces a deficit of $4.5 trillion
over the next decade, including an adjusted
deficit of 4 percent of GDP in 2003 and an
average deficit of just over 3 percent of GDP
during the rest of the decade.

Policymakers face three sets of budget challenges:
near-term deficits (over the next two years),
medium-term deficits (over the next three to 10
years), and long-term deficits (beyond the 10-
year horizon). The near-term deficits are not a
major problem in and of themselves—the economy
could use a boost right now and unusual
events like a war should be at least partially
funded via deficits.

The implied medium- and long-term deficits,
however, are troubling. First, our adjusted
unified budget shows a deficit in each of the
next 10 years, even though the economy is
predicted to have reached full employment
within the next few years. This indicates a persistent
and fundamental imbalance between
projected tax and spending policies even before
the bulk of the baby boomers will have retired.
Second, the medium-term deficits will be followed
by a period in which projected deficits
rise substantially. The time profile of projected
deficits implies that if fiscal responsibility is not
established in the remainder of this decade, it
will prove much more difficult to do so after the
baby boomers start retiring.

Ignoring the medium- and long-term fiscal gaps
would represent a significant policy mistake.
Making the fiscal gap worse would be an even
bigger mistake. Policymakers should be particularly
wary of proposals that would raise
medium- and long-term deficits; that reduce
medium-term deficits by shifting revenues from
the future to within the 10-year budget window;
or that detract attention from these issues.

The administration’s new budget is replete with
such problematic proposals. These include
making the 2001 tax cut permanent, massively
expanding Roth IRA treatment of saving, encouraging
rollovers of existing IRAs to backloaded
saving plans, and focusing on a five-year
budget horizon. The administration’s policies
would produce unified “deficits as far as the eye
can see” even though the economy is projected
to return to full employment in a few years. The
deficits would be much larger if the retirement
trust funds were not included. The administration’s
proposals would exacerbate the
nation’s fiscal problems in the medium and long