Still Crazy After All These Years: Understanding the Budget Outlook

Alan J. Auerbach,
Alan Auerbach Headshot
Alan J. Auerbach Robert D. Burch Professor of Economics and Law - Economics Department, UC-Berkeley, Director - Robert D. Burch Center for Tax Policy and Public Finance
Jason Furman, and
Jason Furman Aetna Professor of the Practice of Economic Policy - Harvard University, Nonresident Senior Fellow - Peterson Institute for International Economics, Former Brookings Expert
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

April 27, 2007

I. Introduction

The United States has gone undergone major fiscal changes in recent years. Despite the tax cuts enacted early in the decade and the increased spending enacted since then, the Congressional Budget Office (CBO, 2007b) currently projects a baseline surplus of $586 billion in the unified budget over the next 10 years. Under the baseline, the deficit will decline over the next few years, and turn to a surplus by 2012 that will continue to grow through 2017. This paper evaluates recent fiscal outcomes and assesses future fiscal prospects.

First, we review recent changes in the budget outlook. There has been a sizable net deterioration in the budget outlook since 2001. For example, in January 2001, the CBO baseline projected a unified budget surplus of $573 billion in 2007. CBO’s baseline now projects a deficit of $177 billion for 2007 – a deterioration of $750 billion or about 5.5 percent of GDP. This deterioration is due almost entirely to changes in policy. For example, more than 90 percent of the deterioration in the 2007 outlook since 2001 is attributable, according to CBO estimates, to policy changes – tax cuts and increases in spending. The changes in the deficit since 2001 reflect differing trends in policy choices and in economic factors. Beginning in 2001 the deficit rose due to a series of policy changes, including tax cuts, a new Medicare entitlement, and increased spending on defense and homeland security. These policy changes have increased the deficit with each passing year. At the same time, the economy and technical factors that caused revenues to decline in the early 2000s have recovered strongly in recent years. In short, the economic and technical factors that elevated the deficit from 2002-05 have almost entirely reversed themselves, while the effects of policy changes continue to accumulate. As a result, almost all of the net change in fiscal projections since 2001 is due to deficit-increasing changes in policy.