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The Budget Outlook: Analysis and Implications


The Congressional Budget Office’s mid-year update of the economic and budget
outlook, released in late August, provides an opportunity to glean new perspectives on
the fiscal status of the federal government. In a prior paper, we adjust the baseline
projections to provide more appropriate measures of the implications of continuing
current policy and of the underlying financial status of the government (Gale and Orszag
2003c). In this paper, we assess the budget outlook and discuss implications for policy,
with the following principal conclusions:

  • Realistic budget projections show a fundamental, persistent, and growing shortfall
    of projected revenues relative to spending. This implies that the United States is
    on an unsustainable long-term fiscal path and an imbalanced medium-term path.
    Although the CBO baseline projectes unified deficits that average 1 percent of
    GDP and shrink over the next decade, realistic assumptions about current policy
    imply persistent deficits of in excess of 3 percent of GDP in the unified budget
    and in excess of 5 percent of GDP exclusive of retirement trust funds. Under
    reasonable assumptions about current policy, public debt will rise significantly
    and continually as a share of GDP over the next decade, and the full-employment
    deficit excluding the social security trust fund will remain near post-war highs as
    a share of GDP for the latter half of the decade. All budget projections
    deterioriate sharply and permanently after the current decade ends.
  • The deterioration in budget outcomes over the next decade is due largely to a
    decline in revenues relative to prior projections and relative to earlier years.
    Revenues are projected to be more than 1 percent of GDP lower in the next
    decade than over the previous 40 years, whereas spending is projected to be at its
    average share of GDP. Between January 2001 and August 2003, the projected
    budget surplus for 2010 declined by $941 billion, of which 43 percent is due to
    lower revenues and 15 percent is due to increased homeland security and defense
    spending. Net interest payments account–allocated in proportion to the two items
    above–account for 39 percent of the decline. Increased spending on all other
    items accounts for just 1 percent of the decline.
  • It is unlikely that any realistic revision to economic growth projections would be
    sufficient to make the budget problem disappear.
  • If the unified budget, based on realistic assumptions, were to be balanced by
    spending cuts alone, the required reductions would be substantial. For example,
    eliminating the projected (adjusted) unified deficit in 2008 would require a 17
    percent in all non-interest outlays in that year or a 57 percent cut in all outlays
    other than defense, homeland security, net interest, Social Security, Medicare, and
    Medicaid. (For purposes of illustration, these figures focus exclusively on policy
    changes in 2008 and assume no changes before then.)
  • Extending the Administration’s tax cuts, which expire by 2011, and the other
    expiring provisions in the tax code would reduce revenues on a permanent basis
    by 2.5 percent of GDP. This decline is larger than the shortfalls in the Social
    Security and Medicare Hospital Insurance trust funds over the next 75 years.
  • The Administration essentially has no policy to address these issues. It claims its
    policy is to cut spending and to cut taxes to make the economy grow. But it is
    raising spending, and even if its tax cuts raise growth–which most studies find to
    be unlikely–the effects on growth will be insufficient to offset the direct revenue
    losses, as even the Administration’s own writings conclude. In other words, it is
    entirely implausible that the tax cuts are “part of the solution” to the projected
    budget imbalance, rather than part of the problem.
  • A realistic policy response would (a) re-impose the budget rules that have
    expired, (b) trim spending, and (c) allow at least the bulk of the expiring tax
    provisions to sunset as scheduled and roll back some of the more egregious
    features of the recent tax cuts before they are scheduled to sunset.
  • Section I summarizes key features of the budget outlook. Section II discusses the
    economic consequences of budget deficits. Section III compares recent and projected
    trends in deficits, debt, spending and taxes. Section IV provides a framework for
    considering policy responses. Section V considers the Administration’s actions and other
    possible policy responses.

    Peter R. Orszag

    Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard

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