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The Budget Outlook: Updates and Implications


I. Introduction

The Congressional Budget Office (2004) has released new baseline budget projections, covering fiscal years 2005-2014. This paper examines the baseline CBO projections, adjusts the official data in ways that more accurately reflect the current trajectory of tax and spending policies, and discusses some of the implications. We reach the following main conclusions:

  • CBO now projects a 10-year baseline deficit of $1.9 trillion in the unified budget for fiscal years 2005 to 2014. The budget outside of Social Security faces a baseline deficit of $4.3 trillion.
  • These figures represent staggering declines in the budget outlook. Since January 2001, the unified baseline for 2002 to 2011 deteriorated by $8.5 trillion (about $55 billion per week) from a projected surplus of $5.6 trillion to a projected deficit of $2.9 trillion currently.
  • Most (64 percent) of the decline is due to lower revenue projections. The rest is due to higher spending on defense and homeland security (19 percent), and other outlay increases (17 percent). Alternatively, legislated changes account for 60 percent of the decline, economic and technical adjustments for 40 percent.
  • Despite much misleading recent public discussion, the vast majority of the decline in the actual budget over the last four years is due to lower revenues, not higher spending; increases in non-defense discretionary spending have played a particularly modest role in the budget reversal. Between 2000 and 2004, falling revenue accounts for about 75 percent of the increase in the actual deficit as a share of GDP, compared to about 7 percent for domestic discretionary spending outside homeland security. Revenues are currently the lowest share of GDP since 1950, while spending is at its average share of GDP over the past 40 years.
  • As is now widely recognized, the baseline projections use mechanical assumptions that may not be the best representation of current policy. For example, the baseline assume that all expiring tax provisions are allowed to expire, that the alternative minimum tax (AMT) will be allowed to grow explosively, and that real discretionary spending per capita will decline by 8 percent. If the expiring tax provisions are extended, the AMT is held in check (as described below), and real discretionary spending grows with the population, the 10-year unified budget deficit will be $5.5 trillion (3.7 percent of GDP), with deficits of 3.4 percent of GDP or more in every year. These deficits emerge just from efforts to maintain the policy status quo. The differences between the CBO baseline and our adjusted unified budget projections grow over time. In 2014 alone, the difference is more than $740 billion (4.1 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. In the longer term, Social Security and Medicare face significant deficits. Outside of the retirement trust funds, the adjusted 10-year budget faces a deficit of $8.5 trillion over the next decade (5.7 percent of GDP).
  • The simplest way to summarize the fiscal status of the government is thus to note that the retirement trust funds face substantial long-term deficits, and under realistic assumptions about current policy, the rest of government faces deficits in excess of 5 percent of GDP over the next decade.
  • Sustained budget deficits have deleterious consequences. Under assumptions reported by President Bush’s Council of Economic Advisers, the deterioration in the budget outlook since January 2001 will, by 2012, raise interest rates by 125 basis points, reduce annual national income by $340 billion (more than $2,900 per household), and increase U.S. indebtedness to foreign investors. The adverse effects would persist (and grow) over time.
  • It is extremely unlikely that the economy will be able to grow its way out of the deficits, and delaying steps to deal with the problem simply makes it worse. In such an environment, policy-makers may be tempted to turn to budget gimmicks.
  • The only real solution to the nation’s fiscal imbalance is to cut spending and raise taxes. Restoring fiscal discipline will require painful adjustments, and it is unrealistic to think that the required adjustments can be undertaken entirely on one side of the budget or the other. The painful decisions necessary to restore fiscal balance would be easier to enact and especially to enforce if policy-makers reinstated budget rules.
  • Section II summarizes CBO’s recent budget projections and discusses the size and sources of changes in the projections over time. Section III explores adjustments to the official budget baseline. Section IV discusses some of the implications.


    Peter R. Orszag

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

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