The Vanishing Budget Surplus: Interpreting CBO’s New Projections and Fiscal Prospects

Peter R. Orszag and
Peter R. Orszag Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - 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

August 29, 2002

The official federal budget outlook has deteriorated dramatically since January 2001.
The same period has also witnessed increasing recognition that the official budget projections
provide a faulty measure of the nation’s underlying fiscal situation. Recent corporate scandals have heightened concern that misleading accounting data can substantially misrepresent an
entity’s financial health; although federal budget figures are clearly not intentionally fraudulent, as appears to have been the case in some corporate settings, the basic concern about the accuracy of budget figures is relevant to the federal government. With these issues in mind, this paper examines the current budget outlook, the sources of changes in the outlook since January 2001, and adjustments to the official data that more accurately reflect the government’s financial status.

We report three sets of conclusions:

First, the Congressional Budget Office (CBO 2002b) now projects a 10-year baseline surplus of $1 trillion. These projections also show that outside the Social Security Trust Funds, the budget has a deficit of $1.5 trillion over the next 10 years; omitting the Medicare Hospital Insurance Trust Fund as well, the deficit amounts to $1.9 trillion.
These figures represent astonishingly large declines from the forecasts made just 20 months ago. The projected outcome for the fixed time period of 2002 to 2010
deteriorated on a unified budget basis from a surplus of $4.7 trillion in January 2001 to
essentially zero ($13 billion) in August 2002. The projected outcome for 2002 alone changed by $470 billion, from a surplus of $313 billion in January 2001 to a deficit of $157 billion in August 2002.

Second, although much controversy has surrounded the sources of these changes, the fundamental story is quite clear. The short-term changes are due primarily to worsening economic conditions, which account for about two-thirds of decline in the 2002 budget
and half of the projected changes for 2003 to 2005. In contrast, the longer-term changes are due as much to the 2001 tax cut as to economic and technical changes, each of which accounts for just under 40 percent of the decline in projected surpluses between 2007 and 2011.

Third, federal budgeting methods significantly misrepresent the government’s underlying fiscal position. Adjusting the official projections to separate retirement trust funds from the rest of the budget and to provide more realistic estimates of the future implications of current tax and spending policy leaves a far bleaker picture than the official figures suggest. After making these adjustments, the 10-year budget projection shows a deficit
of more than $5.5 trillion—rather than the official surplus of $1 trillion. Moreover, the
differences between the official and adjusted projections grow over time, with the official surplus rising over time and the adjusted deficit rising over time. By 2012, the annual difference between the official and adjusted budget outcomes is almost $1.3 trillion.

Section II summarizes CBO’s recent budget projections and discusses the level and sources of changes in the projections over time. Section III explores adjustments to the official budget baseline. Section IV offers a set of concluding remarks.