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Perspectives on the Budget Outlook


I. Introduction. The release of the Congressional Budget Office’s new baseline budget projections 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 paper 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 government’s financial status. We reach the following conclusions:

· 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 these baseline projections, nor any of the other figures in this paper, includes the budget cost of the recent tax proposals, , a Medicare prescription drug benefit, or the cost of a possible war with Iraq. Incorporating such costs would make the budget outlook look even 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 in January 2001 to essentially zero ($20 billion) in January 2003. The budget outcome for 2002 alone declined by $471 billion: instead of a projected surplus of $313 billion, the unified budget ran a deficit of $158 billion.

· Although significant controversy has surrounded the sources of these changes, the fundamental story is clear. The short-term changes are due primarily to worsening economic conditions, which account for about two-thirds of the decline in the 2002 budget and about half of the projected baseline change for 2003. In contrast, the longerterm changes are due as much to the 2001 tax cut as to economic and technical changes. For example, the 2001 tax cut accounts for 40 percent of the deterioration in the budget outlook for 2010; economic and technical changes account for 37 percent.

· The official projections significantly misrepresent the government?s underlying fiscal position. Adjusting the projections to provide more realistic estimates of the future implications of current tax and spending policies leaves a bleaker picture than the official figures suggest. After making these adjustments, the adjusted unified budget projection shows a deficit in every single year through 2013 and a 10-year deficit of about of about $1.0 trillion. This deficit emerges just from efforts to maintain the policy status quo. The differences between the official unified budget baseline and the adjusted projections for the unified budget grow over time. The difference between the official and adjusted outcomes for the unified budget in 2013 alone is more than $600 billion.

· All of these 10-year figures for the unified budget depend on large surpluses accruing in trust funds for Social Security, Medicare, and government pensions. The adjusted budget outside of these trust funds faces a deficit of $4.4 trillion over the next decade.

· Policy makers 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). Although 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 medium-term deficits are troubling, especially since they will be followed by a period in which projected deficits rise substantially. Ignoring the medium- and long-term fiscal gaps would represent a significant policy mistake. Likewise, efforts to reduce the medium-term deficit that in turn raise the longer-term deficit should be seen as disingenuous and misleading. 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.

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.

Peter R. Orszag

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

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