We present new estimates of the budget outlook, based on the latest projections from the Congressional Budget Office and the Medicare and Social Security Trustee reports. The medium-term budget outlook has not changed appreciably since earlier this year. Under reasonable assumptions, the federal government is likely to face deficits in excess of 6 percent of GDP by late in the decade, with the debt-GDP ratio reaching 90 percent by or before 2020 and passing its previous all-time high of 109 percent by around 2022. The long-term budget outlook is sensitive to assumptions about how health care spending will respond to recent legislation. However, even under the most optimistic assumptions regarding health care spending, the most likely estimate suggests a long-term fiscal gap of between 6 and 7 percent of GDP. Policymakers and the public will eventually be forced to address these issues, but addressing them sooner rather than waiting until a full-blown crisis hits would allow for more reasonable and gradual adjustments.
The United States faces the prospect of large federal fiscal deficits in the immediate future, the next 10 years, and the longer term. The short-term deficits – the result of the tax cuts and spending increases of the last decade, the “Great Recession,” and economic policy adjustments in the past year – are generally thought to be helping the economic recovery. In contrast, the medium-term deficits projected for the next 10 years and the long-term deficits projected beyond 2020 are a source of concern. Even if they do not lead immediately to a crisis, they will nevertheless create growing and serious burdens on the economy.
The unsustainability of federal fiscal policy has been discussed at least since the 1980s. But the problem has increased in importance and urgency in recent years, for several reasons. First, the medium-term projections have deteriorated significantly. Second, the issues driving the long-term projections – in particular, the retirement of the baby boomers and the aging of the population and the resulting pressure on Medicare and to some extent Social Security – which were several decades away in the 1980s – are now imminent. Third, there are increasing questions about the rest of the world’s appetite for U.S. debt, as the United States has changed from a net creditor country in 1980 to a vast net borrower currently. Fourth, many countries around the world and many of the 50 states also face daunting fiscal prospects currently.
In light of these issues, this paper provides new projections of the federal budget over the medium and long terms. This paper provides new projections of federal budget outcomes, using the August 2010 Congressional Budget Office (CBO 2010d) projections, recent reports by the Social Security and Medicare trustees (Medicare Trustees 2010), an analysis by Medicare actuaries (Medicare Actuary 2010). It updates the analysis in Auerbach and Gale (2010), which was written before these reports were published. We highlight both the main results and the changes from the earlier analysis below.
The analysis begins with the Congressional Budget Office (CBO) baseline budget projections. CBO (2010d) projects the 2010 deficit to be $1.34 trillion, about 9 percent of GDP. Other than 2009, this represents the largest deficit as a share of the economy since World War II. For 2011-2020, the CBO baseline projects a cumulative deficit of $6.2 trillion, with deficits declining sharply to 2.5 percent of GDP by 2014 and remaining at or below 3.0 percent of GDP through 2020. This would be a reassuring outcome, except that the CBO baseline is not intended to represent likely or probable outcomes. Rather, it essentially reports the implications of the assumption that Congress does nothing over the next 10 years. All tax provisions currently scheduled to expire are assumed to do so as scheduled, for example.
A more plausible way to project future outcomes may be to assume that future Congresses will act more or less like previous Congresses, for example in granting continuances to expiring tax provisions. To generate a better measure of where fiscal policy is headed, we alter the CBO baseline assumptions in ways that we believe are more representative of the continuation of current policies. Under this extended policy scenario, we estimate a 10-year deficit of $11.5 trillion, or 6.0 percent of GDP. As in CBO’s baseline, deficits decline in the near term, but only to 4.7 percent of GDP by 2014, and unlike in CBO’s baseline, deficits then rise substantially, to 6.6 percent of GDP by 2020.
A third way to project future outcomes is to examine the Administration’s budget proposals. These figures are not quite as pessimistic as those under extended policy, but are troubling nonetheless. The 10-year deficit under Obama policy is projected to be $9.7 trillion. The deficit declines to 3.9 percent of GDP by 2014. By 2020, although the economy is projected to have been at full employment for several years, the deficit rises to 5.2 percent of GDP. Spending rises to 23.7 percent of GDP (the highest since World War II, except for the current downturn), the debt-to-GDP ratio rises to 90 percent (the highest since 1947), and net interest payments rise to 4.1 percent of GDP (the highest share ever and larger than defense or non-defense discretionary spending).
All of these figures are poised to rise further after 2020, implying that the situation is unsustainable. The debt-to-GDP ratio will pass its 1946 high of 108.6 percent by 2033 under the CBO baseline, but much sooner – in 2022- under extended policy. Under both scenarios, however, the debt-to-GDP ratio would then continue to rise rapidly, contrary to its sharp decline in the years immediately after 1946.
All of the estimates above, for the 10-year horizon and the debt-GDP ratio headed into the next decade, are very close to those provided in Auerbach and Gale (2010). That is, little has changed to alter the medium-term (10-year) budget outlook in the period since March, except for health care legislation, which our earlier work incorporated.
The health reform package’s impact on the long-term budget outlook is more controversial. To examine long-term issues more formally, we estimate a long-term fiscal gap – the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt-to-GDP ratio at its current level. Using current-law assumptions for Medicare spending, as put forth by the Medicare trustees (2010), and depending on the time frame employed, the fiscal gap is estimated to be about 4-5 percent of GDP under the assumptions in the CBO baseline, about 5-6 percent of GDP under the assumptions under Obama policy, and about 6-7 percent of GDP in the extended policy scenario. However, the fiscal gap rises by 2-3 percent of GDP under all of these scenarios when substituting the Medicare outlay estimates put forth by the Medicare actuaries (Medicare Trustees 2010) and rises by an additional 1-2 percent when using assumptions employed by CBO (2010d). As a result, the gap is estimated to be as high as 12 percent of GDP under our worst-case scenario. These estimates show both that health care reform is an important part of the long-term budget outlook, but that even very substantial and sustained reform of health care will leave a significant fiscal gap. As a result, the budget outlook will create difficult trade-offs for policy makers and the American public.
 This paper builds on analysis and conventions we have developed in numerous previous papers including Auerbach and Gale (1999, 2000, 2001, 2009, 2010), Auerbach et al. (2003), and Auerbach, Furman and Gale (2007, 2008).