So What Will the Deficit Really Be?

Last week, the Congressional Budget Office (CBO) released its updated Budget and Economic Outlook and the Office of Management and Budget (OMB) released its Mid-Session Review (see our analysis here). Popular press accounts have reported CBO's ten year deficit projections at $7.1 trillion and OMB's at $9.1 trillion. However, it is important to note that these numbers are measuring two different things....

CBO's $7.1 trillion deficit estimate comes from their "current law" baseline (referred to as the BEA baseline) which assumes laws play out as they are on the books. OMB's $9.1 trillion projection is a deficit estimate assuming the passage of all the policies in President Obama's proposed budget. The numbers differ both because they are measuring different things, and because they are relying on different economic and technical assumptions.

In our recent analysis, CRFB has drawn a bridge between these two numbers, using OMB's estimate of the BEA baseline and OMB's estimate of its own "current policy" baseline* as intermediaries. Below, we offer some further explanation of the differences between each of these four measurements of future deficits.

As the chart above shows, CBO's baseline is quite similar to OMB's estimate of the BEA baseline over the next five years. The deficit impact of CBO's decision to treat Fannie Mae and Freddie Mac as government entities is roughly offset by differences in economic and technical assumptions. Between 2015 and 2019, however, CBO expects significantly lower levels of economic growth (2.4% versus 3% annually) resulting in less revenue collection. Because of this and other assumptions, OMB's BEA baseline projects ten year deficit levels roughly $875 billion lower than CBO's baseline

Once calculating the BEA baseline, OMB uses it to construct its own "current policy" baseline. Rather than making projections based upon the policies scheduled under current law, this baseline assumes that politicians will enact legislation to continue certain policies. In particular, they assume all of the 2001 tax cuts will be renewed, the AMT will be patches every year, and scheduled physician payment cuts in Medicare will be averted. Taken as a whole, these policies cost around $4.3 trillion over the next decade.

 From this baseline, the OMB adds in the effects of the President's policy proposals. Health care reform, at least in the President's budget, is projected to be revenue neutral. However, the Administration does expect new tax cuts and increased discretionary spending. At the same time, they project considerable deficit reduction, compared to their current policy baseline, mainly from ending the war in Iraq, allowing the 2001/2003 tax cuts to expire for those making over $250,000 a year, and auctioning carbon permits under a cap and trade system. Taken on the whole, the Administration's policies  are projected to reduce the deficit by $1.5 trillion over the next ten years, relative to their current policy baseline. Relative to a current law baseline, though, their policies would increase the deficit by roughly $2.8 trillion.

So how big will the deficit be over the next ten years? $7.1 trillion, $6.3 trillion, $10.6 trillion, or $9.1 trillion?

Almost certainly, the answer is none of the above. For one, both CBO's and OMB's economic projections come with a considerable amount of uncertainty, especially in the later years. And the size and composition of the economy will dramatically effect the amount of revenue we will raise and spending we will have committed.

In addition, there is considerable uncertainty as to what policies will be enacted. It is highly unlikely that we will simply allow current law to play out, but also implausible that we will adopt and maintain all of the President's policies.

Whatever the situation, though, recent projections suggest a dire fiscal situation over the next decade. To prevent it, we need a fiscal consolidation plan.