Budget Projections

How Much Savings Would It Take to Make Debt Sustainable?

CBO's budget outlook, little changed since its last update, shows the same story it has for a few years: the debt picture will stabilize through about the end of the decade, but then will grow by nearly 5 percentage points of GDP between 2020 and 2025 from 74 to 79 percent of GDP.

Simply stabilizing the debt at current levels would require $1.3 trillion of deficit reduction over a decade, while putting debt on a downward path as a share of GDP -- a minimum standard of sustainability  -- would require $2.4 trillion of savings.

In previous iterations of CBO's baseline, we showed an illustrative savings path that would leave debt clearly declining as a percent of GDP. For example, in May 2013, we showed that it would take $2.2 trillion of savings over ten years compared to our realistic baseline to put debt on a downward path to 67 percent by 2023. We used this level because the downward path proved robust to having more frontloaded savings, worsening economic projections, and lawmakers enacting deficit-increasing policies.

However, two years have now passed and CBO's projections worsened in the meantime, so the target could be somewhat more lax but require higher savings. Getting debt to 70 percent of GDP by 2025 would take $2.4 trillion of savings compared to CBO's baseline. We estimate that a reasonably backloaded plan of this magnitude would put the trajectory of debt on a clear downward path, and leave deficits in a consistent decline to about 2 percent of GDP by 2025 (instead of deficits increasing as a percent of GDP after 2016 under current law). Of course, actual plans may vary and the extent to which they would ensure long-term sustainability depends greatly on the types of policies included.

CRFB Publishes Analysis of CBO's 2015 Budget and Economic Outlook

Yesterday, CRFB published an analysis of CBO’s latest Budget and Economic Outlook. The six-page document summarizes the forecasts and emphasizes the return of trillion-dollar deficits over the next ten years. Although CBO projects slightly decreasing deficits over the next two years, there will be a jump from a 2016 low of $467 billion to a $1.09 trillion by 2025.

CBO Report Shows Return of Trillion-Dollar Deficits

Trillion-dollar deficits are coming back in 2025. That's one of the many stories told by the new budget update released today by the Congressional Budget Office. The deficit, which had fallen to a post-recession low of $483 billion (2.8 percent of GDP) last year, is projected to fall slightly more this year to $468 billion (2.6 percent of GDP), but increase to reach $1.09 trillion (4.0 percent of GDP) by 2025.

Debt will also grow substantially in nominal dollars, from $13 trillion today to $21.6 trillion by 2025. As a percent of GDP, debt will remain stable near its current post-war record of around 74 percent of GDP through 2020, but then it too will start rising quickly, reaching nearly 79 percent of GDP by 2025 and continuing to grow thereafter. As CBO explains, this continuing long-term growth would not be sustainable:

Such large and growing federal debt would have serious negative consequences, including increasing federal spending for interest payments; restraining economic growth in the long term; giving policymakers less flexibility to respond to unexpected challenges; and eventually heightening the risk of a fiscal crisis.


 

CRS Talks About Need for Fiscal Sustainability and Plans to Achieve It

The Congressional Research Service's Jane Gravelle recently put out a paper on plans to address long-term deficits and debt. The piece both goes through the many problems with the current budget outlook and different plans that have tried to address it.

Gravelle notes that debt will rise significantly over the next quarter-century to exceed the size of the economy, despite the fact that non-health and non-Social Security spending will decline as a share of GDP.

Although the debt held by the public is projected to be relatively stable over the next decade, the Congressional Budget Office (CBO) projects it will rise to 106% of GDP by 2039. This increase in debt is mainly due to growth in federal spending on health care programs and Social Security, as well as increasing interest payments that typically accompany rising budget deficits. Although spending on these programs is rising, other types of federal spending have remained constant or declined. These trajectories are projected to continue under current policy.

The following table shows how certain areas of the budget are expected to grow or contract as a percent of the economy between 2013 or 2024.

Discussing the Uncertainty of Long-Term Budget Projections

An old saying goes, "Nothing is certain but death and taxes." But in budget projections, neither of those things -- mortality rates nor revenue levels -- nor a host of other economic and technical variables can be predicted with perfect precision. This simple fact has led many commentators to question the usefulness of long-term forecasts that go out as far as 75 years, but also prompted suggestions about how to reduce uncertainty or at least tailor policies to account for it. On Monday, the Brookings Institution's Hutchins Center on Fiscal and Monetary Policy released three working papers and held an event shedding light on both of these questions.

The first paper "The Economics and Politics of Long-Term Budget Projections" by Brookings Senior Fellow Henry Aaron discussed the usefulness of various long-term projections. He argued that 75-year projections for the overall budget -- performed by CBO -- and for Medicare -- performed by their Trustees -- are not all that helpful and should be limited to 25 years. He argued that requiring 75-year numbers forces forecasters to make unrealistic assumptions or otherwise make arbitrary determinations about very uncertain variables like health care cost growth. He did see a use in 75-year projections for Social Security because of lawmakers' tendency to make very gradual benefit cuts, so that lengthy projection period is necessary to fully measure the financial impact of legislation and see how much of a shortfall they have to close.

While Aaron suggested that long-term projections other than Social Security are not useful, University of California, Berkeley's Alan Auerbach takes the opposite conclusion: the uncertainty makes it all the more important to reduce deficits since things could be worse.

His paper entitled "Fiscal Uncertainty and How to Deal With It" started by acknowledging the many different changes in economic variables that can affect the budget. Of course, the uncertainty also compounds the longer projections go for, as more variables factor in and the chance of error increases. But he did not see this as a reason to disregard the projections all together.


Source: Brookings Institution

Why the 40-Year Average is a Poor Benchmark

In response to Howard Gleckman's piece on the FY 2014 deficit where he noted that the budget had returned to "normal," Donald Marron wrote that the most common concept of normal is not all that useful. The 2014 budget ended up being close to the 40-year historical averages for spending, revenue, and deficits. That average is often considered a benchmark for fiscal metrics, and it is frequently used by the CBO and others.

Still, Marron notes that this average may not be helpful in assessing the appropriateness of the size of deficits because of what those deficits have lead to and how bad years can skew the numbers.

But what has been the result of that “normal” policy? From 1975 to today, the federal debt swelled from less than 25 percent of GDP to more than 70 percent. I don’t think many people would view that as normal. Or maybe it is normal, but not in a good way.

Just before the Great Recession, the federal debt was only 35 percent of GDP. Over the previous four decades (1968 through 2007), the deficit had averaged 2.3 percent of GDP, almost a percentage point lower than today’s 40-year average.

But what would be a better benchmark? Brad DeLong suggests having deficits to keep debt-to-GDP constant, but that has a few problems. In the current context, it would leave debt at a historically high level and leave no room for error. Below, we will look at a few other benchmarks.

Falling Deficit is Not a Sign of Fiscal Sustainability

With the Congressional Budget Office's (CBO) year-end Monthly Budget Review having been released, we published a report today showing what the 2014 totals mean for the budget.  The FY 2014 budget deficit totaled $486 billion, according to CBO’s estimates (official numbers will come from the Treasury Department on Friday). Although this is nearly 30 percent below the FY 2013 deficit and two-thirds below the 2009 peak, the country remains on an unsustainable fiscal path.

What Happened to Interest Rates?

One of the biggest stories in CBO's August budget update was the huge downward revision to expected spending on interest to service the debt, down by $615 billion in total through 2024.

Primarily, this revision stems from lower projected interest rates, resulting in $465 billion less spending over ten years. Another $90 billion came from technical changes (mostly from estimates of payments on inflation-protected debt securities), and $60 billion came from a lower debt burden as a result of all the revisions in the new baseline (a change known as debt service). The interest rate story is the most interesting, though, since it has the largest implications for the federal government's interest burden in the future.

Our analysis of the report noted that interest rates had been revised down both in the short term and the longer term. In 2014, the rate on ten-year Treasury notes is now expected to average 2.8 percent rather than 3.1 percent, and to stabilize by 2019 at 4.7 percent instead of 5.0 percent. CBO made a similar revision to projected three-month T-bill rates. As a result of these changes, interest spending was revised down by more than $30 billion through 2016 and by $50-65 billion annually in the 2017-2024 period.

This downward revision by CBO continues a recent trend of declining projections as interest rates have stayed depressed for longer and the economy has been slower to recover than CBO originally anticipated.

CFR: U.S. Falling Behind Other Advanced Countries on Debt

The Council on Foreign Relations has released a new report and scorecard comparing the United States federal debt situation to other G-7 countries (Canada, France, Germany, Italy, Japan, and the United Kingdom). The verdict is not good. While the U.S. had a much lower debt-to-GDP ratio in 2000 than the G-7 average, it has since caught up and is expected to have higher debt than every country in the group besides Japan by 2040. The report's author Rebecca Strauss shows the deterioration in the U.S. fiscal position since 2000 plus the daunting trajectory of debt going forward.

Although the G-7 as a whole has seen its debt rise as a percent of GDP since 2000, the U.S. government's rise has been much faster, with debt more than doubling over that time period. Average G-7 debt was 54 percent of GDP in 2000 compared to 34 percent for the United States. Since then, U.S. debt has grown to nearly the levels of the G-7, with average G-7 debt at 86 percent and the U.S. at 82 percent (note the report uses different numbers than CBO in order to make an apples-to-apples comparison with other countries). In addition, the share of debt owned by foreign countries has risen from one-third to about half in that period of time. Much of the growth in U.S. debt has come since 2009, when deficits averaged 7.6 percent of GDP largely due to the financial crisis, slow recovery, and economic stimulus measures.


Source: International Monetary fund

Separating "Current Law" from A "Do Nothing" Baseline

CBO’s baseline budget projections are often referred to as “current law” since they generally assume Congress continues the laws as they are written (even when that is not the most realistic scenario). However, CBO’s baseline deviates in several important ways from what would happen under a strict interpretation of current law -- that is, if Congress were to pass no new laws.

For context, the CBO baseline is based on specifications laid out in the Congressional Budget Act of 1974 and the Gramm-Rudman-Hollings Act of 1985. Lawmakers wanted the baseline to be a useful benchmark against which to measure legislative changes, so they modified the baseline's assumptions from "pure" current law to better accomplish that goal. These deviations ensure that lawmakers will get relevant information about the magnitude of policy changes rather than having them obscured by technicalities. CBO is instructed to modify the strict interpretation of current law in cases when not doing so would be clearly unreasonable and thus devalue the baseline's function.

CBO's baseline differs from a strict current law baseline in four main ways.

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