Budget Projections

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.

The $1.8 Trillion Drop in Revenue Projections

With the economy recovering slower than originally anticipated, the government now expects to collect significantly less revenue this decade than it did just two years ago. The most recent budget projections from the Congressional Budget Office (CBO) show the government taking in $1.8 trillion less over a ten-year period than was projected in February 2013.

Growing entitlement spending is the primary source of growth in the federal budget, but this growth would not lead to higher debt if revenues kept pace. Despite the savings from the widely noted $900 billion slowdown in health care spending since March 2011, federal revenues are set even faster, widening the deficit. Over the same 2013-2021 time period, revenue projections have fallen $1.2 trillion since February 2013 and net health care spending has fallen $780 billion since March 2011.

February 2013 was the first budget baseline after the fiscal cliff law, which allowed certain tax cuts for high earners to expire while permanently extending most of the 2001/2003 tax cuts. In that baseline, revenues were expected to climb to 18.5 percent of GDP, both in the immediate future and by the end of the decade. Over the last two years, though, CBO has continually revised these revenue projections downward, particularly in their February baseline of this year. The last month's projections showed revenue staying under 18.2 percent of GDP throughout the period.

Half of the $1.8 trillion is due to decreases in individual income tax revenue. Payroll taxes experienced a similar but smaller decline. Corporate tax revenue is expected to be much lower than expected in the near term – projections for 2016 dropped over 15 percent – but only slightly lower over the long term. Excise taxes are the only exception to the decline, with projections that have slightly increased over the last two years.

How Alternative Policies Could Affect the Budget

CBO's latest budget projections, while a slight improvement, are not good news for the country's fiscal future. Debt is higher than at any time in our country's history other than World War II, will rise to 77 percent of GDP by the end the decade and continue to climb thereafter. But even these projections may be too optimistic, since they assume policymakers do nothing to add to the debt by extending expiring provisions, repealing savings already in place, or enacting new unpaid-for legislation. While this may be a realistic assumption in some cases, policymakers in other cases have shown reckless disregard for budget discipline.

To show that the debt could be worse under different assumptions, CBO produces an "Alternative Fiscal Scenario" (AFS), which assumes that policymakers extend all expiring and expired tax provisions, permanently extend "doc fixes" to avoid a 24 percent Medicare physician payment cut next spring, and repeal the sequester. With these assumptions, debt would reach nearly 86 percent of GDP by the end of the decade.

To show the range of possibilities, we have estimated the debt under two different scenarios.

CRFB Analyzes CBO’s Updated Budget and Economic Forecast

Moments ago, CRFB published a new 6-page paper summarizing CBO’s latest Budget and Economic Outlook. Under its current law baseline, CBO estimates that federal debt held by the public will reach 74 percent of GDP by the end of 2014 – a post-war record and more than twice the level at the end of 2007. Debt will fall slightly to below 73 percent by 2018 but, beyond that, CBO’s forecasts show that debt levels will resume their upward trend, reaching 77.2 percent of GDP in 2024.

This growing debt is largely the result of a projected rise in spending levels not matched by equivalent increases in revenue. While CBO forecasts revenue to remain roughly stable as a share of GDP, at about 18 percent, spending will increase from 20.4 percent of GDP in 2014 to 21.8 percent in 2024. As we explain in our paper:

Much of this increase is due to the growth in the entitlement programs resulting from health care cost growth, population aging, and the coverage expansion under the Affordable Care Act. Social Security will grow from 4.9 percent of GDP in 2014 to 5.6 percent by 2024. Meanwhile, federal health spending will grow from 4.9 percent of GDP to 5.9 percent by 2024. The fastest growing portion of the budget, however, is interest payments; they will rise precipitously as a result of rising interest rates and growing debt levels. Net interest costs are projected to double between 2014 and 2021 -- from 1.3 percent of GDP in 2014 to 2.7 – and grow to 3 percent of GDP by 2024.

Overall, health care programs, Social Security, and interest spending will account for a striking 85 percent of the increase in spending over the next decade.

Newest Budget Projections Show Gloomy Fiscal Picture

The Congressional Budget Office (CBO) just released its August baseline, updating budget projections from April and economic projections from February. In short, CBO continues to show debt on an unsustainable path, rising continuously as a percent of GDP after 2018. Combined with its long-term projections released last month, the agency shows the clear need to enact deficit reduction to avert a huge rise in debt over the long term. 

While debt will improve in the near term, declining from 74.4 percent of GDP in 2014 to 72.8 percent by 2018, it will then rise to 77.2 percent of GDP by 2024. This upward trend would in all likelihood continue beyond 2024 as entitlement and interest spending growth will clearly outpace revenue. These ten-year numbers are largely similar to the April projections, which had debt reaching 78 percent of GDP in 2024.

Debt as a Percent of GDP in CBO's Baseline

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