Deficits and Debt
Original October 8th: the Congressional Budget Office (CBO) projected the FY 2014 budget deficit at $486 billion. While the CBO works closely with Treasury to come up with their estimates, CBO's report was preliminary.
The FY2014 budget deficit totaled $483 billion, according to today’s statement from the Treasury Department. Although this is nearly 30 percent below the FY2013 deficit and 66 percent below its 2009 peak, the country remains on an unsustainable fiscal path.
In this paper, we show:
- Annual deficits have fallen substantially over the past five years, largely due to rapid increases in revenue (mostly from the economic recovery), the reversal of one-time spending during the financial crisis, small decreases in defense spending, and slow growth in other areas.
- Simply citing the 66 percent fall in deficits over the past five years without context is misleading, since it follows an almost 800 percent increase that brought deficits to record-high levels.
- Even as deficits have fallen, debt has continued to rise, more than doubling as a percent of GDP since 2007 to record levels not seen other than during a brief period around World War II.
- Both deficits and debt are projected to rise over the next decade and beyond, with trillion-dollar deficits returning by 2025 and debt exceeding the size of the economy before 2040, and as soon as 2030.
Unfortunately, the recent fall in deficits is not a sign of fiscal sustainability.
The Deficit in FY2014
According to the Treasury Department, the federal deficit totaled $483 billion in FY2014 (an initial estimate from the Congressional Budget Office on October 8th estimated the deficit at $486 billion), with $3.02 trillion of revenue and $3.50 trillion of spending. The figure below largely reflects CBO’s estimates rather than Treasury’s final numbers.
Since 2009, the budget picture has changed significantly, with deficits falling by 66 percent, from $1.4 trillion to slightly under $500 billion. This reduction was driven largely by the 44 percent (roughly $900 billion) increase in tax collections, primarily a result of the economic recovery, which has helped restore revenues as a share of GDP from their depressed 2009 levels to about their historical average. New taxes from the American Taxpayer Relief Act and the Affordable Care Act have also played a role.
At the same time, nominal spending is nearly $15 billion lower than in 2009, even as the economy grows, and inflation erodes its value. The decreases are largely driven by the absence and reversal of financial rescue and economic recovery spending through the Troubled Asset Relief Program (TARP), the rescue of Fannie Mae and Freddie Mac, and the stimulus, though defense spending has also fallen. Most other categories of spending have grown in nominal terms; however, Medicare, non-defense discretionary spending, and interest costs have grown more slowly than was expected.
Importantly, at $483 billion (2.8 percent of GDP), last year’s deficit was still substantially higher than the pre-recession deficit of $161 billion (1.1 percent of GDP) in 2007.
Deficits Fell From Record Levels But Will Rise Again
A 66 percent drop in annual deficits since 2009 is certainly significant, but when put in context it is less impressive than some would suggest. The rapid fall was from record-high levels and followed a rapid increase. At $1.4 trillion, the 2009 deficit was the highest ever as a share of the economy except during World War II (and in real dollar terms, the highest in history), having increased 779 percent from 2007 as a result of the Great Recession and measures enacted to combat it.
Moreover, while legislated spending reductions, tax increases, and other factors played a role, the end of trillion-dollar deficits was mostly the expected result of the economic recovery and the fading of measures intended to boost the recovery. As unemployment rates have fallen and GDP recovers, revenue collection has risen to more normal levels and countercyclical spending in areas such as unemployment insurance and food stamps has begun to subside. Meanwhile, stimulus and financial rescue measures enacted to speed the recovery have mostly wound down.
Unfortunately, even with these gains, the deficit remains more than three times as high as in 2007 (1.7 percentage points higher as a percent of GDP) and is projected to grow over time. Under CBO’s current law baseline, annual deficits will return to trillion-dollar levels by 2025. Under their more pessimistic Alternative Fiscal Scenario, the deficit will reach $1.5 trillion in 2025, exceeding the nominal-dollar record set in 2009.
As Deficits Fall, the Debt Keeps Rising
Arguably the most important metric of a country’s fiscal health is its debt-to-GDP ratio. And unfortunately, even as deficits have fallen the last five years, debt has grown. Indeed, over the same period that deficits fell by 66 percent, nominal debt held by the public grew by 69 percent – from $7.5 trillion to $12.8 trillion. As a percent of GDP, debt has grown extremely rapidly, from 35 percent of GDP in 2007 to 52 percent of in 2009 and to over 74 percent in 2014.
Falling deficits have not prevented the debt from growing; rather, they have only slowed down the growth trend. While the debt-to-GDP ratio may stabilize for a few years, debt is projected to continue growing faster than the economy over the long run. As the population ages, health care costs grow, and interest rates rise to more normal levels, CBO projects debt will rise from 73 percent of GDP in 2018 to 77 percent of GDP by 2024, and will exceed the size of the economy before 2040. Under CBO’s Alternative Fiscal Scenario (AFS), debt will exceed the size of the economy before 2030.
The fact that deficits have fallen from their trillion-plus dollar levels is an encouraging sign that the economy continues to recover. Unfortunately, Washington’s myopic focus on short-term deficits has likely slowed the recovery by cutting deficits somewhat too fast in the short term while leaving substantial imbalances in place over the long term.
While the deficit has indeed dropped significantly, this drop followed a massive increase, was largely expected, and does not suggest the country is on a sustainable fiscal path. Currently, debt levels are at historic highs and projected to grow unsustainably over the long run.
In only a decade, deficits are projected to again exceed $1 trillion, and within 15 to 25 years debt is projected to exceed the entire size of the economy.
Policymakers must work together on serious tax and entitlement reforms to put debt on a clear downward path relative to the economy, not declare false victories and sweep the debt issue under the rug.
Download a printer-friendly version of the paper here.
Today, the Congressional Budget Office (CBO) released updated budget and economic projections for the coming decade, showing today’s record-high debt levels continuing to rise over the next decade. The report focuses on a “current law” baseline, which assumes policymakers break with the current practice of deficit-financing extensions of various expired or expiring policies. Even under this somewhat optimistic scenario, CBO shows the following:
- In nominal dollars, deficits will grow from $506 billion in 2014 to $960 billion in 2024, and debt will grow from $12.8 trillion to $20.6 trillion.
- As a percent of GDP, debt will stabilize around its post-World War II record high of 74 percent through 2020, before rising to above 77 percent of GDP by 2024.
- Deficits will remain below 3 percent of GDP through 2018, but rise to 3.6 percent of GDP by 2024.
- Federal revenues will stabilize at about 18 percent of GDP, while spending will grow from 20.4 percent of GDP in 2014 to 21.8 percent in 2024.
- The fastest growing part of the budget is interest payments, which will rise from 1.3 to 3.0 percent of GDP by 2024. Spending on the major health and retirement programs will grow from 9.8 to 11.5 percent of GDP.
- Compared with prior estimates, CBO expects the economy to be somewhat weaker, mostly due to 2014 growth being 1.2 percentage points lower.
- Compared with prior projections, CBO expects the debt to be about $400 billion lower in 2024, reaching 77.2 percent of GDP rather than 78 percent.
- If extrapolated forward, we find CBO would project debt to exceed the size of the economy before 2040 and reach nearly 150 percent of GDP by 2060.
CBO continues to show an unsustainable outlook for federal debt, even under current law. Under CBO’s Alternative Fiscal Scenario, where Congress extends various expiring tax provisions, continues “doc fixes,” and eliminates sequestration, debt would reach 85.7 percent of GDP in 2024 instead of 77.2 percent. Lawmakers will therefore need to strictly abide by pay-as-you-go rules and take steps to control the growth of entitlement spending, while enacting other tax and spending reforms to put debt on a downward path over the long run.
See the full paper below, or download it here.
The Congressional Budget Office (CBO) today released its 2014 Long-Term Budget Outlook, detailing the budget picture for the next 75 years. The report shows debt rising as a share of the economy continuously after 2017, a trend which CBO describes as unsustainable over the long run.
Under the Extended Baseline Scenario (EBS), which assumes that policymakers allow temporary spending and tax provisions to expire and do not further increase deficits in the years ahead, debt held by the public will rise from 74 percent of Gross Domestic Product (GDP) in 2014 – a post-war record – to 108 percent by 2040, 147 percent by 2060, and 212 percent by 2085.
This dramatic rise in debt assumes policymakers act in a fiscally responsible manner. The Alternative Fiscal Scenario (AFS), which assumes that policymakers will increase spending and reduce taxes compared to current law, shows a steeper climb in debt – to 170 percent of GDP by 2040, and by our calculations to 330 percent by 2060, and 620 percent by 2085.
Despite legislation in recent years to raise revenue and reduce spending – particularly discretionary spending – the long-term debt situation remains far from solved. Health and retirement programs will continue to grow faster than the economy at a quicker pace than revenue growth, leading to growing deficits, rising interest costs, and ever-rising debt levels.
Policymakers should act quickly to put in place tax and entitlement reforms to put debt on a sustainable long-term path. The longer we wait to act, the more severe the consequences and the more painful the choices will be.
See the full paper below, or download it here.
Note: The paper's mention of the change in deficits from 2015 to 2024 has been corrected.
The Hill | October 29, 2013
The recent budget showdown was both completely predictable and totally avoidable, as was the resulting damage to our economy and public confidence in our government. Not only did the shutdown and debt-ceiling standoff slow growth, waste money and inhibit basic governmental functions, but it distracted from the real issue: the long-term debt challenge facing our nation.
It is time for leaders to break the cycle of bouncing from crisis to crisis by taking three common-sense steps: Stop the madness, start talking and solve the problem.
Reopening the government and raising the debt ceiling was a good start in at least putting the madness on hold, and agreeing to establish a conference committee on the budget resolution will help facilitate a start of discussions. Our leaders must now find a way to make these discussions fruitful both in terms of slowing the growth of our debt and ending the practice of operating the world’s largest economy on a month-to-month basis.
We suggest deliberations should start by identifying areas of agreement. There seems to be broad-based support for reforming farm subsidies, modifying the federal worker retirement system and charging user fees that better reflect the actual costs of certain government programs. Savings in these areas could be used to soften the blow of the mindless sequestration over the next year or two and allow appropriators to fund defense and non-defense discretionary programs at more reasonable levels.
Trading across-the-board, temporary and anti-growth cuts for more targeted and permanent savings would represent an important step, but negotiators must resist the temptation to declare victory with such a “small ball” approach.
As Congressional Budget Office Director Doug Elmendorf recently warned, despite some improvements, “the fundamental federal budgetary challenge has hardly been addressed.” A budget conference that does not make progress in this area will not have lived up to its potential.
And progress could indeed be made if leaders start talking to each other instead of talking at each other. The two parties have been close to agreement in the past, and there is more potential for common ground than either side realizes.
Both sides have taken encouraging steps toward a principled compromise. The budget President Obama put forward earlier this year incorporated some tough choices and politically difficult compromises, including adopting a chained Consumer Price Index to measure inflation more accurately and achieving significant savings from Medicare. House Budget Committee Chairman Paul Ryan (R-Wis.) recently identified a number of areas of potential agreement in an op-ed, including means-testing Medicare premiums, modernizing Medicare cost-sharing rules and pursuing pro-growth tax reform.
Building from some of these policies and concepts, any responsible plan must have a few key elements. It should slow the rate of growth in federal healthcare spending by enacting structural reforms that improve incentives for all parties. It should eliminate unwarranted subsidies and low-priority spending while reducing fraud and improving the way we index the federal budget to inflation. It should protect and enhance important investments and support for low-income individuals. It should put in place a process that allows House Ways and Means Committee Chairman Dave Camp (R-Mich.) and Senate Finance Committee Chairman Max Baucus (D-Mont.) to pursue comprehensive tax reform that cuts tax preferences to lower rates, promotes growth and reduces the deficit. Finally, it should find a way to reform Social Security on a separate track to make the program financially sound for future generations.
Savings from these policies should be used both to reduce the mindless cuts from sequestration and help to stabilize and reduce the debt as a share of the economy. A plan large enough to at least stabilize the debt could also be used to justify a permanent indexing of the debt limit, which would put an end to the repeated political brinksmanship by eliminating the need to pass debt-ceiling increases so long as the debt remains on a sustainable path.
Earlier this year, the two of us put forward a plan — built on the progress made in previous bipartisan negotiations — to achieve $2.5 trillion in savings, replacing the sequester with smarter, more gradual deficit reduction that would avoid disrupting a fragile economic recovery while putting the debt on a clear downward path relative to the economy over the next 10 years and beyond. Importantly, the plan would achieve this deficit reduction while respecting the principles and priorities of both parties. It called for significant savings from entitlement reforms, but with important protections for low-income and vulnerable populations. Likewise, it proposed additional revenues for deficit reduction, provided that those revenues be achieved through pro-growth tax reform and not higher marginal income rates.
The proposal we put forward is not our ideal plan, and it is certainly not the only plan. We also recognize that it may not be possible to reach a bipartisan agreement on a plan as aggressive as the one we put forward. But so far, we have done the easy stuff (raising taxes on the wealthy and calling for unspecified cuts in discretionary spending) and we’ve done the stupid stuff (across-the-board cuts under sequestration). Now it’s time to do the tough stuff and the smart stuff: reforming our entitlements and tax code.
Policymakers should seek to reach agreement on a framework that at a minimum stabilizes the debt as a share of GDP. Reaching such an agreement will require Democrats to accept some structural reforms of entitlements, and will require Republicans to use a portion of revenues that will result from simplifying the tax code for deficit reduction, instead of using all savings to reduce tax rates. But such an agreement is achievable.
It is going to take real political courage on both sides to come together to find common ground. The problem is real, the solutions are painful, and there is no easy way out. But there is room for a solution if both parties commit to stop the madness, start talking and solve the problem.
The Hill | October 9, 2013
We are on a collision course with financial calamity. A first-time-ever failure to extend the federal debt limit would lead to higher interest rates not only for the U.S. government, but also for every business, home, car, student and personal loan in America. The looming debt ceiling — and the ongoing government shutdown — is causing harmful uncertainty around the world and here at home.
But there is a way out.
It’s right in front of us. Bipartisan proposals have been advanced to get America back on track. Whether it is Simpson-Bowles, Domenici-Rivlin or even where President Obama and Speaker John Boehner (R-Ohio) left off their negotiations two years ago, there are common elements in all of these plans that could be implemented now to bring this crisis to a close.
Here are the common elements:
- Extend the debt limit for at least one year, preferably two, without condition. That aligns with Obama’s position that we not negotiate on the debt limit.
- Do the negotiating within the context of a continuing resolution to fund the government and end the shutdown.
- Agree to the Republican funding level of $988 billion for this fiscal year.
- Agree on a process for individual and corporate tax reform next year. The goal should be to reduce rates and raise additional revenue to go toward deficit reduction. A reasonable goal would be $300 billion to $400 billion in additional revenue over the next 10 years.
- Agree to additional savings in Medicare and other healthcare accounts by better coordinating care, especially of the chronically ill. A reasonable target would be $300 billion to $400 billion over the next 10 years.
- Take the savings from numbers 4 and 5 above and use them to cut in half the effects of the sequester.
- Adopt “chained CPI” as a more accurate measure of inflation that both reduces spending and raises revenue. The combined effect is a savings of about $250 billion over the next 10 years
- Repeal the medical device tax of 2.3 percent, about which no one seems enthusiastic.
- Name a commission to reform Social Security to ensure its long-term solvency. The longer we wait, the more draconian the solutions will have to be.
Of course, neither party would be completely happy with all of these proposals. However, it’s not really a “bargain” if neither side has to give up things on its wish list.
We can do this. We can end the shutdown, resolve our debt crisis and put America back on a more sustainable course for the future. Let’s do it!