Current Policy Extensions and Growth

If lawmakers extended various current policies, as opposed to letting them expire as they are set to under current law, what would happen to economic growth over the coming decade?

In its most recent Long Term Outlook, CBO presented an Alternative Fiscal Scenario (AFS) with current policies that are expected to be extended in the near future—the biggest component of which being a full extension of the 2001/2003 tax cuts. Other assumptions in the AFS include faster discretionary spending growth, AMT patches, and annual "doc fixes" to prevent scheduled cuts in Medicare payments to physicians. The effects of these policies on the alternative baseline show alarming spending growth and comparatively slower revenue growth in the long-run (click here to read our newest policy paper on more realistic medium- and long-term projections). As for their affect on economic growth, in the recent Budget Update CBO states:

"Under those alternative assumptions, real GDP would be higher in the first few years of the projection period but lower in subsequent years than under CBO’s baseline forecast."

So, despite the seemingly positive short-term effects on GDP that tax cuts and other policies may have, growth will be slower later on as a consequence—and federal debt would balloon to 185 percent of GDP by 2035. CBO reports that despite higher growth in the near-term:

"Over time, the negative consequences of very high federal borrowing build up....real GDP would fall below the level in CBO’s baseline projections later in the coming decade because the larger budget deficits would reduce or 'crowd out' investment in productive capital and result in a smaller capital stock."

Interest rates under the AFS would rise to nearly 4 percent of GDP by 2020 -- much higher than the current level of 1.4 percent. The AFS would also improve unemployment in the short-term, estimating that:

“[T]he unemployment rate would be lower by 0.3 to 0.8 percentage points at the end of 2011—that is, 8.0 percent to 8.5 percent.”

Focusing just on the tax cuts, CBO's newest estimates give us an idea just how costly it would be to extend all or parts of them over the coming decade. Since the debate in Washington has been centered on either extending them fully or for those earning less than $200,000 ($250,000 for couples), we have included those costs in the table below.

The cost of extending the 2001/2003 tax cuts for all but high earners (and even if they were fully extended) would be even larger if lawmakers continue patching the Alternative Minimum Tax (AMT)—in fact, almost $700 billion more over ten years—and this is very likely to occur. CBO estimates that the tax increases for all but high earners combined with AMT patches would result in $2.4 trillion more in deficits over 10 years, $2.7 trillion if just all the 2001/2003 tax cuts are extended, and a whopping $3.9 trillion more in deficits over 10 years if the AMT patch and all of the 2001/2003 tax cuts are extended.

Clearly, the larger projected debts must be taken into account in any policy debate on tax cut issue. More broadly (and as we argue in our newest policy paper), lawmakers should decide which policies are the most important for the country going forward, and then they should find way to pay for the policies they choose.