How Does the Budget Look Now?

After a tense few days, or weeks for that matter, lawmakers have enacted a fiscal cliff package -- the American Taxpayer Relief Act. With budget negotiations likely laying low for a few days, we turn our attention to where the deal leaves the budget. We previously analyzed the budgetary effect of each provision of the deal relative to both current law and current policy. In this blog, we will go into more detail on what the budget will look like after the deal.

Where the bill leaves the budget, however, depends heavily on assumptions made about the future. We look at two scenarios in detail: new current law projections and CRFB Realistic projections. The graph below shows debt under each scenario pre- and post-deal, while the text and tables further down go into more detail.

[chart:7572]

^{Source: CBO, CRFB calculations}

As we said yesterday, though this package will avert much of the short-term economic effects of the fiscal cliff as a result of temporarily waiving the sequester and renewing most of the tax cuts, it will not halt the longer-term trend of rising debt and the associated economic threats. The 2001/2003/2010 tax cuts and AMT patch will be permanently extended, while the sequester, unemployment benefits, tax extenders, and doc fix will be at least temporarily extended (see a table of the provisions and their budgetary impact here). The deal will add about $4.6 trillion to the debt relative to current law, although it does save $650 billion relative to current policy.

Debt under Current Law Projections

The current law scenario which previously had debt on a downward path now has converged significantly toward the unsustainable current policy path, since current law now includes an extension of most of the 2001/2003/2010 tax cuts and a permanent AMT patch. The current law scenario, however, still allows the sequester to take effect in two months; the tax extenders, Medicare doc fix, and unemployment benefits to expire in one year; and the 2009 refundable tax credit expansions to lapse in five years. Our estimate of what current law projections (including a drawdown of war spending) would show is presented in the table below.

Under current law with a war drawdown, debt would reach a size equal to 73 percent of the economy by 2022, about where it was at the end of 2012, and likely higher levels over the long term.

^{Source: CBO, CRFB calculations}

Debt Under CRFB Realistic Projections

This picture is worse if you look at the CRFB Realistic Baseline. In contrast to current law, this baseline assumes the sequester is permanently repealed, annual doc fixes continue, the refundable tax credits are extended permanently, and war spending draws down as scheduled rather than increasing with inflation. Our Realistic Baseline also assumes that the tax extenders and unemployment benefits expire as scheduled at the end of 2013.

Under CRFB Realistic, debt will likely reach a size equal to 79 percent of the economy by 2022, and much higher levels over the long-term.

^{Source: CBO, CRFB calculations}

One could also argue that the tax extenders could realistically be extended in perpetuity (as their name indicates) without being offset. If that happens, revenue would fall, and spending would increase due to higher interest payments on the debt. Under this scenario, debt will likely reach a size of more than 80 percent of the economy by 2022, and much higher levels beyond that.

It is clear that none of these scenarios are very favorable for the economy over the long term. Stabilizing the debt within a decade is the bare minimum for achieving fiscal sustainability, since changing demographics and rising health care costs will swamp the budget over the next few decades.

Still, there is further opportunity for action, especially given that some parts of the deal are temporary. This package is just the first phase of fiscal negotiations that will pick up again very soon to deal with these outstanding issues. Hopefully, lawmakers will agree on a sufficient and long term deal to stop reckless last-minute deal making.

Stay tuned for more analysis of the fiscal cliff deal throughout the week!