Spending and Revenues in the Long Term Outlook

After much anticipation, the CBO has released its Long Term Budget Outlook, which gives the first glimpse at the long-term effects of the recently-enacted health care legislation. In the report, which was released at the third meeting of President Obama's fiscal commission, the extended-baseline scenario (current law) shows drastic improvement from last year's outlook, but the alternative scenario, which is composed of policies more likely to occur, shows a shocking amount of debt.

First, the good news. The extended baseline scenario shows health care spending coming down from levels in the 2009 outlook. By 2083, health spending is about 2 percent of GDP lower than it was projected last year. This decrease is due to both the effects of the health care legislation and to a methdological change by CBO in which they assume lower health cost growth.

Total spending in 2083 is about nine percentage points lower in the 2010 extended baseline outlook compared to last year. About 85 percent of that drop is due to a decrease in spending on interest, which stems mainly from drastically higher revenues that hold debt down compared to the 2009 outlook. Revenues were projected to reach about 26 percent of GDP by 2083 in the 2009 outlook, but this year's outlook projects revenues to reach 30 percent mostly due to tax increases in the health care legislation. The higher revenue obviously decreases the debt, which significantly decreases interest paid on the debt.

Ironically, the biggest driver of the decreased spending in the 2010 extended baseline scenario is higher taxes.

Now the bad news.

While the extended baseline presents a much rosier scenario compared to last year, the alternative scenario paints a fiscal nightmare.  Debt held by the public threatens to break into the quadruple digits (though we would surely never get there), and spending on interest takes up more than half the entire budget by the end of the outlook.

The alternative fiscal scenario assumes that the 2001/2003 Bush tax cuts are made permanent, the AMT and Medicare physician payments continue to be patched, and most importantly, the Medicare spending cuts and slowing of the growth rate of the health insurance subsidies do not occur after 2020.

Under this scenario, primary spending is at 35 percent in 2083, only about 3.5 percentage points higher than current law. However, interest spending is at an astounding 45 percent of GDP, meaning we will be paying more to our creditors than for every government program combined. This leaves total spending at an unbelievable 80 percent of GDP. Revenues don't contribute to debt reduction in this scenario because CBO assumes that lawmakers will change the tax code to keep them at a constant 19.3 percent of GDP after 2020.

The main lessons to draw from this report is that there is still serious work to be done on the spending side.  We must be vigilant to make sure health are cost-cutting measures stick, and we will also need to raise sufficient revenues. Even under the rosy scenario of current law, debt is above 100% of GDP and government is spending is 37 percent of GDP. Those levels are well above historical averages and approaching records. Also, it is unlikely that lawmakers would have the political will to raise anywhere close to 30 percent of GDP in revenues to keep the debt in check. The long term outlook underscores that we have to get to work now to solve our future fiscal problems.