What Happened to the Alternative Fiscal Scenario?

Update: CBO has now released its official Alternative Fiscal Scenario estimates (tab 6 of the Excel). They find that debt reaches 165 percent of GDP in 2039, one year later than we estimated.

As we prepared for CBO's Long-Term Outlook to be released Tuesday, we anticipated two sets of projections: the Extended Baseline Scenario (EBS), which approximates current law, and the Alternative Fiscal Scenario, which includes current policies that were set to expire. This has been normal practice by CBO in recent years, and has allowed them to demonstrate the fiscal consequences of continuing current actions even if new laws were technically required to see them through. This year, CBO focused only on their Extended Baseline Scenario, a choice which will be the topic of the first post of in our Long-Term Outlook series.

So why did CBO virtually abandon the Alternative Fiscal Scenario in this report? We can’t know for sure, but we do have some ideas. Most importantly, major differences in the past between current law and the Alternative Fiscal Scenario – the expiration of the 2001/2003/2010 tax cuts and of “AMT patches” – were resolved permanently in the fiscal cliff deal. As a result, there is no longer a question as to whether we will update the AMT each year or let it snap back to 2000 levels, or whether we will continue current tax rates – most (though not all) tax law is now permanent. That change alone closed about $5 trillion of the gap between current law and the AFS through 2023.

Of course, a number of differences between current law and the AFS still remain. Unlike the AFS, current law assumes sequestration continues, physicians accept a 24 percent payment cut, and a number of temporary tax cuts expire as scheduled. While a realistic baseline might correct for these assumptions, it would also make offsetting corrections, assuming that disaster spending on Hurricane Sandy relief will not continue at current levels and war spending will continue to drawdown. Taking these all together, the difference between CRFB's Realistic baseline and CBO's current law baseline in 2023 is only 2 percent of GDP.

Still, the AFS does provide some useful (and large) long-term assumptions which may (or may not) be more realistic than CBO’s Extended Baseline. Specifically, it freezes revenue as a percent of GDP after 2023, increases other mandatory and discretionary spending to their historical averages, and assumes some Medicare provider reductions will not continue to be sustainable beyond 2023.

Below, we make an effort to replicate CBO’s Alternative Fiscal Scenario using data about the current policies involved. Under these projections, debt would pass 150 percent of GDP by the mid-2030s and 400 percent by the early 2060s. CBO suggests that when economic effects are included, debt would reach 200 percent of GDP by 2040 or so.

[chart:9118]

^{Source: 2013 CBO Long-Term Outlook and 2012 CBO Long-Term Outlook with GDP Revisions}

What is interesting about these projections is how similar they look to last year’s AFS. Though there have been changes in the levels of debt as a share of the economy, it remains on a clear upward trajectory. While the exact "crisis point" is unknown, it would be unlikely that the U.S. could continue on this path without seeing some kind of fiscal crisis. Last year, CBO stopped projecting numbers after 250 percent of GDP as it did not believe it could reliably forecast the certain parts of the budget with such high interest levels.

The Alternative Fiscal Scenario may not be the most likely scenario going forward, but instead could be thought of as the most pessimistic of the possible scenarios. Next week, we will publish the newest CRFB Realistic baseline, which will fall somewhere between current law and the AFS (although closer to current law). Importantly, all three scenarios show that we are on an unsustainable fiscal path.