The Corner

The CBO’s New Budget Outlook: Debt Ahoy!

This morning, the Congressional Budget Office (CBO) released an update to its budget and economic outlook for the next decade. In news that will be shocking to none of my readers, the federal debt is projected to grow over the course of the decade.

Check out their chart below:

By CBO’s estimate, the federal debt held by the public will reach 74 percent of GDP at the end of this fiscal year, a level not seen in the US since the topsy-turvy budgetary days of FDR and WWII. By 2024, the federal debt is projected to reach 77 percent of GDP. Before the onset of the recession, federal debt constituted a “mere” 35 percent of GDP. If current economic trends continue, debt levels that were once rationalized by extraordinary economic circumstances may simply become the new normal.

The CBO is more pessimistic than the Obama administration about GDP growth over the next decade, but they’re probably still more optimistic than a lot of Americans. These projections are assuming improvements in aggregate demand, higher consumer spending, and a turnaround of the housing sector. Should any of these changes fail to materialize, GDP growth may remain below even the CBO’s tempered projections, and the debt-to-GDP ratio could be even higher than expected.

Now, here is another alarming aspect of this report: Outlays are growing at an average of 5.2 percent per year, which is greater than nominal GDP growth. This is one of our key problems. We will never get the budget under control with federal spending consistently growing faster than our economy.​

Some commentators have pointed to shrinking short-term deficits as one cause for celebration. I am not so cheerful. While this year’s budget deficit is projected to be $506 billion, which is $170 billion lower than last year’s deficit, it’s still higher than the $492 billion 2014 deficit anticipated in CBO’s projections from April. The discrepancy largely stems from lower-than-anticipated corporate-income-tax receipts.

What’s more, these magically declining budget deficits could easily be reversed by the usual congressional ineptitude. Should a misguided Congress kick the can of sequester cuts down the road again, then deficits could balloon by as much as $900 billion over the next decade. Extending a host of expiring tax subsidies and other abuses of the tax system, at least some of which is expected, would boost deficits by another $900 billion. Additionally, as Wonkblog reports, much of the apparent deficit improvements stem from changes in the way that CBO calculates interest payments on the debt. Even with all of that, the CBO also projects that budget deficits will exceed 3 percent of GDP by 2018 and will continue to grow to almost 4 percent by 2024.

Over at the Cato Institute, Nicole Kaeding highlights some other key points:

‐ According to CBO, Medicaid spending jumped 15 percent year-over-year. Adding millions of new individuals under ObamaCare to Medicaid comes at a steep price.  Social Security spending jumped 4.6 percent.

‐ The entitlement programs continue to drive spending projections and put enormous weight on the budget. CBO estimates that Social Security, the major health care programs, and interest account for 85 percent of projected spending increases over next ten years.

‐ Mandatory spending–which includes the big entitlement programs–will increase 5.5 percent annually over next ten years. ObamaCare leads the way. The newly created subsidies for health insurance will cost taxpayers $1 trillion over ten years, growing from $17 billion in 2014 to $450 billion in 2024.

Here is a chart showing where our future budget money will be going:

The Heritage Foundation’s Romina Boccia sums up the need for entitlement reforms nicely:
Conservatives who seek to limit government spending should advocate for entitlement reform. Government continues to overreach and harm economic growth with unnecessary and inappropriate federal regulations enforced with discretionary spending. Undoubtedly, many domestic federal programs should be eliminated, consolidated, or privatized. However, an almost singular focus on reducing discretionary spending misses the proverbial forest for the trees. Congress should reform entitlement programs and cut non-defense discretionary spending.

Unfortunately, the CBO’s projections on these issues in the report may be too optimistic. For one, they assume Congress will stop doing the “doc fix” after March 31, 2015 (the Medicare trustees no longer make this assumption) — doing it, as expected, would “cost” $131 billion over ten years. More important, the Medicare projections still assume the more than $750 billion in savings over ten years (mostly from reductions in payments to doctors and hospitals) that both CBO and the Medicare trustees have said would demand unprecedented improvements in productivity. And while CBO has been predicting the economy will pick up for some time now, we’ve yet to see these improvements materialize.

Why should we care about this? Because, as my colleague Jason Fichtner and I recently noted in a paper about America’s debt challenges, empirical studies of historical government debt levels suggests that high debt-to-GDP ratios are associated with lower levels of economic growth. We’re not talking about the problematic Reinhart and Rogoff paper:

There is ample academic evidence that higher debt levels slow economic growth. While there have been challenges to Harvard University economists Carmen Reinhart and Kenneth Rogoff’s landmark 2010 paper—which demonstrated that countries with debt-to-GDP ratios higher than 90 percent have notably lower economic growth—their essential finding of the adverse impact of high indebtedness on growth has been supported by studies from the European Central Bank, the International Monetary Fund, and the Bank for International Settlements, among othersResearch has also shown that high levels of debt inhibit economic competitiveness.

A high debt environment also limits the government’s ability to respond to adverse economic conditions. A 2008 study published by the European Central Bank found that when a country’s debt level is between 44 percent and 90 percent, the multiplier on economic activity is positive but likely below one. That is, the government spends a dollar but gets less than a dollar in growth. When debt passes 90 percent, fiscal multipliers go to zero; no growth emerges from the increased spending. In these situations, an increase in deficits today reduces private spending by increasing the magnitude of future fiscal adjustment costs.

If government mismanagement of public finances goes unchecked for too long, then at some point in the future Americans will face the dual burdens of high interest payments and economic stagnation.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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