Chapter
1
The Congressional Budget Office (CBO) estimates that the federal budget deficit for this fiscal year will amount to $407 billion, or 2.9 percent of gross domestic product (GDP). That estimate of the 2008 deficit is about $20 billion higher than what CBO expected in March, after adding in the anticipated costs of funding for operations in Iraq and Afghanistan and other activities related to the war on terrorism.1
The federal fiscal situation has deteriorated markedly over the past year. The projected deficit for this year is more than twice as large as the deficit recorded for 2007, which was $161 billion, or 1.2 percent of GDP. Furthermore, CBO’s projections indicate that if current laws remain in place, deficits for the next two years will stay above $400 billion, in the vicinity of 3 percent of GDP (see Table 1-1).
Projected Deficits and Surpluses in CBO’s Baseline
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Source: Congressional Budget Office.
Note: GDP = gross domestic product; n.a. = not applicable.
b. Debt held at the end of the year.
In CBO’s baseline, projected deficits decline in 2011 and 2012 as the scheduled expiration of various tax provisions causes a rapid rise in estimated revenues. Many policymakers and other analysts believe that at least some of those tax provisions will be extended past their scheduled expirations. Nonetheless, if all tax provisions expired as specified under current law and if other policies remained the same (the assumptions underlying CBO’s baseline projections), deficits would range, according to CBO’s estimates, between 0.6 percent and 1.0 percent of GDP for fiscal years 2012 through 2018 (see Figure 1-1).
(Percentage of gross domestic product)
Source: Congressional Budget Office.
CBO’s current baseline projections for the 10-year period from 2009 to 2018 appear significantly less favorable than those published in March, when CBO projected surpluses beginning in 2012 and a cumulative 10-year surplus of $0.3 trillion. Updated estimates for the 2009–2018 period now show deficits in each year and a cumulative 10-year deficit of $2.3 trillion. The bulk of that change results from the timing of appropriations for operations in Iraq and Afghanistan. Supplemental funding of $97 billion was appropriated for that purpose in June, and that amount is incorporated for each year in the updated projections (with adjustments for inflation). That change, by itself, adds about $1 trillion to projected spending over the 2009–2018 period (excluding debt-service costs). Revised economic assumptions also contribute significantly to the change in the budget outlook, adding about $850 billion to the aggregate deficit over that period. (See Appendix A for details on changes in CBO’s baseline.)
Federal debt held by the public is expected to total $5.4 trillion at the end of this fiscal year, or 38.2 percent of GDP. Under CBO’s baseline projections, debt held by the public (as a percentage of GDP) would rise next year and remain at roughly 40 percent of GDP through 2012, after which it would begin to decline slightly, falling to 35.5 percent of GDP by 2018.
Over the long term, the federal budget is on an unsustainable path. Without changes in current policies, the growing demand for resources—caused primarily by rising health care costs and, to a lesser degree, by the nation’s expanding elderly population—will put increasing pressure on the budget. Federal spending for Medicare and Medicaid combined is expected to total 4.6 percent of GDP this year. Without changes in law, CBO estimates, such spending will rise to 6.0 percent of GDP in 2018—an increase of 30 percent in 10 years. Over the same period, Social Security spending will rise from 4.3 percent of GDP to 5.0 percent.
CBO’s baseline projections are not intended to be a forecast of future budgetary outcomes; rather, they serve as a neutral benchmark that legislators and others can use to assess the potential effects of policy decisions. As such, CBO’s baseline projections do not incorporate anticipated changes in policy. However, this chapter describes the budgetary implications of some alternative policy assumptions. For example, CBO has constructed two possible scenarios for future spending related to military operations in Iraq and Afghanistan and other activities associated with the war on terrorism. Those scenarios incorporate different assumptions about how rapidly troop levels might be reduced. Under both scenarios, outlays over the 10-year period would be significantly lower than those in CBO’s baseline projections.
CBO also has estimated alternative projections for federal revenues under a scenario in which all of the tax provisions that are scheduled to expire over the next 10 years would be extended and the alternative minimum tax (AMT) would be indexed for inflation. According to estimates provided by the Joint Committee on Taxation, enacting those changes alone would add about $100 billion to the projected deficit for 2009, boosting that figure to more than $500 billion. Over the 2009–2018 period, those changes would increase projected deficits by about $4.2 trillion, even without taking into account any additional debt-service costs.
In addition to following long-standing rules about the treatment of current laws and policies, CBO’s baseline projections are based on assumptions about how the economy will perform in the future and how tax and spending policies will affect that performance. Because actual outcomes almost certainly will differ from CBO’s projections, it is useful to view those projections as the midpoint within a range of potential outcomes. For example, even though CBO projects deficits for the next several years (under baseline assumptions), there is some likelihood that, under those assumptions, the budget could show a surplus. For 2010, for example, CBO projects the probability of a deficit under current policies to be 92 percent, implying an 8 percent chance of a surplus (see Table 1-1).
CBO estimates that the deficit in 2008 will be more than twice as large as the shortfall in 2007, rising from $161 billion (or 1.2 percent of GDP) in 2007 to $407 billion in 2008, or about 2.9 percent of GDP. The significant expansion in the deficit is the result of a substantial increase in spending and a halt in revenue growth. In 2008, CBO estimates, federal spending will be 8.3 percent higher than it was in 2007; at the same time, total revenues will be less than they were in 2007 (see Table 1-2).
Average Annual Growth Rates of Revenues and Outlays Since 1997 and as Projected in CBO’s Baseline
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Source: Congressional Budget Office.
Notes: The growth rates in this table do not account for shifts in the timing of certain payments or receipts.
a. When constructing its baseline, CBO uses the employment cost index for wages and salaries to inflate discretionary spending related to federal personnel and the GDP price index to adjust other discretionary spending.
b. Includes excise taxes, estate and gift taxes, customs duties, and miscellaneous receipts.
c. Includes offsetting receipts (funds collected by government agencies from other government accounts or from the public in businesslike or market-oriented transactions that are recorded as offsets to outlays).
On the basis of tax collections through July, CBO expects federal revenues to total $2.5 trillion this fiscal year (see Table 1-3), a decline of 0.8 percent from 2007. That drop is largely a result of rebates provided in the Economic Stimulus Act of 2008 (Public Law 110-185), which was enacted in February. Without those rebates, revenues would have increased by about 1.5 percent in 2008. If all of the direct effects on revenues of the Economic Stimulus Act—both the rebates and the business depreciation provisions—were excluded, revenues would have increased by about 2.5 percent this year, CBO estimates.
CBO’s Baseline Budget Projections
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Source: Congressional Budget Office.
Note: n.a. = not applicable.
Revenues from all major sources have grown more slowly in 2008 than in 2007. Withholding of individual income and payroll taxes, the largest source of tax collections, is expected to grow by about 4 percent in 2008, after rising by nearly 7 percent in both 2006 and 2007.2 That deceleration stems from slower growth of wages and salaries. (For a full discussion of the economic outlook, see Chapter 2.) Nonwithheld receipts of income and payroll taxes—mainly final payments made with tax return filings for 2007 and quarterly estimated payments of taxes in 2008—are expected to rise by about 5 percent this year, after increasing by roughly 13 percent last year. Corporate income tax receipts have begun to decline significantly after growing rapidly between 2003 and 2006. CBO expects receipts of corporate income taxes to end the year down by 15 percent, reflecting falling corporate profits and the impact of the recent changes in law that affect how businesses can depreciate investments made in 2008.
CBO expects that, as a share of GDP, federal revenues will total 17.9 percent in 2008, almost 1 percentage point lower than the 18.8 percent recorded in 2007. The decline relative to GDP is largely attributable to the drop in corporate receipts, which are expected to fall from 2.7 percent of GDP in 2007 to 2.2 percent this year, and in individual income tax receipts, which are expected to decline from 8.5 percent of GDP to 8.2 percent. CBO anticipates that other sources of revenue will remain more stable relative to GDP.
Individual Income and Social Insurance Taxes. In combination, receipts from individual income and social insurance taxes are expected to rise by 1.2 percent in 2008 and total $2.1 trillion. Although individual income taxes are anticipated to fall by 0.4 percent, social insurance taxes are estimated to rise by 3.3 percent.
The decline in receipts from individual income taxes stems largely from the effects of the rebates enacted in the Economic Stimulus Act. Those rebates reduce individual income tax receipts and increase outlays for refundable tax credits.3 By the end of the fiscal year, almost $100 billion in rebates will have been disbursed, CBO expects, with roughly $60 billion of that amount representing revenue reductions. Without those rebates, CBO estimates, individual income tax receipts would have increased by about 5 percent in 2008. (That calculation does not incorporate the dynamic effects of the rebates on the economy and, therefore, on revenues.)
Payments of individual income and social insurance taxes are generally made in two forms:
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As amounts that employers withhold from their employees’ paychecks and remit to the federal government on behalf of their employees; and |
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As nonwithheld amounts that individuals pay directly, either in the form of quarterly estimated installments or as final payments made when they file their yearly income tax returns. |
CBO expects withholding for combined income and payroll taxes to climb by about 4 percent in 2008. Those amounts grew more quickly at the beginning of the fiscal year (in the last quarter of calendar year 2007) and began to slow appreciably near the beginning of calendar year 2008, mainly because of slower growth in wages and salaries. CBO projects that wages and salaries, as measured in the national income and product accounts (NIPAs), will grow by 4.3 percent in 2008, down from 6 percent in the previous two years.
Nonwithheld receipts of income and payroll taxes are expected to climb by about 5 percent this year. Quarterly estimated payments and final payments are each projected to increase by about that same percentage. CBO expects that most of the revenue-reducing effects on individual income taxes of the enhanced depreciation rules enacted in the Economic Stimulus Act will occur in 2009. Those depreciation rules affect individual income tax receipts through their impact on depreciation claimed by noncorporate businesses, whose income is taxed at the individual level. Refunds of income taxes (excluding the rebates) are projected to grow by about 6 percent.
Corporate Income Taxes. CBO expects corporate income tax receipts to fall by 15 percent in 2008, to $315 billion. (Without the effects of the depreciation provisions enacted in the Economic Stimulus Act, CBO estimates, corporate receipts would have fallen by a smaller amount, roughly 9 percent.) That decline follows a rapid run-up over the 2003–2006 period, when receipts rose by an average of almost 40 percent annually.
Declining corporate profitability has reduced the amount of corporate income tax receipts. Economic profits, as measured in the NIPAs, are projected to fall by about 3 percent this year, and domestic economic profits are expected to drop by 11 percent. (The latter are a closer measure of the corporate tax base because they exclude profits earned abroad by U.S. corporations, on which they often pay little or no U.S. tax.) Neither of those measures of profit includes the effects of the recent changes to depreciation law.
Outlays will rise by $226 billion this year, CBO estimates, to nearly $3.0 trillion—an increase of 8.3 percent. That amount of spending would equal about 20.8 percent of GDP, up from 20.0 percent last year. Spending for both mandatory and discretionary programs will contribute to the increase.
In total, CBO estimates, mandatory spending will increase by $135 billion from 2007 levels, a 9.3 percent rise. Outlays for discretionary programs—whose funding is set anew each year through appropriation acts—are anticipated to climb by $85 billion (or 8.1 percent) this year; the bulk of that increase stems from defense spending. The government’s net interest costs will increase by $7 billion, CBO estimates.
Mandatory Spending. Outlays for mandatory programs generally are determined by eligibility rules and benefit levels that are set in law rather than established through the annual appropriation process. Excluding payments for net interest, mandatory spending will total $1.6 trillion in 2008, CBO estimates, about 54 percent of total federal outlays. The projected growth in such spending for 2008 (9.3 percent) is more than three times the rate experienced in 2007 and is more than 50 percent higher than the average annual rate of growth over the 1997–2006 period.
Unlike in recent years, when the growth in federal spending for Medicare and Medicaid drove the uptick in mandatory outlays, the growth this year is fueled by outlays for other mandatory programs. In particular, outlays for the refundable portion of the income tax rebates, at $38 billion, make up a sizable share of the projected $135 billion increase in mandatory spending. Other significant contributors are the Federal Deposit Insurance Corporation’s (FDIC’s) outlays for deposit insurance and payments for unemployment compensation, which CBO estimates will be substantially higher than in 2007, in part because of the availability of emergency extended unemployment compensation (see Table 1-4).4
CBO’s Baseline Projections of Mandatory Spending
(Outlays, in billions of dollars)
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Source: Congressional Budget Office.
Notes: Spending for the benefit programs shown above generally excludes administrative costs, which are discretionary.
SCHIP = State Children’s Health Insurance Program; GSE = government-sponsored enterprise.
a. Excludes offsetting receipts (funds collected by government agencies from other government accounts or from the public in businesslike or market-oriented transactions that are recorded as offsets to outlays).
b. Includes Temporary Assistance for Needy Families and various programs that involve payments to states for child support enforcement and family support, child care entitlements, and research to benefit children.
d. Income security includes veterans’ compensation, pensions, and life insurance programs. Other benefits are primarily education subsidies.
e. CBO’s estimate of the expected value of the temporary authority granted to the Secretary of the Treasury to purchase any obligations of and securities issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
With the number and size of failed financial institutions up sharply this year, CBO expects federal outlays for deposit insurance to rise by more than $15 billion. As of July 2008, the FDIC had spent about $18 billion to cover the insured deposits of insolvent institutions. CBO anticipates that recoveries from the sale of assets held by those banks and thrifts and receipts from insurance premiums will partially offset those outlays in 2008 and in future years.
Outlays also will be up significantly for programs that are designed to spend more when economic conditions deteriorate. CBO estimates that disbursements for unemployment compensation will rise by $11 billion this year—about one-third higher than they were in 2007. Projected outlays from the recently enacted emergency extended unemployment compensation program make up about 40 percent of that increase. In addition, CBO expects that rising caseloads and higher monthly benefits will cause spending for Food Stamps to jump by nearly 11 percent, or about $4 billion.
Growth in outlays for both Medicare and Social Security will slow this year compared with their growth last year, while federal spending for Medicaid will continue to expand at a strong pace. In 2007, spending for Medicare increased by nearly 17 percent from the previous year’s level; this year, it will rise by about 4 percent, CBO estimates. In part, that slower growth is a result of legislative changes that shifted some spending out of 2006 and into 2007. Also, payments to plans for Part D (the prescription drug benefit) were reduced this year to correct for overpayments made in 2006. After adjusting for those changes, growth this year for Medicare spending will be about 6 percent, CBO estimates (and growth in 2007 would have been 12 percent, bolstered by the implementation of Part D for the full year).
Less dramatically, Social Security outlays will climb by 5.3 percent this year, compared with last year’s 6.9 percent gain. That slowing is largely the result of a lower cost-of-living adjustment for 2008. (The 2007 growth rate for Social Security outlays also was affected by an accounting adjustment to that program in 2006; if that change were taken into account, growth in Social Security outlays would have been 5.8 percent last year.) Outlays for Medicaid are expected to be 6.2 percent higher than they were last year. That rate of growth is somewhat greater than the program experienced in 2007 (5.5 percent) but below the most recent 10-year average for that program (7.0 percent). In total, outlays for Medicare, Medicaid, and Social Security will exceed $1.25 trillion in 2008, CBO estimates, constituting about 40 percent of federal spending (not including offsetting receipts) and 8.9 percent of GDP.
Discretionary Spending. Outlays for discretionary programs are estimated to constitute 38 percent of total federal spending in 2008. The $1.1 trillion in discretionary outlays (up from $1.0 trillion in 2007) represents an increase of 8.1 percent from last year’s level (see Table 1-5). The rate of growth in discretionary spending for 2008 is well above last year’s 2.4 percent and higher than the 6.7 percent average annual increase recorded in recent years.
CBO’s Baseline Projections of Discretionary Spending
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Source: Congressional Budget Office.
Notes: Nondefense discretionary outlays are usually higher than budget authority because of spending from the Highway Trust Fund and the Airport and Airway Trust Fund, which is subject to obligation limitations set in appropriation acts. The budget authority for such programs is provided in authorizing legislation and is not considered discretionary.
Discretionary spending in CBO’s baseline is projected using the inflators specified in the Balanced Budget and Emergency Deficit Control Act of 1985: the gross domestic product deflator (now replaced by the GDP price index) and the employment cost index for wages and salaries.
More than half of discretionary outlays are spent on national defense. CBO estimates that defense outlays will total $605 billion in 2008—a gain of 10.5 percent from last year’s level. (The increase drops to 9.7 percent when a shift in the timing of certain personnel payments from 2007 into 2006 is taken into account.) That rate of growth is the highest since 2004 and reflects a rapid run-up in budget authority (the authorization to incur financial obligations that will result in outlays) over the past three years; such authority has escalated by 11.2 percent a year, on average, since 2005 (see Figure 1-2).
Discretionary Budget Authority
Source: Congressional Budget Office.
Recent increases in defense spending have stemmed from higher funding for operations in Iraq and Afghanistan and for other activities related to the war on terrorism, as well as for defense activities not directly related to those conflicts. Funding for war-related operations continued to expand in 2008 (by about 9 percent). Budget authority for non-war-related defense programs rose even more than funding for the war in 2008—by roughly 11 percent. (For an overview of funding since 2001 for operations in Iraq and Afghanistan and other activities related to the war on terrorism, see Box 1-1.)
Box 1-1.
Funding for Operations in Iraq and Afghanistan and for Other Activities Related to the War on Terrorism
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Since September 2001, lawmakers have provided a total of $858 billion in budget authority for military and diplomatic operations in Iraq, Afghanistan, and other regions in support of the war on terrorism and for related veterans’ benefits and services (see the table). Appropriations specifically designated for those activities, which averaged about $93 billion a year from 2003 through 2005, rose to $120 billion in 2006, to $171 billion in 2007, and to $186 billion in 2008. The Congress has appropriated $68 billion for war-related activities for the first part of 2009.
Funding to date for military operations and other defense activities related to the war totals $771 billion, most of which has gone to the Department of Defense (DoD). Lawmakers have also provided more than $38 billion to train and equip indigenous security forces in Iraq and Afghanistan.1 A total of $810 billion has thus been appropriated since September 2001 for defense operations in Iraq and Afghanistan and for the war on terrorism.
In addition, $46 billion has been provided for diplomatic operations and foreign aid to Iraq, Afghanistan, and other countries that are assisting the United States in the war on terrorism. Of that amount, $16 billion was appropriated for the Iraq Relief and Reconstruction Fund.
DoD reports that in 2008, obligations for operations in Iraq and Afghanistan and for other activities related to the war on terrorism have averaged about $11 billion per month through June, the last month for which data are currently available. That rate is unchanged from the average monthly obligations in 2007. Because more than half of the funding for 2008 was provided at the end of June, however, the Congressional Budget Office (CBO) expects that monthly obligations will increase during the last quarter of this fiscal year.
Operation Iraqi Freedom accounts for approximately 82 percent of all reported obligations in 2008—down from 85 percent in 2007; Operation Enduring Freedom (which refers mainly to operations in and around Afghanistan) accounts for another 18 percent. Additional security missions that have taken place in the United States since the terrorist attacks of September 11, 2001—such as combat air patrols over Washington, D.C., and New York City (known as Operation Noble Eagle)—account for less than 1 percent.
Because most appropriations for operations in Iraq and Afghanistan and for other activities related to the war on terrorism appear in the same budget accounts that record appropriations for DoD’s other functions, determining how much has actually been spent for those activities is difficult. However, CBO estimates that appropriations for defense operations in Iraq and Afghanistan and for the war on terrorism resulted in outlays of about $430 billion through fiscal year 2007 (with about $115 billion occurring in 2007). Of the funds appropriated for international affairs related to the war, about $30 billion was spent through 2007, CBO estimates. In total, outlays for operations in Iraq and Afghanistan amounted to about $120 billion last year. Outlays in 2008 (which also include outlays from prior years’ appropriations) will total about $145 billion, in CBO’s estimation.
Estimated Appropriations Provided to Date for U.S. Operations in Iraq and Afghanistan and for the War on Terrorism, 2001 to 2009
(Budget authority, in billions of dollars, by fiscal year)
Source: Congressional Budget Office.
Note: * = between zero and $500 million.
a. CBO estimated the funding provided for Operation Iraqi Freedom by allocating funds on the basis of information in budget justification materials from the Department of Defense and in monthly reports on the agency’s obligations.
b. Includes Operation Enduring Freedom (in and around Afghanistan), Operation Noble Eagle (homeland security missions, such as combat air patrols, in the United States), the restructuring of Army and Marine Corps units, classified activities other than those funded by appropriations for the Iraq Freedom Fund, efforts to permanently increase the size of the Army and Marine Corps, and other operations. (For 2005 through 2009, funding for Operation Noble Eagle has been intermingled with regular appropriations for the Department of Defense; that funding is not included in this table because it cannot be identified separately.)
c. Funding for indigenous security forces, which was appropriated in accounts for diplomatic operations and foreign aid (budget function 150) in 2004 and in accounts for defense (budget function 050) since 2005, is used to train and equip local military and police units in Iraq and Afghanistan.
d. Excludes about $3 billion in spending through 2008 for medical care, disability compensation, and survivors’ benefits for veterans of operations in Iraq and Afghanistan and the war on terrorism. Those amounts, which were not explicitly appropriated for war-related expenses, are based on CBO’s estimates of spending from regular appropriations for the Department of Veterans Affairs.
1.
The $38 billion includes $5 billion provided for Iraqi security forces in 2004 in an appropriation for the Department of State’s Iraq Relief and Reconstruction Fund.
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Nondefense discretionary outlays are expected to climb from $493 billion in 2007 to $520 billion this year, an increase of $27 billion, or 5.5 percent. That increase is spread widely throughout the budget. However, outlays in several areas are expected to grow substantially—in particular, for veterans’ health benefits ($4.3 billion), transportation programs ($4.9 billion), and immigration, customs, and border enforcement ($2.1 billion). In the other direction, outlays for disaster relief are anticipated to be $2.2 billion lower than in 2007; outlays for community development and for relief and reconstruction efforts in Iraq are also likely to be lower, by nearly $2 billion each in 2008.
Net Interest. Federal outlays for net interest payments will grow by 2.9 percent this year to a total of $244 billion (or 1.7 percent of GDP). For 2008, federal payments for net interest will represent about 8 percent of all federal outlays. The increase in interest outlays results from higher inflation, an increase in the amount of federal debt, and more intragovernmental interest payments, effects that are mostly offset by lower short-term interest rates.
Baseline Budget Projections for 2009 Through 2018
Under the assumptions underlying the baseline, the budget deficit would rise to $438 billion in 2009. Revenues would increase by 6.8 percent in 2009, rebounding from their slump this year. Outlay growth would slow moderately to 6.9 percent. As a percentage of GDP, both revenues and outlays would increase relative to their levels in 2008. Because growth in outlays is projected to outstrip growth in revenues, the deficit would increase.
At 3.0 percent of GDP, the deficit in 2009 would be slightly larger than it is estimated to be this year. Under current laws and policies, the deficit would fall to 2.8 percent of GDP in 2010, CBO projects, and drop further to 2.0 percent of GDP in 2011. Deficits would decline faster starting in 2012, when the full effects of the expiring tax provisions would be realized. By 2018, the federal deficit would represent about 0.6 percent of GDP under the assumptions of CBO’s baseline projections.
CBO projects that receipts will climb from 17.9 percent of GDP in 2008 to about 18.5 percent of GDP in 2009 and 2010. After 2010, projected revenues increase sharply with the expiration of provisions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). By 2012, revenues in CBO’s baseline reach 20.0 percent of GDP. Because of the structure of the individual income tax, projected revenues continue to rise thereafter relative to the size of the economy, to 20.4 percent of GDP by 2018.
Individual Income Taxes. CBO projects that under current law, individual income tax receipts as a share of GDP will rise from 8.2 percent this year to 10.9 percent in 2018. The scheduled expiration of various current tax provisions causes projected revenues to increase in 2009 and 2010 and rise even more in 2011 and 2012. In addition, certain characteristics of the tax system cause revenues from individual income taxes to grow faster than GDP in most years. However, in some years, particularly 2009 and 2010, those factors are offset by projected slower growth in capital gains realizations and, to a lesser extent, by CBO’s assumption that the portion of recent receipts that cannot be explained on the basis of current economic data will gradually disappear starting in 2010.
Various changes in tax rules that are scheduled to occur would boost individual income tax receipts relative to GDP over the next decade. The higher exemption amounts that have mitigated the effects of the alternative minimum tax expired at the end of 2007. CBO expects that, in the absence of future legislation, the resulting increase in tax liability in 2008 will be paid almost entirely in fiscal year 2009, raising receipts relative to GDP by about 0.5 percentage points. Disbursements of rebates will be completed in fiscal year 2008, providing another (slightly smaller) boost to revenues in 2009. Furthermore, a number of changes in tax law that were originally enacted in EGTRRA and JGTRRA are scheduled to expire at the end of December 2010, raising projected revenues sharply in 2011 and 2012. Those changes in law would, among other things, increase statutory tax rates on ordinary income, capital gains, and dividends; narrow the 15 percent tax bracket for people who file jointly; and reduce the child tax credit. Those expirations would boost income tax receipts by roughly 1.0 percentage point of GDP through 2018, CBO estimates.
In addition, several characteristics of the tax code cause effective tax rates—the amount of taxes paid as a percentage of personal income—to increase over time. One characteristic is the phenomenon known as real bracket creep, wherein the overall growth of real (inflation-adjusted) income causes more income to be taxed in higher tax brackets. That factor is projected to push up receipts relative to GDP by about 0.5 percentage points over the next 10 years. Moreover, as nominal income rises, a growing share will be claimed by the AMT.5 CBO estimates that without changes in law, the AMT will increase tax revenue relative to the size of the economy by about 0.4 percentage points between 2008 and 2018. Also, taxable distributions from tax-deferred retirement accounts, such as individual retirement accounts and 401(k) plans, are expected to grow more rapidly than other income as the population ages. Taxation of those sources of retirement income is expected to cause revenues to rise relative to the size of the economy by about 0.4 percentage points over the 2009–2018 period.
CBO’s projection of the increase in individual income tax receipts arising from those combined factors is held down by the expected slower growth in capital gains and by an assumption about how long unexplained factors boosting recent individual income tax receipts will last. Strong growth in capital gains realizations since 2002 has raised them to a level relative to GDP that is well above that implied by historical relationships, given the rate at which they are currently taxed. CBO estimates that capital gains realizations will decline relative to GDP except in 2010, when the imminent increase in the top tax rate on gains (from 15 percent to 20 percent) scheduled for 2011 will encourage taxpayers to speed up their sale of assets, to 2010. CBO projects that revenue from capital gains will fall relative to GDP by about 0.4 percentage points by 2018.
In addition, despite a recent slowing in revenue growth, total receipts over the past three years have risen faster than can be explained by current data. The particular sources of those unexplained receipts will not be known until information from 2006, 2007, and 2008 tax returns becomes available. In the absence of that information, CBO assumes that the unexplained portion will persist through 2009 and that such receipts will gradually decline over the following several years. Over the longer term, the relationship between taxable income and GDP will return to that seen in the most recently available tax return data, CBO expects. That assumption causes projected revenues to decrease as a share of GDP by about 0.3 percentage points.
Corporate Income Taxes. Revenues from corporate income taxes are projected to be near 2.1 percent of the economy through 2012, before declining to 1.9 percent of GDP thereafter, the same level that was seen, on average, between 1980 and 2007.
In recent years, corporate profits reached new highs relative to GDP; domestic economic profits peaked at 10.7 percent of GDP in 2006. CBO projects that domestic economic profits will be 8.4 percent of GDP in 2008 and fall to 7.7 percent by 2010, before returning to 8.3 percent of GDP after 2011, a level more consistent with their historical relationship to GDP.
Social Insurance and Other Taxes. Receipts from social insurance taxes are projected to grow at roughly the same rate as the economy over the next decade, primarily because wages and salaries are expected to remain relatively constant as a share of GDP during that period. As a result, social insurance taxes in CBO’s baseline projections stay between 6.3 percent and 6.4 percent of GDP through 2018.
Total revenues from sources other than income and payroll taxes are expected to remain at about 1.1 percent of GDP through 2011 and then rise to 1.3 percent of GDP in 2012 and 1.4 percent of GDP by the end of the 10-year period.
The increase in other taxes as a share of GDP can be attributed to changes in the laws affecting estate and gift taxes. Under the provisions of current law, receipts from estate and gift taxes are anticipated to remain at about 0.2 percent of GDP through 2009 and then decline to 0.1 percent of GDP as the estate tax is reduced and, under EGTRRA, ultimately repealed for 2010. However, the estate tax is scheduled to be reinstated in 2011, which causes projected receipts to rebound to 0.3 percent of GDP in 2012 and to 0.4 percent of GDP by 2018.
Revenues from customs duties, earnings of the Federal Reserve System, and other miscellaneous sources are projected to remain relatively stable as a percentage of GDP over the 2009–2018 period.
Under the assumptions governing the construction of CBO’s baseline, total outlays are projected to average 21.1 percent of GDP over the next 10 years, compared with 20.0 percent in 2007 and 20.8 percent in 2008. Under current law, mandatory outlays are estimated to grow rapidly, outstripping growth in nominal GDP. In contrast, discretionary spending is projected to grow much more slowly, under the assumption that funding increases at the rate of inflation.
Mandatory Spending. Outlays for mandatory spending are projected to rise to about $1.7 trillion in 2009, 9.0 percent higher than the amount expected in 2008 (assuming no changes in current law). That year-over-year increase for 2009, which is similar to the increase expected this year, would be higher than the average rate of growth recorded over the past 10 years. Over the 2010–2018 period, CBO projects, those trends will moderate to some extent, with growth in mandatory spending averaging 5.4 percent under baseline assumptions.
Despite somewhat slower growth in Medicare spending in 2008, CBO projects that long-running trends of high growth in such spending will resume in 2009, with outlays for that program (not including offsetting receipts) rising by 9.3 percent. Over the 2010–2018 period, growth will average 6.7 percent a year, CBO projects, in line with the 6.9 percent growth experienced over the past decade. Under current law, and thus in the baseline, projected growth in Medicare spending is limited by a rate-setting system (the "sustainable growth rate") that controls the fees paid for physicians’ services in Medicare. Under that system, CBO projects, those fees will be reduced by about 21 percent in 2010 and more there-after. If legislation was enacted to override those reductions (as has happened in every year since 2003), spending on Medicare could be significantly greater than is projected in CBO’s baseline.6
CBO expects Medicaid outlays to rise by 9.7 percent in 2009. Strong growth in spending for that program is expected to persist in the coming years, with increases averaging 8.1 percent annually through 2018. At that time, federal spending for Medicaid will reach $449 billion, or 2.0 percent of GDP, CBO estimates.
Outlays for Social Security are expected to grow faster over the coming decade than in previous years. Over the 1997–2006 period, such spending increased at a rate of 4.6 percent per year, on average. CBO estimates that outlays for Social Security will rise by 7.9 percent next year and by 6.0 percent per year from 2010 to 2018. The most significant factor underlying next year’s anticipated increase in outlays is a higher cost-of-living adjustment. CBO expects that the adjustment in January 2009 will be 5.7 percent, nearly double the average of almost 3 percent paid out in each of the past five years. As inflation (the basis of the cost-of-living adjustment) moderates in subsequent years, CBO expects the rate of growth to diminish.
Another factor pushing up Social Security spending is the increase in caseloads. The oldest baby boomers began filing for Social Security benefits in calendar year 2008, and those caseload effects will be felt more fully in fiscal year 2009. Over the longer term, growth in caseloads will accelerate as more of the baby boomers collect benefits, with the number of beneficiaries rising from 51 million in 2009 to 64 million in 2018, CBO estimates.
Also contributing to the growth in mandatory spending over the next 10 years are greater outlays for veterans’ benefits. Mandatory spending on veterans’ benefits includes disability compensation, pensions, and life insurance programs, as well as readjustment benefits (which include education subsidies).7 Together, those benefits will total $48 billion in 2009, CBO estimates. By 2018, CBO projects, they will total $66 billion. Although compensation and pension expenses are projected to grow at a rate of about 2.2 percent a year, on average, veterans’ readjustment expenses will rise more rapidly. Outlays for those benefits will more than triple in coming years, CBO estimates, as provisions of the Post-9/11 Veterans Education Assistance Act of 2008 (enacted as part of Public Law 110-252) take effect. That legislation created a new education program for individuals with active-duty service since September 11, 2001. CBO projects that the cost of those benefits will rise from $4 billion in 2009 to $12 billion by 2018.
Outlays for other mandatory programs are projected to grow more slowly—or, in some cases, decline—after showing large increases in 2008 and 2009. Growth in outlays for refundable tax credits, unemployment compensation, Food Stamps, and deposit insurance is likely to slow over the coming 10 years, compared with their rapid growth in the near term. Payments of the refundable portion of the tax rebates issued in 2008 will amount to $6 billion in 2009 and will not be a factor in future outlays under current law. CBO estimates that outlays for unemployment compensation will continue to rise in 2009 (by about 30 percent from their level in 2008). In CBO’s baseline projections, they then fall in the following years as the unemployment rate drops and the provisions of Public Law 110-252 (which temporarily extends the number of weeks an individual can collect unemployment benefits) expire. In addition, outlays for Food Stamps are projected to grow by 17 percent next year. CBO estimates that the average monthly benefit will jump by 12 percent in 2009, mostly because of higher inflation, but also because caseloads are expected to rise significantly—by about 5 percent. Growth in spending for that program will moderate in the following years, CBO projects, rising at an annual rate of about 2 percent, on average.
For fiscal years 2009 to 2018, CBO projects that receipts collected by the FDIC will exceed the costs that the agency will incur in those years to cover insured deposits. Those receipts will come from the sale of assets acquired from failed financial institutions, from increased deposit insurance premiums charged to banks and thrift institutions, and from interest earned on the balances in the Deposit Insurance Fund. As a result, in contrast to the $14 billion in net outlays expected for 2008, CBO projects that the FDIC will show net receipts (that is, negative outlays) for the following 10 years.
CBO’s baseline projections also include the estimated effects of recently enacted legislation that provides temporary authority to the Secretary of the Treasury to purchase any obligations and securities issued by the government-sponsored enterprises Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Projected outlays for 2009 and 2010 reflect an expected-value estimate of $25 billion resulting from that provision.8 That new authority expires on December 31, 2009.
Discretionary Spending. In CBO’s latest baseline projections, total discretionary outlays grow at an average annual rate of 2.6 percent, rising from $1.2 trillion next year to $1.5 trillion in 2018.9 Relative to GDP, discretionary outlays fall from 8.2 percent in 2009 to 6.8 percent in 2018. (The budgetary effects of alternative assumptions about the growth of discretionary spending are discussed later in this chapter.)
CBO’s projections of discretionary spending through 2018 are based on the rules applied to baseline projections and reflect the most recent funding provided. That base level includes both regular and supplemental appropriations. The timing of such appropriations can cause sharp swings in CBO’s projections of total discretionary outlays over 10 years. For example, in June, the Supplemental Appropriations Act of 2008 (Public Law 110-252) provided $111 billion in budget authority for 2008, mostly for operations in Iraq and Afghanistan and for other activities related to the war on terrorism. For 2009, the law also provided $68 billion in funding for such purposes and another $7.5 billion, primarily for disaster relief and for international programs (see Table 1-6). The 2008 supplemental funding and the appropriations for 2009 have been extrapolated to future years in CBO’s baseline. Incorporating that supplemental funding into the baseline boosts CBO’s projection of discretionary outlays over the 2009–2018 period by nearly $1.2 trillion over the amount projected in March.10
Funding for Military Operations in Iraq and Afghanistan and for Other Activities Related to the War on Terrorism, 2008 and 2009
(Budget authority, in billions of dollars)
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Source: Congressional Budget Office.
a. A joint resolution making continuing appropriations for the fiscal year 2008, and for other purposes (Public Law 110-92), enacted September 29, 2007.
b. Department of Defense Appropriations Act, 2008 (Public Law 110-116), enacted November 13, 2007.
c. Consolidated Appropriations Act, 2008 (Public Law 110-161), enacted December 26, 2007.
d. Supplemental Appropriations Act, 2008 (Public Law 110-252), enacted June 30, 2008.
Net Interest and the Debt Limit. Under assumptions governing the baseline, net interest costs are estimated to fall in 2009 to $227 billion as a result of recent declines in short-term interest rates and projected lower inflation (see Table 1-7). For the following two years, rising short-term interest rates in CBO’s economic forecast and growing federal debt raise projected outlays for net interest by an average of 17 percent per year. Growth then slows to an average annual rate of 4 percent as projected deficits decline with the expiration of the tax provisions enacted in EGTRRA and JGTRRA. Over the 2009–2018 period, outlays for net interest under CBO’s baseline projections average 1.8 percent of GDP.
CBO’s Baseline Projections of Federal Interest Outlays and Debt
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