Reducing the Deficit: Spending and Revenue Options

Report
March 10, 2011

CBO regularly issues a compendium of budget options to help inform federal lawmakers about the implications of possible policy choices. This volume—one of several reports that CBO produces regularly for the House and Senate Committees on the Budget—presents more than 100 options for altering federal spending and revenues. Nearly all of the options would reduce federal budget deficits. The report begins with an introductory chapter that describes the current budgetary picture and the uses and limitations of this volume. Chapters 2 and 3 present options that would reduce mandatory and discretionary spending, respectively. Chapter 4 contains options that would increase revenues from various kinds of taxes and fees.

Federal budget deficits will total $7 trillion over the next decade if current laws remain unchanged, CBO projects. If certain policies that are scheduled to expire under current law are extended instead, deficits may be much larger. Beyond the coming decade, the aging of the U.S. population and rising health care costs will put increasing pressure on the budget. If federal debt continues to expand faster than the economy—as it has since 2007—the growth of people's income will slow, the share of federal spending devoted to paying interest on the debt will rise, and the risk of a fiscal crisis will increase.

This report presents 105 illustrative options that would reduce projected budget deficits. As in past reports, the options cover an array of policy areas—from defense to energy to entitlement programs to provisions of the tax code. The budgetary effects shown for most options span the 10 years from 2012 to 2021 (the period covered by CBO's January 2011 baseline budget projections), although many options would have longer-term effects as well. The options are grouped into three major budget categories: mandatory spending, discretionary spending, and revenues. In most cases, the table accompanying an option shows the option's estimated budgetary effects in each of the next 10 years, as well as 5- and 10-year totals.

The options in this volume come from legislative proposals, various Administrations' budget proposals, Congressional staff, other government entities, and private groups, among others. Because the spending options in this volume are intended to help lawmakers review individual programs, they do not include large-scale budget initiatives, such as eliminating entire departments or agencies. The options are intended to reflect a range of possibilities, not a ranking of priorities, and the report does not provide an exhaustive list of policy alternatives. The inclusion or exclusion of a particular policy change does not represent an endorsement or rejection by CBO. In keeping with CBO's mandate to provide objective, impartial analysis, this report makes no recommendations.

Budget Decisions: The Current Context

Over the past 40 years, federal debt held by the public has averaged 35 percent of the country's annual economic output (gross domestic product, or GDP). Because of massive deficits during the past few years, that ratio climbed to 62 percent by the end of last year, the highest level since shortly after World War II.

In CBO's current-law baseline, the deficit is projected to equal 9.8 percent of GDP in 2011, shrink to 4.3 percent of GDP by 2013 (after certain tax provisions are scheduled to expire and the economy has recovered further from the recession), and then range between 2.9 percent and 3.4 percent of GDP through 2021—close to the average of 2.8 percent seen over the past 40 years. Those deficits would push total debt held by the public to 77 percent of GDP by 2021.

Moreover, CBO's baseline projections are predicated on the assumption that many policies now in place are allowed to expire over the next decade, as scheduled under current law. Those expiring policies include the major reductions in individual income taxes originally enacted in 2001 and 2003 and recently extended through 2012, as well as the higher exemption amounts for the alternative minimum tax. If those policies and others were extended, budget deficits would be much larger than in that baseline.

Over the longer term, the continued aging of the population and growth in health care costs will almost certainly push up federal spending significantly relative to GDP under current law. Without changes in law, spending on Social Security and the government's major mandatory health care programs (Medicare, Medicaid, the Children's Health Insurance Program, and health insurance subsidies to be provided through insurance exchanges) will increase from roughly 10 percent of GDP today to about 16 percent over the next 25 years. If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt.

To prevent federal debt from becoming unsupportable, lawmakers will have to restrain the growth of spending substantially, raise revenues significantly above their historical share of GDP, or pursue some combination of those two approaches.

Options for Reducing Mandatory Spending

Mandatory spending includes spending for entitlement programs and certain other payments to people, businesses, nonprofit institutions, and state and local governments. For mandatory spending programs, funding levels are generally determined not by annual appropriations but by eligibility rules, benefit formulas, and other parameters set by Congress in authorizing legislation.

The largest programs in this category are Social Security, Medicare, and Medicaid, which together accounted for 74 percent of mandatory spending in 2010 and are projected to account for 81 percent by 2021, under current law.

The options in this section encompass a broad range of mandatory spending programs. Although the options are grouped by program, some of the options for different programs are conceptually similar. For instance, two options address the effects of applying different inflation factors to the benefit formulas for certain programs. Other options would alter the balance of spending between the government and program participants or between the federal government and the states.

Of the 32 options in the mandatory spending chapter:

  • Fifteen deal with spending for health care programs.
  • Seven would make changes to Social Security or other retirement programs.
  • Ten focus on Fannie Mae, Freddie Mac, and programs that deal with education, energy, or agriculture.

Options for Reducing Discretionary Spending

Spending governed by the Congress's annual appropriation acts—which is labeled discretionary spending—accounts for nearly 40 percent of federal outlays. In 2010, roughly half of discretionary spending went for defense. The other half paid for a wide range of federal activities, including law enforcement, homeland security, transportation, national parks, disaster relief, scientific research, and foreign aid. CBO's baseline projections reflect the assumption that discretionary spending will grow at the rate of inflation and will thus decline to 28 percent of total spending by 2021.

Of the 38 options in the discretionary spending chapter:

  • Two options, one for defense spending and one for nondefense spending, present broad alternatives for freezing or reducing discretionary spending.
  • Twelve other options deal with defense spending.
  • The other 24 options cover a broad array of nondefense programs.

Most of the options show savings calculated relative to CBO's baseline projections—that is, the 2011 appropriation annualized, adjusted for projected inflation in later years. The budgetary effects of several options that involve spending for defense procurement were estimated on a different basis—they were measured relative to the Department of Defense's (DoD's) 2011 Future Years Defense Program (FYDP). CBO determined that it would be more informative to estimate the effects of procurement options relative to DoD's published plan because CBO's baseline for defense procurement is not based on detailed plans for weapon systems. Because the 2011 FYDP extends for only five years, however, CBO's estimates for procurement options are presented with tables that show just five years of costs or savings. The text of each procurement option discusses the effect of the option on DoD's long-term acquisition plans.

Options for Increasing Revenues

Federal revenues come from taxes on individual and corporate income, payroll taxes for social insurance programs (such as Social Security and unemployment compensation), excise taxes, estate and gift taxes, remittances from the Federal Reserve System, customs duties, and miscellaneous fees and fines. The two largest sources are individual income taxes and social insurance taxes, which together produce more than 80 percent of the government's revenues.

The revenue chapter presents 35 options to increase revenues. The options are grouped in a number of broad categories according to the part of the tax system they would target:

  • Individual income tax rates
  • The individual income tax base
  • Individual income tax credits
  • The Social Security tax base
  • Corporate income tax rates
  • Taxation of income from businesses and other entities
  • Taxation of income from worldwide business activity
  • Consumption and excise taxes
  • Health care provisions
  • Other taxes and fees

Nearly all the estimates for the revenue options were prepared by the staff of the Joint Committee on Taxation (JCT). If combined, the options might interact with one another in ways that could alter their revenue effects as well as their impact on households and the economy. For simplicity in presentation, some of the changes in revenues shown in the tables represent the net effects of an option on both revenues and outlays combined.

Caveats About This Report

The estimates shown in this volume could differ from any later cost estimates by CBO or revenue estimates by JCT for legislative proposals that resemble these options. One reason is that the policy proposals on which those later estimates would be based might not precisely match the options presented here. Another reason is that the baseline budget projections against which such proposals would ultimately be measured might have been updated and thus would differ from the projections used for this report.

The estimated budgetary effects of options do not reflect the extent to which a policy change would affect interest payments on federal debt.

CBO's analyses do not attempt to quantify the impact of options on state spending. Some options that would affect other levels of governments or the private sector might involve federal mandates. The discussions of the options in this volume do not address the costs of potential mandates.