The Budget & Economic Outlook: An Update

August 25, 2009

Today CBO issued its annual summer update of the budget and economic outlook. CBO estimates that the federal budget deficit for 2009 will total $1.6 trillion, which, at 11.2 percent of gross domestic product (GDP), will be the highest since World War II. That deficit figure results from a combination of weak revenues and elevated spending associated with the economic downturn and financial turmoil. The deficit has been boosted by various federal policies implemented in response, including the stimulus legislation and aid for the financial, housing, and automotive sectors.

CBO estimates that, as the economy recovers, if current laws and policies remained in place, the deficit would shrink but remain above $500 billion per year, or more than 3 percent of GDP, throughout the 20102019 period. As a result, debt held by the public would continue to grow as a percentage of GDP during that time. That debt, which was as low as 33 percent of GDP in 2001, would reach an estimated 54 percent of GDP this year and grow to 68 percent of GDP by 2019.

Those projections generally follow the rules, originally established in law, that have traditionally governed baseline projections. However, some of the resulting assumptions may underestimate potential deficits. Because they presume no changes in current tax laws, the projections incorporate increases in revenues that would result from the expiration of tax reductions enacted earlier in this decade and provisions that have kept the alternative minimum tax (AMT) from affecting many more taxpayers. They also assume that future annual appropriations grow each year at the rate of inflation. Those assumptions result in projected revenues that, as a percentage of GDP, would be high by historical standards, and projected discretionary spending that, relative to GDP, would be low by historical standards. Many other outcomes are possible. If, for example, those tax reductions were continued, the parameters of the AMT were indexed for inflation, and future annual appropriations were to remain at their 2009 share of GDP, the deficit in 2019 would reach 8.5 percent of GDP, by CBOs estimates.

Since it last issued baseline projections in March, CBO has reduced its estimate of the deficit for 2009 by $80 billion. Both outlays and revenues are now expected to be lower in the current year than previously estimated, by $165 billion and $85 billion, respectively. A large drop (of $203 billion) in the estimated subsidy cost of the Troubled Asset Relief Program (TARP) dominates the change in projected outlays for 2009; other changes (mostly in revenues) offset much of that decrease.

Although various indicators suggest that the recession may have ended or is likely to end within the next few months, CBOs economic forecast anticipates a relatively slow and tentative recovery. A number of forces, including global economic weakness, continued strains in financial markets, and households desire to rebuild their savings, are expected to restrain economic growth for the next few years.

Specifically, CBO estimates positive economic growth during the second half of calendar year 2009, at an annual rate of 1.6 percent, following declines at an annual rate of 6.4 percent in the first quarter and 1.0 percent in the second quarter. In CBOs forecast, real GDP grows by 2.8 percent between the fourth quarter of 2009 and the fourth quarter of 2010, by 3.8 percent in 2011, and by an average of 4.5 percent in 2012 and 2013. With the economy functioning well below its potential level, inflation is projected to remain very low; the consumer price index for all urban consumers, with food and energy prices excluded, is expected to increase by 1.6 percent this year, by 1.1 percent in 2010, and by 1.0 percent in 2011 (as measured by the change in the index from the fourth quarter of one year to the fourth quarter of the next year).

Beyond the 10-year budget window, the nation will face further significant fiscal challenges posed by rising health care costs and the aging of the population. Continued large deficits and the resulting increases in federal debt would, over time, reduce economic growth. Putting the nation on a sustainable fiscal course will require some combination of lower spending and higher revenues than the amounts now projected.