The Challenge of Attaining a Sustainable Federal Budget

July 18, 2011

As the nation addresses the budgetary challenges facing the federal government, one of the central questions to resolve is how big a government we want to have. During the past 40 years, government spending has ranged from as low as 18.2 percent of gross domestic product (GDP) in 2000 and 2001 to as high as 25.0 percent in 2009, averaging about 21 percent. Revenues, however, have averaged only 18 percent of GDP. One possible approach to addressing the longstanding mismatch between government spending and revenues—a mismatch that would grow substantially if current tax and spending policies are extended—would be to shrink spending so that it equals revenues at their historical 18-percent share of GDP. What would it take to accomplish that?

The following chart shows federal spending and its key components as shares of GDP: on average during the past 40 years; in 2007 before the recession began; and in 2021 under CBO’s current-law baseline projections. In the chart, the “major health programs” are Medicare, Medicaid, the Children’s Health Insurance Program, and insurance subsidies to be provided through exchanges in coming years; “all other spending” includes Food Stamps, unemployment compensation, other income security programs, veterans’ benefits, federal civilian and military retirement benefits, transportation, health research, education and training, and many other programs.

The Changing Landscape of Federal Spending

(Percent of GDP)

Note: Major health programs are Medicare, Medicaid, the Children’s Health Insurance Program, and exchange subsidies. The projection for 2021 is from CBO's most recent baseline projections published in March 2011.

One big challenge in bringing spending down is the fact that the rising costs of health care and the aging of the population are working in the opposite direction, pushing spending up for major government programs as they are currently structured. Largely because of those trends, spending on Social Security and the major health programs is projected to rise from 8.7 percent of GDP in 2007 to 12.2 percent in 2021. (The expansion of federal outlays for health insurance coverage in last year’s health care legislation plays a smaller role in that increase.)

The projected decline in other broad categories of spending as a share of GDP between 2007 and 2021—to just over 8 percent of GDP, about one-quarter below their historical average—owes partly to expected improvement in the economy and partly to the assumption underlying CBO’s baseline projections that spending subject to annual appropriations will increase with inflation but not with growth in real (inflation-adjusted) GDP. Nevertheless, under those baseline assumptions, spending under current law is projected to reach nearly 24 percent of GDP by 2021.

Thus, as can be seen in the chart, limiting federal spending to 18 percent of GDP would require a cut in spending relative to CBO’s baseline projections for 2021 of roughly one-quarter. (The precise amount of the required cut in federal programs would depend on interest outlays in 2021, which depend in turn on the size of deficits between now and then—and on interest rates in 2021. For simplicity, the rest of this paragraph assumes that programmatic spending would need to be cut by about one-quarter.) If certain categories of spending were protected from any cuts, then the proportional cuts to other types of spending would need to be larger. For example, if Social Security and the major health programs faced no cuts, then defense and other non-interest spending would need to be cut by about 60 percent. Alternatively, if defense and other non-interest spending faced no cuts, then outlays for Social Security and the major health programs would need to be cut by about 40 percent. Most of the outlays for those programs cover benefits for people over age 65, with smaller shares for blind and disabled people and for nonelderly able-bodied people. Thus, cutting outlays for Social Security and the major health programs to that extent would mean changing the sorts of benefits we provide for older Americans.

The budgetary imbalance could also be addressed by boosting revenues above historical levels relative to GDP—but it would take a substantial increase to bring revenues in line with projected spending under current law. For example, under current law, the expiration of the tax cuts enacted since 2001, the growing reach of the alternative minimum tax, the tax provisions of the recent health care legislation, and the way in which the tax system interacts with economic growth would result in revenues in 2021 reaching about 21 percent of GDP—about one-sixth above their historical average. But even then, the deficit would still be roughly 3 percent of GDP, and debt would be rising slowly relative to GDP. Thus, with older Americans receiving the benefits projected under current law, fiscal policy is not on a sustainable path even with: (a) tax revenues rising above their historical average share of GDP; and (b) the rest of the government apart from programs focused on older Americans playing a much smaller role relative to the size of the economy than during the past several decades.

The budget numbers tell a clear story: Given the aging of the population and the rising cost of health care, attaining a sustainable budget for the federal government will require the United States to deviate from the policies of the past 40 years in at least one of the following ways:

  • Raise federal revenues significantly above their average share of GDP;
  • Make considerable changes to the sorts of federal benefits we provide for older Americans;
  • Substantially reduce the role of the rest of the federal government—that is, defense (the largest single piece), Food Stamps, unemployment compensation, other income security programs, veterans’ benefits, federal civilian and military retirement benefits, transportation, health research, education and training, and other programs—in our economy and society.

We as a society will either have to pay more for our government, accept less in government services and benefits, or both. For many people, none of those choices is appealing—but they cannot be avoided for very long.