More About the Challenge of Attaining a Sustainable Federal Budget

July 22, 2011

Earlier this week, I wrote a blog posting about the challenges facing policymakers as they work to put the federal budget on a sustainable path.

The central conclusion in the earlier posting, illustrated by the following chart, was the following: 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 major changes to the sorts of benefits we provide for older Americans;
  • Substantially reduce the role of the rest of the federal governmentthat 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 programsin our economy and society.

The Changing Landscape of Federal Spending

(Percent of GDP)

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

Its worth returning to the basic math of the federal budget that makes those choices so stark. Here are the key facts about federal budget policy during the past several decades and CBOs projections for 2021:

  • Revenues have averaged 18.0 percent of GDP during the past 40 years.
  • Under current law, CBO projects that spending on Social Security and the major health care programsMedicare, Medicaid, the Childrens Health Insurance Program, and insurance subsidies to be provided through exchanges in coming yearswould be 12.2 percent of GDP in 2021. 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 those outlays to a substantial extent means changing the sorts of benefits we provide for older Americans. More specifically: CBO projects that more than four-fifths of Social Security outlays in 2021 will go to benefits for retired workers and their dependents and survivors, with the remaining less than one-fifth going to benefits for disabled workers and their spouses and children. In addition, even with the significant expansion of federal support for health care for lower-income people in last years legislation, CBO projects that about half of outlays for the major health care programs in 2021 will go to people over age 65, with another quarter going to the blind and disabled, and the remaining quarter going to able-bodied nonelderly citizens.
  • All spending apart from Social Security, the major health care programs, and interest payments on the debt has averaged 11.5 percent of GDP during the past 40 years. That broad category includes defense (by far 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.
  • Therefore, continuing Social Security and the major health care programsmost of whose benefits go to older Americansin their current form, and operating the rest of the government in line with its role in the economy and society during the past 40 years, would cost 23.7 percent (12.2+11.5) of GDP by 2021. That amount exceeds the historical average revenue share of GDP by nearly 6 percentage pointsand interest payments on the debt havent even been included yet.

What do these figures imply about the choices that policymakersand citizensconfront about future policies?

First, if we choose to keep revenues at their average share of GDP during the past 40 years, then we cannot provide the same sorts of benefits for older Americans and have the rest of the government play the same role it played during that period.

An example of that approach is the long-term budget proposal put forward by Congressman Paul Ryan, the Chairman of the House Budget Committee, which is the basis for the Congressional budget resolution passed this year by the House of Representatives. That proposal would hold revenues at 18 percent of GDP in 2022. In that year, according to CBOs analysis, the proposal would reduce spending on the major health care programs by about one-quarter relative to current law. It would also set spending apart from Social Security, the major health care programs, and interest payments at 6 percent of GDPabout half its historical average (see figurebelow). All told, CBO projects that federal spending would be 20 percent of GDP in that year, and the deficit would equal about 2 percent of GDP.

Although the budget would not be balanced under this proposal in that year, the deficit would be small enough that debt held by the public would be declining slowly relative to GDP. Thus, the proposal would put fiscal policy on a sustainable path with tax revenues near their historical average share of GDP by making major changes in the benefits provided to older Americans and giving the rest of the government a much smaller role relative to the size of the economy than it has played during the past several decades.

Second, if we choose instead to provide the same sorts of benefits to older Americans as we did during the past 40 years, then we cannot keep revenues at their average share of GDP and have the rest of the government play the same role it played during that period.

For example, consider CBOs current-law baseline projections. 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 20.8 percent of GDPabout one-sixth above the historical average. In addition, under the assumptions that guide CBOs baseline projections, all noninterest spending apart from Social Security and the major health care programs would equal 8.3 percent of GDPmore than one-quarter below its historical average (see figure below). Even so, with Social Security and the major health care programs reaching 12.2 percent of GDP and net interest costs growing to 3.4 percent of GDP under current law, the deficit would 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 tax revenues rising above their historical average share of GDP and 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 it did during the past several decades.

Third, if we choose instead to have the government apart from programs focused on older Americans play the same role it played in our economy and society during the past 40 years, then we cannot keep revenues at their average share of GDP and provide the same sorts of benefits for older Americans as we did during that period.

For example, suppose that all spending in 2021 apart from Social Security, the major health care programs, and interest payments on the debt equaled 11.5 percent of GDP, matching its historical average. Suppose also that revenues followed their projected path under current law, pushing them to 20.8 percent of GDP, one-sixth above their historical average share of GDP by 2021. And suppose that outlays for Social Security and the major health care programs were cut by one-quarter from their projected amount under current law (to about 9 percent of GDP). Even still, total noninterest outlays would exceed the amount in CBOs baseline, which, together with the revenue projected under the baseline, leaves debt rising slowly relative to GDP (see figurebelow). Thus, with the rest of the government apart from programs focused on older Americans playing the same role relative to the size of the economy as during the past several decades, fiscal policy would not be on a sustainable path even with tax revenues rising above their historical average share of GDP and major changes in benefits for older Americans.

Therefore, the country faces difficult tradeoffs in putting the federal budget on a sustainablepath. If we are honest with ourselves about those tradeoffsif we recognize them and understand them, rather than trying to deny themthen we can make the best choices for our future. We at CBO will continue to work hard to provide objective, nonpartisan information and analysis that can assist the Congress in that process.

(Percent of GDP)