This morning I testified before the Senate Budget Committee on our annual Budget and Economic Outlook, which was released on Tuesday. As I did in my testimony before the House Budget Committee, I highlighted many of the points that were included in Tuesday’s blog post. In today’s post, I want to discuss in more detail an issue I addressed in my testimony: how some possible changes to current law would affect the economy over the next decade.
CBO’s baseline is crafted, as directed in law, so as to provide a benchmark for assessing the budgetary impact of possible changes in laws governing taxes and spending. Of course, future fiscal policy is likely to differ from that embodied in current law in at least some respects. To illustrate how some changes to current law would affect the economy over the next 10 years, CBO examined an alternative path for fiscal policy (an "alternative fiscal scenario") that would maintain some tax and spending policies that have recently been in effect but would differ, under current law, in the coming decade.
Maintaining the policies encompassed by that scenario would have different short-term and long-term effects on the economy. Doing so would:
This budgetary scenario incorporates the assumptions that all expiring tax provisions (other than the payroll tax reduction), including those that expired at the end of December 2011, are instead extended; that the alternative minimum tax is indexed for inflation after 2011 (starting at the 2011 exemption amount); that Medicare’s payment rates for physicians’ services are held constant at their current level; and that the automatic enforcement procedures specified by the Budget Control Act do not take effect (but the original caps on discretionary appropriations in that legislation remain in effect).
Each of those policy changes would add to budget deficits, which would be significantly larger than those in CBO’s baseline projections. As a result, federal debt held by the public would accumulate much more rapidly. Deficits would average 5.4 percent of GDP over the 2013–2022 period, rather than the 1.5 percent reflected in CBO’s baseline projections. Debt held by the public would climb to 94 percent of GDP in 2022, the highest figure since just after World War II.
As shown in the table below, CBO estimates indicate that real GDP would be higher in the first few years of the projection period than in CBO’s baseline economic forecast, primarily as a result of increased aggregate demand:
But ultimately, economic growth would be dampened:
A policy’s effects on gross national product (GNP) provide a better measure of its impact on U.S. residents’ income than its effects on GDP—because GNP excludes foreigners’ earnings on investments in the domestic economy but includes U.S. residents’ earnings overseas. CBO estimates that:
If policymakers wanted to achieve both a short-term economic boost and medium-term and long-term fiscal sustainability, they would need to enact policies that leave deficits significantly wider than in our current-law baseline for the next few years but significantly narrower than in our alternative fiscal scenario for later in the decade.
The slides I used during my testimony can be found here.