The Budget and Economic Outlook: Fiscal Years 2009 to 2019
The sharp downturn in housing markets across the country, which undermined the solvency of major financial institutions and severely disrupted the functioning of financial markets, has led the United States into a recession that will probably be the longest and the deepest since World War II. The Congressional Budget Office (CBO) anticipates that the recession—which began about a year ago—will last well into 2009.
Under an assumption that current laws and policies regarding federal spending and taxation remain the same, CBO forecasts the following:
- A marked contraction in the U.S. economy in calendar year 2009, with real (inflation-adjusted) gross domestic product (GDP) falling by 2.2 percent.
- A slow recovery in 2010, with real GDP growing by only 1.5 percent.
- An unemployment rate that will exceed 9 percent early in 2010.
- A continued decline in inflation, both because energy prices have been falling and because inflation excluding energy and food prices—the core rate—tends to ease during and immediately after a recession; for 2009, CBO anticipates that inflation, as measured by the consumer price index for all urban consumers (CPI-U), will be only 0.1 percent.
- A drop in the national average price of a home, as measured by the Federal Housing Finance Agency’s purchase-only index, of an additional 14 percent between the third quarter of 2008 and the second quarter of 2010; the imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts.
- A decrease of more than 1 percent in real consumption in 2009, followed by moderate growth in 2010; the rise in unemployment, the loss of wealth, and tight consumer credit will continue to restrain consumption—although lower commodity prices will ease those effects somewhat.
- A financial system that remains strained, although some credit markets have started to improve; it is too early to determine whether the government’s actions to date have been sufficient to put the system on a path to recovery.
The major slowdown in economic activity and the policy responses to the turmoil in the housing and financial markets have significantly affected the federal budget. As a share of the economy, the deficit for this year is anticipated to be the largest recorded since World War II. Under the rules governing CBO’s budget projections—that is, an assumption that federal laws and policies regarding spending and taxation remain unchanged—the agency’s baseline reflects these key points:
- CBO projects that the deficit this year will total $1.2 trillion, or 8.3 percent of GDP. Enactment of an economic stimulus package would add to that deficit. In CBO’s baseline, the deficit for 2010 falls to 4.9 percent of GDP, still high by historical standards.
- CBO expects federal revenues to decline by $166 billion, or 6.6 percent, from the amount in 2008. The combination of the recession and sharp drops in the value of assets—most significantly in publicly traded stock—is expected to lead to sizable declines in receipts, especially from individual and corporate income taxes.
- According to CBO’s estimates, outlays this year will include more than $180 billion to reflect the present-value of the net cost of transactions under the Troubled Asset Relief Program (TARP), which was created in the fall of 2008. (Broadly speaking, that cost is the purchase price minus the present value, adjusted for market risk, of any estimated future earnings from holding purchased assets and the proceeds from the eventual sale of them.) The TARP has the authority to enter into agreements to purchase assets totaling up to $700 billion outstanding at any one time, but the net cost over time will be much less than that amount.
- The deficit for 2009 also incorporates CBO’s estimate of the cost to the federal government of the recent takeover of Fannie Mae and Freddie Mac. Because those entities were created and chartered by the government, are responsible for implementing certain government policies, and are currently under the direct control of the federal government, CBO has concluded that their operations should be reflected in the federal budget. Recognizing that cost in 2009 adds about $240 billion (in discounted present-value terms) to the deficit this year.
- Economic factors have also boosted spending on programs such as those providing unemployment compensation and nutrition assistance as well as those with cost-of-living adjustments. (Such adjustments for 2009 are large because most of them are based on the growth in the consumer price index over the four quarters ending in the third quarter of 2008.)
CBO anticipates that the current recession, which started in December 2007, will last until the second half of 2009, making it the longest recession since World War II. (The longest such recessions otherwise, the 1973–1974 and 1981–1982 recessions, both lasted 16 months. If the current recession were to continue beyond midyear, it would last at least 19 months.) It could also be the deepest recession during the postwar period: By CBO’s estimates, economic output over the next two years will average 6.8 percent below its potential—that is, the level of output that would be produced if the economy’s resources were fully employed (see Figure 1). This recession, however, may not result in the highest unemployment rate. That rate, in CBO’s forecast, rises to 9.2 percent by early 2010 (up from a low of 4.4 percent at the end of 2006) but is still below the 10.8 percent rate seen near the end of the 1981–1982 recession.
(Percentage of potential gross domestic product)
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.
Notes: The GDP gap is the difference between real (inflation-adjusted) gross domestic product and its estimated potential level (which corresponds to a high level of resource—labor and capital—use).
Data are quarterly and are plotted through the fourth quarter of 2019.
In preparing its economic forecast, CBO assumes that current laws and policies governing federal spending and taxes do not change. This forecast, therefore, does not include the effects of a possible fiscal stimulus package. On that basis, CBO anticipates that real GDP will drop by 2.2 percent in calendar year 2009, a steep decline. CBO expects the economy to begin a slow recovery in the second half of 2009 and to grow by a modest 1.5 percent in 2010 (see Table 1).
CBO’s Economic Projections for Calendar Years 2009 to 2019
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board.
Notes: GDP = gross domestic product; PCE = personal consumption expenditure.
Economic projections for each year from 2009 to 2019 appear in Appendix B.
c. The personal consumption expenditure chained price index.
d. The personal consumption expenditure chained price index excluding prices for food and energy.
e. The consumer price index for all urban consumers.
f. The consumer price index for all urban consumers excluding prices for food and energy.
CBO expects inflation to continue to decline, both because energy prices have been falling and because inflation excluding energy and food prices—the core rate—tends to ease during and immediately after a recession. For 2009, CBO anticipates that the increase in the CPI-U will be only 0.1 percent. For 2010, CBO forecasts the CPI-U to be higher—at 1.7 percent—because energy prices are not expected to lessen inflation that year.
The sudden decline in economic activity in the second half of last year signaled that the recession could be severe. The recession was precipitated by a drop in house prices and housing starts, which abruptly undermined the solvency of financial institutions and severely disrupted the functioning of financial markets. A sharp rise in oil prices between early 2007 and the middle of 2008 further debilitated economic activity. Those recessionary pressures were largely offset for a time by strong growth of exports and by government policies that included a significant easing of monetary policy and tax rebates during the spring and summer of 2008. By the middle of last year, the growth of output had weakened but remained, on average, about 2 percent. By the fall of last year, however, additional turmoil hit financial markets even though policymakers had provided extraordinary amounts of support to the markets in order to contain it (see Appendix A). As spending by consumers and businesses weakened, output fell at an annual rate of 0.5 percent in the third quarter and probably fell much more in the fourth quarter. The price of oil also dropped rapidly late last year; if sustained, lower oil prices will temper the decline in output.
Normally, sharp contractions in economic activity are followed by rapid rebounds, but this forecast anticipates that the recovery in 2010 will be slow for a number of reasons. Although financial conditions are expected to improve, the pace of improvement will be restrained because it will take time for financial institutions to recover from losses due to loan defaults. As a result, borrowers will continue to find the terms and availability of credit tight, which will increase the cost of capital and hold back the growth of investment and consumption, dampening economic activity for several years. Similarly, the excess supply of vacant houses is expected to suppress the typical rebound in housing construction next year. Spending also will be muted as households continue to adjust to the large declines in wealth of the past few years. Last, foreign economies will not provide an offsetting boost in demand: Although economic growth overseas remained strong during the housing collapse of 2007 and 2008, providing support to U.S. producers, those economies are now weakening and are likely to restrain the U.S. recovery in 2010.
The federal budget will provide some support to the economy in 2009 and 2010, even in the absence of any new stimulus legislation. Federal tax liabilities (and therefore revenues) fall proportionately more than incomes in recessions, and that additional drop dampens the decline in households’ real after-tax spending power. In addition, spending on some programs, such as those providing unemployment insurance and the Supplemental Nutrition Assistance Program (formerly known as the Food Stamp program), automatically increases during recessions. Those recession-induced changes in the federal budget tend to smooth out economic cycles. The magnitude of those “automatic stabilizers” can be only roughly estimated, but in CBO’s forecast about $250 billion of the change in the deficit (about 1.8 percent of GDP) between 2008 and 2009 appears to be attributable to them.1
In contrast, spending by state and local governments will only mildly ease the downturn in economic activity. In response to lower-than-expected revenues and requirements for balanced budgets, they are cutting back their spending on goods and services, and CBO’s forecast assumes essentially no real growth in that spending this year. Total state and local deficits (including both the operating and the capital accounts) will increase, but the change in the total deficits will be small relative to the recession-induced change in the federal deficit.
A major source of uncertainty in the outlook is the degree and persistence of turmoil in financial markets and the resulting impact on the future course of the economy. Many financial instruments and practices that contributed to the financial crisis came into widespread use only in the past decade, and the scale of the problems and the worldwide linkages of financial markets are significantly different from what they were in previous episodes of financial stress in the United States. Furthermore, the scale and novelty of federal intervention, particularly by the Federal Reserve, and uncertainty about the degree to which those interventions will affect the economic outlook, make it particularly difficult for analysts to use historical patterns to forecast the near future.
It is possible that the extensive support that the Federal Reserve and the Department of the Treasury have provided to banks and other financial institutions—and have promised to continue to provide—will soon restore a measure of confidence that will permit a rapid rebound in economic activity. Alternatively, greater declines in house prices than CBO anticipates may generate further losses on mortgage-backed securities. Because institutions’ direct and indirect exposure to those securities is still not clear, banks may remain unwilling to lend to one another or to other, nonfinancial, customers, making it difficult for many households and businesses to obtain financing. Furthermore, foreign lenders, who have recently been willing to lend to the U.S. government on very advantageous terms, may become less willing to do so in the future, which would tend to raise interest rates in this country and dampen economic activity.
CBO does not attempt to predict cyclical movements beyond the near term—that is, in the current projections, beyond 2010—but instead aims to describe an average path on which the economy’s actual output gradually converges with its potential output.2 In these projections, the anticipated GDP gap—the difference between actual and potential output—will not close until early 2015 (see Figure 1). After that point, CBO projects, GDP will average close to its potential and therefore will grow at the same rate: 2.3 percent.
Inflation, as measured by the price index for personal consumption expenditures in the national income and product accounts (the inflation measure that the Federal Reserve watches most closely), averages 1.9 percent per year during the latter years of CBO’s projections (2015 to 2019). That estimate implies a slightly higher growth rate, 2.2 percent, for the CPI-U and a slightly lower growth rate, 1.9 percent, for the overall GDP price index. The projected unemployment rate averages 4.8 percent during those years, equal to CBO’s estimate of the average sustainable rate in the long run. The interest rate on 3-month Treasury bills is projected to average 4.7 percent, and the rate on 10-year Treasury notes, 5.4 percent.
Although housing starts and house prices have fallen substantially, the inventory of unsold homes remains very high. The correction in the housing market will probably continue for most of this year.
The volume of home construction started to fall early in 2006 when the number of vacant units started to increase and real prices of houses, which had been rapidly increasing, suddenly plateaued. In 2007, house prices started to fall and have continued to do so, with the worst of the decline concentrated in California, Florida, Arizona, and Nevada. According to CBO’s forecast, the national average price of a house will fall by an additional 14 percent between the third quarter of 2008 and the middle of 2010. Because consumer prices are expected to grow less than 1 percent over that period, the real price of the average house falls by a similar amount (see Figure 2). Price changes in specific areas may be quite different, however.
Inflation-Adjusted House Prices, 1975 to 2010
Sources: Congressional Budget Office; Federal Housing Finance Agency; Department of Commerce, Bureau of Economic Analysis.
Notes: The index shown is the Federal Housing Finance Agency’s purchase-only house price index for 1991 to the present and estimated values using the total index for previous years, divided by the personal consumption price index.
Data are quarterly and are plotted through the fourth quarter of 2010.
The imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts (see Figure 3). The percentage of owned (as opposed to rented) units that were vacant and for sale jumped from a 20-year average of 1.7 percent between 1985 and 2005 to 2.8 percent in the third quarter of 2008. Largely because of that increase, housing starts dropped from an annual rate of 2.1 million in the summer of 2005 to 0.7 million at the end of 2008. CBO anticipates that housing starts will not begin to recover until late in 2009.
Sources: Congressional Budget Office; Department of Commerce, Bureau of the Census.
Notes: Housing starts include both single-family and multifamily homes.
Data are quarterly and are plotted through the fourth quarter of 2015.
The imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts (see Figure 3). The percentage of owned (as opposed to rented) units that were vacant and for sale jumped from a 20-year average of 1.7 percent between 1985 and 2005 to 2.8 percent in the third quarter of 2008. Largely because of that increase, housing starts dropped from an annual rate of 2.1 million in the summer of 2005 to 0.7 million at the end of 2008. CBO anticipates that housing starts will not begin to recover until late in 2009.
After rising for much of last year, mortgage rates—both for conforming loans (ones eligible to be purchased by the government-sponsored enterprises [GSEs] Fannie Mae and Freddie Mac) and larger, jumbo, loans—decreased late last year, particularly at the end of December (see Figure 4).3 Lower mortgage rates have spurred applications for mortgage refinancing, but the number of applications for loans to finance home purchases remains low.
Interest Rates on Mortgage Loans, January 2007 to January 2009
Sources: Congressional Budget Office; Bankrate.com.
Notes: Conforming mortgage loans are those that can be purchased by Fannie Mae and Freddie Mac on the secondary loan market. Jumbo mortgage loans are all loans that are larger than conforming loans.
Data are weekly and are plotted through January 2, 2009.
Foreclosure rates, however, are unusually high for all types of mortgages, particularly for subprime adjustable-rate mortgages (ARMs), putting more pressure on the financial system (see Figure 5). From early 2006 to the first half of 2008, foreclosures of properties with subprime ARMs jumped from the 2 percent average that had been experienced for eight years to 7 percent, although the percentage decreased slightly in the third quarter of 2008. Foreclosure rates are likely to remain high while house prices continue to fall and the economy remains in recession. Many homeowners have negative equity in their homes (that is, they owe more on their mortgage than the market value of their house) and will not be able to refinance their mortgage.4
Foreclosure Rates, 2000 to 2008
Sources: Congressional Budget Office; Mortgage Bankers Association.
Notes: ARM = adjustable-rate mortgage.
Data are quarterly and are plotted through the third quarter of 2008.
Financial markets have been under stress since August 2007, and the financial crisis deepened in the second half of 2008. In September 2008, with an ongoing decline in house prices, a slowing of real economic activity, and negative news about the state of several large financial institutions, financial markets appeared on the verge of freezing up, particularly the interbank market for short-term loans. A measure of that risk is the spread between the three-month London interbank offered rate (or Libor, the interest rate that major banks charge other banks for loans of that duration) and the three-month average of the expected federal funds rate (the Federal Reserve targets the federal funds rate in its conduct of monetary policy). That spread jumped sharply in the fall, reaching a record level of 3.6 percentage points on October 10 (see Figure 6). That increase reflected financial markets’greater uncertainty about the ability of banks to repay their loans.
The Risk Spread on Lending Between Banks, January 2007 to January 2009
Sources: Congressional Budget Office; Bloomberg.
Notes: A spread is the difference between two interest rates. One, the three-month Libor (London interbank offered rate), is the interest rate major banks offer to other banks for loans of that duration. The other is the average federal funds rate expected over a three-month period as measured by the overnight index swap contract.
Data are weekly and are plotted through January 2, 2009.
The Federal Reserve has sought to reestablish the flow of funds in the economy, using a variety of mechanisms that, together, raised banks’ reserves to $848 billion by the end of 2008 from $13 billion 12 months earlier and increased the Federal Reserve’s overall balance sheet from $892 billion to $2,247 billion. The Federal Reserve cut its target for the federal funds rate from 5.25 percent in August 2007 to between zero and 0.25 percent in December and correspondingly lowered the discount rate (which is the rate that banks pay for borrowing from the Federal Reserve's discount window). However, even with short-term interest rates close to zero, the Federal Reserve has continued to provide additional support to credit markets using a strategy known as “quantitative easing.” In doing so, the Federal Reserve has greatly extended its loan facilities, accepting as collateral assets that have been shunned by private lenders because of the heightened uncertainty. In addition, the Federal Reserve announced in late November plans to purchase, over the next few quarters, up to $100 billion in debt issued by Fannie Mae, Freddie Mac, and Ginnie Mae and up to $500 billion in mortgage-backed securities guaranteed by those entities.5 As of late December, the Federal Reserve had purchased about $15 billion in debt issued by those entities.
The Treasury also has intervened in the financial markets, mostly to improve the solvency of financial institutions. After failing to restore confidence in Fannie Mae and Freddie Mac with the Housing and Economic Recovery Act of 2008—which temporarily authorized the Treasury to purchase obligations and securities issued by the two entities—the government took control of them. In the fall of 2008, the Congress authorized the Troubled Asset Relief Program, which the Treasury used to provide $248 billion to financial institutions by the end of December, with the aim of helping to get credit flowing again. In addition, the Treasury will assist the automobile industry by making loans to General Motors and Chrysler (and providing assistance to GMAC, a financial services company), with the goal of improving their long-term viability.
By the end of December 2008, some credit markets had improved, although the financial system remains strained. The spread between the Libor and the expected federal funds rate has dropped markedly from the very high levels observed in October 2008, but—at 1.2 percent—it remains unusually high. The spread between the interest rate on commercial paper, a kind of loan that plays a key role in providing short-term credit to both financial and nonfinancial businesses, and the three-month Treasury bill rate also dropped markedly in the last half of December 2008 (see Figure 7). However, in view of the high volatility of the markets in recent months, it is too early to determine whether the government’s actions are having a permanent effect.
A Risk Spread in the Commercial Paper Market, 2006 to 2008
Sources: Congressional Budget Office; Federal Reserve Board.
Notes: The spread is calculated as the difference between interest rates on AA asset-backed commercial paper and the three-month Treasury bill. The rate for commercial paper is that paid by the issuing institutions (primarily corporations).
Data are monthly and are plotted through December 2008.
The stock market has plummeted in reaction to both the dismal news about the financial state of some firms and the downturn in economic activity. The Standard & Poor’s 500 index fell by almost 45 percent from the peak in October 2007 to December 2008, and the value of stock in Fannie Mae and Freddie Mac fell almost to zero. The huge decline in equity wealth—of around $6 trillion between the end of 2007 and the end of 2008—is an important factor holding down households’ spending.
The financial crisis has spread around the world. The credit squeeze has caused the governments of several industrialized countries to nationalize major banks or provide significant financial support to them. Gloomy economic outlooks have also pummeled equity markets in both industrial and emerging economies. In 2007, when emerging economies appeared to have weathered the initial stages of the crisis unfolding in industrial economies, there was hope that the relative vitality of emerging economies (such as those of China, India, and Brazil) would help moderate the downturn in the industrial world. That hope was dampened in 2008 as those economies weakened under the weight of falling exports and reversals of capital inflows. Despite bold initiatives announced by policymakers in industrial as well as emerging economies—for example, the large cuts in interest rates by the European Central Bank and the Bank of England and the large fiscal stimulus measure announced by the Chinese government—the outlook for the growth of economic activity worldwide is poor.
Personal consumption spending sagged during the second half of last year because of three main factors: declining employment, large decreases in wealth, and tighter credit conditions (see Figure 8). Looking ahead, CBO anticipates that the rise in unemployment, lagged effects of declines in wealth, and tight consumer credit will continue to restrain consumption. Lower expenditures on petroleum imports, however, will act like a tax cut and will ease those effects somewhat (see Figure 9). CBO projects that real consumption will decrease by about 1.2 percent in 2009 and then grow moderately, by about 1.6 percent in 2010.
Real Personal Consumption Expenditures, 1970 to 2019
(Percentage change from previous year)
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.
Note: Data are quarterly and are plotted through the fourth quarter of 2019.
Petroleum Imports as a Percentage of Nominal GDP, 1970 to 2010
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.
Notes: GDP = gross domestic product.
Data are quarterly and are plotted through the fourth quarter of 2010.
The looming increase in unemployment and its effect on real disposable income will severely restrict consumption growth. Employment is projected to fall by more than 2 percent in 2009 and the number of hours worked by more than 3 percent. Helped in part by falling energy prices, real disposable income is expected to grow by half a percent in 2009.
The decline in house prices and the drop in stock prices sharply reduced the net worth of households, by roughly 20 percent between the middle of 2007 and the fourth quarter of 2008. That decrease in wealth, in turn, is reducing spending on personal consumption. According to CBO’s estimates, that wealth effect will subtract about 1 percentage point from the growth of personal consumption spending in 2009, after having reduced the growth of spending by almost the same amount in 2008.
The financial turmoil has also played a role in weakening households’ spending by reducing the credit available to consumers, especially for those with limited borrowing opportunities or little collateral. The Federal Reserve’s October 2008 survey of senior loan officers suggests that banks are not yet willing to resume extensive lending to consumers. Banks’ willingness to make consumer loans has dropped to its lowest level since 1980 (see Figure 10).
Banks’ Willingness to Lend, 1970 to 2008
Sources: Congressional Budget Office; Federal Reserve Board.
Notes: The figure shows the net percentage of respondents reporting a greater willingness to make consumer installment loans over the past three months in the Federal Reserve Board’s Senior Loan Officer Opinion Survey on Bank Lending Practices.
Data are quarterly and are plotted through the fourth quarter of 2008.
By CBO’s calculations, tight credit will subtract about 1.5 percentage points from consumption growth in 2009.
Changes in the Forecast Since the Summer of 2008
CBO has significantly changed its forecast from the one published in September 2008 (see Table 2). House prices contracted more than expected, equity prices fell, and the extent of the credit crunch in financial markets was unanticipated. The resulting loss of wealth—together with the lack of available credit—depressed consumption, employment, and GDP in the second half of 2008 by much more than CBO expected. Those developments indicated that the economic slowdown would be much more severe and more protracted than was previously anticipated. The new forecast shows lower growth of GDP, higher unemployment in subsequent years, lower commodity prices, lower investment, and lower inflation.
CBO’s Current and Previous Economic Projections for Calendar Years 2008 to 2018
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board.
Note: GDP = gross domestic product; percentage changes are measured from one year to the next.
a. Values as of December 10, 2008.
d. The consumer price index for all urban consumers.
In the current forecast, the growth of real GDP is 3 percentage points lower in 2009 and 2 percentage points lower in 2010 than in the previous forecast. The projected average unemployment rate is 2 percentage points higher in 2009 and 3 percentage points higher in 2010. Lower commodity prices and excess productive capacity have dramatically lowered the expected growth of the CPI-U in 2009—to 0.1 percent, compared with the 3.1 percent forecast previously. The projected increase in the CPI-U in 2010 has been reduced from 2.2 percent to 1.7 percent.
CBO’s projection for the growth of potential output—2.3 percent, on average, during the 10-year period—is one-tenth of a percentage point slower than what was estimated in last summer’s report. Therefore, in the current forecast, by 2018, real potential GDP is about 1 percentage point lower. That downward revision is driven largely by two developments: First, the projection for business investment is considerably lower than it was in the previous forecast, which lowers the projected rate of capital accumulation and the amount of capital goods that will be available for each worker. Second, the projection for potential total factor productivity (TFP)—the growth of output that is not explained by the growth in the inputs of labor and capital—is also lower. CBO forecasts that potential TFP will grow at an average annual rate of 1.3 percent during the 2009–2019 period, compared with the 1.4 percent rate anticipated last summer.6
The lingering effects of the recession lower inflation and interest rates in this forecast from 2011 to 2013, and as a result, the average inflation rate and the average interest rates over the whole 2011–2019 period are slightly lower than in the summer forecast. As in the summer forecast, the inflation forecast for the period after 2014 reflects the assumption that the Federal Reserve’s monetary policy will achieve an average rate of inflation, measured by the personal consumption price index, of about 2 percent during those years.
Comparison with Other Forecasts
Comparing CBO’s forecast with others, including the Blue Chip consensus (the average of about 50 forecasts by private-sector economists), is difficult because most of them incorporate an assumption of substantial additional fiscal stimulus, while CBO’s (following rules specified by law) does not.7
In CBO’s forecast, the decline of 2.2 percent in real GDP in 2009 is greater than it is in the Blue Chip consensus forecast and in the average of the bottom 10 forecasts, which is a decline of 1.8 percent (see Table 3). Although some of the forecasts within the Blue Chip are expecting slower growth in the CPI-U in 2009, the consensus estimate of overall inflation, 0.6 percent, is higher than CBO’s estimate of 0.1 percent. The Blue Chip consensus expects an unemployment rate of 7.8 percent next year, which is one-half percent lower than CBO’s projection. CBO expects lower interest rates for 3-month Treasury bills and for 10-year Treasury notes than do the survey participants.
Comparison of Economic Forecasts by CBO and the Blue Chip Consensus for Calendar Year 2009
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board; and Aspen Publishers, Inc., Blue Chip Economic Indicators (December 10, 2008).
Notes: GDP = gross domestic product.
The Blue Chip consensus is the average of about 50 forecasts by private-sector economists. The latest Blue Chip consensus does not extend past 2009.
The ongoing turmoil in the housing and financial markets has taken a major toll on the federal budget. CBO currently projects that the deficit this year will total $1.2 trillion, or 8.3 percent of GDP. That total, however, does not include the effects of any future legislation. Enactment of an economic stimulus package, for example, would add to the 2009 deficit. In any event, as a percentage of GDP, the deficit will most likely shatter the previous post-World War II record high of 6.0 percent posted in 1983 (see Figure 11).
The Total Deficit or Surplus as a Share of GDP, 1970 to 2019
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.
Notes: GDP = gross domestic product.
Data are for fiscal years, plotted through 2019.
A drop in tax revenues and increased federal spending (much of it related to the government’s actions to address the crisis in the housing and financial markets) both contribute to the robust growth in this year’s deficit. Compared with receipts last year, collections from corporate income taxes are anticipated to decline by 27 percent and individual income taxes by 8 percent; in normal economic conditions, they would both grow by several percentage points. In addition, the estimated deficit includes outlays of more than $180 billion to reflect the cost of transactions of the TARP.8
The projected deficit for 2009 also incorporates CBO’s estimate of the cost to the federal government of the recent takeover of Fannie Mae and Freddie Mac. Because those entities were created and chartered by the government, are responsible for implementing certain government policies, and are currently under the direct control of the federal government, CBO has concluded that their operations should be reflected in the federal budget. Recognizing the cost of the takeover adds about $200 billion (in discounted present-value terms) to the deficit this year, reflecting the long-term net cost of the more than $5 trillion in credit guarantees issued and loans held by those entities at the start of the fiscal year. In addition, the cost of Fannie Mae’s and Freddie Mac’s new credit activity in 2009 will total $38 billion, CBO estimates.
The Administration’s Office of Management and Budget (OMB) will ultimately determine the budgetary treatment of Fannie Mae and Freddie Mac. If it chose to continue to treat them as nongovernmental entities, CBO would estimate the 2009 deficit to total $966 billion (including anticipated purchases by the Treasury of equity in those two entities).
CBO’s baseline projections are not intended to be a forecast of future budgetary outcomes; rather, they serve as a neutral benchmark that legislators and others can use to assess the potential effects of policy decisions. As such, CBO’s baseline budget projections, like its economic projections, do not incorporate potential changes in policy. On that basis, CBO estimates that the deficit will decline substantially in 2010—to 4.9 percent of GDP (see Table 4). Much of that decline will result from smaller outlays for Fannie Mae, Freddie Mac, and the TARP. In addition, CBO’s projections incorporate a significant increase in revenues from the alternative minimum tax (AMT), reflecting the assumption that the exemption amounts for that tax will revert to previous levels (although they have been adjusted annually for the past several years).
Projected Deficits and Surpluses in CBO’s Baseline
Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board.
Notes: GDP = gross domestic product; n.a. = not applicable.
Debt issued by Fannie Mae and Freddie Mac is not included in debt held by the public.
b. Debt held at the end of the year.
c. Under CBO’s proposed treatment of showing the two government-sponsored enterprises (GSEs) within the budget, injections of cash equity from the Treasury to the GSEs would be intragovernmental transfers.
In CBO’s baseline, the projected deficit drops further over the following two years—to 3.3 percent in 2011 and 1.6 percent in 2012. That result is largely predicated on the assumption that certain tax provisions originally enacted in 2001 and 2003 will expire in December 2010, as currently scheduled.9 Incorporating that assumption about tax policy boosts the projected growth in revenues to more than 10 percent per year in both 2011 and 2012.
CBO projects that revenues will increase and some spending will moderate or decline as the economy gradually improves over the next few years. By the latter part of the 10-year projection period, the estimated deficits fall to about 1 percent of GDP. For the 2009–2018 period (the 10-year period used in the previous baseline), CBO is now projecting deficits that total about $1.8 trillion more than those projected in September 2008; about $1.0 trillion of that change occurs in 2009 and 2010. Primarily because of the change in the economic outlook, projected revenues over the 10-year period are, on average, about $280 billion a year lower. Projected outlays are also lower, however, mostly because they extrapolate the funding provided so far this year for operations in Iraq and Afghanistan, which is nearly $120 billion lower than the total of war-related appropriations for 2008. Additional supplemental appropriations for those purposes are anticipated later in the year.
The federal fiscal situation in 2009 will be dramatically worse than it was in 2008. Under the assumption that current laws and policies remain in place (that is, not accounting for any new legislation), CBO estimates that the deficit this year will total $1.2 trillion, more than two and a half times the size of last year’s. As a percentage of GDP, the deficit this year will total 8.3 percent (as compared with 3.2 percent in 2008)––the largest since 1945.
The deterioration in the fiscal picture results from both increased outlays and decreased revenues. Relative to what they were last year, outlays will rise dramatically—by 19 percent according to CBO’s estimates. Much of that increase is a result of policy responses to the turmoil in the housing and financial markets—particularly spending for the TARP and the conservatorship of Fannie Mae and Freddie Mac.10 In addition, economic developments have reduced tax receipts (particularly from individual and corporate income taxes) and boosted spending on programs such as those providing unemployment compensation and nutrition assistance as well as those with cost-of-living adjustments.
Outlays. Without changes in current laws and policies, CBO estimates, outlays will rise from $3.0 trillion in 2008 to $3.5 trillion in 2009 (see Table 5). Mandatory spending is projected to grow by almost $570 billion, or by 36 percent; nearly three-quarters of that growth results from the activities of the TARP and CBO’s treatment of Fannie Mae and Freddie Mac as federal entities. Discretionary spending is projected to grow by $52 billion, or by 4.6 percent. In contrast, net interest is anticipated to decline by 22 percent as a result of lower interest rates and lower inflation. In total, outlays will be equal to 24.9 percent of GDP, a level exceeded only during the later years of World War II.
CBO’s Baseline Budget Projections
Source: Congressional Budget Office.
Note: n.a. = not applicable.
CBO estimates that incorporating the two housing GSEs into the federal budget would add nearly $240 billion to outlays in 2009.11 Most of that amount results from a one-time expense—the long-term net cost of taking on Fannie Mae’s and Freddie Mac’s portfolios of mortgage loans and guarantees.12
Assuming that the TARP eventually disburses the full $700 billion that was specified in the legislation that created the program, CBO has estimated outlays of more than $180 billion for 2009 to account for the subsidy costs related to those investments and loans.13
Spending for certain other mandatory programs is expected to rise sharply this year. The faltering economy has increased outlays for unemployment compensation and the Supplemental Nutrition Assistance Program. Unemployment compensation is projected to nearly double—from $43 billion last year to $79 billion this year—as a result of increased unemployment and legislation to date extending such benefits. Outlays for the nutrition assistance program are expected to grow by 27 percent—from $39 billion to $50 billion—primarily because of increases in caseloads and benefits (resulting from higher food prices).
The three largest mandatory programs—Social Security, Medicare, and Medicaid—are all anticipated to record growth of at least 8 percent this year. Some of that growth stems from the relatively high rate of inflation recorded early in 2008, which boosted cost-of-living adjustments for retirees and the cost of health care. In addition, rising unemployment will add to Medicaid spending by increasing the number of beneficiaries.
Discretionary spending under current laws and policies is projected to grow by 4.6 percent in 2009. In CBO’s baseline, defense outlays rise by 5.0 percent and nondefense outlays by 4.1 percent. However, most programs are currently operating under a continuing resolution, which holds funding for 2009 at the level provided for 2008. Final appropriations and additional funding for operations in Iraq and Afghanistan may increase outlays for 2009 and beyond, and any stimulus package may raise discretionary spending further.
Even though the amount of debt held by the public is projected to grow by nearly $1.4 trillion this year (excluding any effects of future legislation), net interest payments are projected to decline by more than 20 percent. Short-term interest rates on federal debt have plummeted to near zero in recent months, and long-term rates have fallen by 100 basis points since last summer.14 Such low rates have substantially reduced the near-term cost of borrowing. In addition, the lower inflation forecast for the current year has reduced the projected cost of interest on the Treasury’s inflation-protected securities by $35 billion relative to what it was last year.
Revenues. CBO expects federal revenues under current laws and policies to total $2.4 trillion this fiscal year, a decline of $166 billion, or 6.6 percent, from the amount in 2008. The combination of the recession and sharp drops in the value of assets—most significantly in publicly traded stock—is expected to lead to sizable declines in receipts from individual and corporate income taxes and, to a much lesser extent, from estate and gift taxes. Receipts from individual income taxes are projected to decline this year by $86 billion, or by 8 percent, and receipts from corporate income taxes by $81 billion, or by 27 percent. In CBO’s baseline, an increase in social insurance (payroll) tax receipts of $14 billion, or 2 percent, offsets a small portion of the projected overall decline in revenues.
As a share of GDP, revenues are projected to decline from 17.7 percent in 2008 to 16.5 percent in 2009—about the share recorded in 2003 and 2004 but otherwise the lowest since 1959. Typically, revenues as a percentage of GDP drop in recessions, and CBO expects the decline to be especially pronounced this year as a result of the sharp fall in asset prices and in taxable corporate profits.15
The substantial decline in the stock market is expected to sharply reduce revenues in 2009 from a variety of sources: realizations of capital gains by individuals and corporations; distributions by individuals from their tax-deferred retirement accounts, such as 401(k)s and individual retirement accounts; and estate and gift taxes. The largest of those effects is concentrated in receipts from individual income taxes. Tax liabilities from individuals’ realized capital gains are projected to drop in tax year 2008 by about $55 billion, or by more than 40 percent, mostly affecting federal receipts in 2009.
Declines in corporate capital gains represent just a portion of the expected weakness in corporate receipts. CBO expects profits of corporations to decline substantially because, as in most recessions, income from their sales and investments will drop faster than their costs of paying workers, paying interest on debt, and depreciating their equipment and structures. For tax year 2008, CBO also expects a substantial increase in tax deductions for bad debts, which include loans that businesses make that they can no longer collect. In addition, steep 2008 losses in the financial industry, which was very profitable in 2006 and 2007, mean that many firms in that sector will be able to apply those losses to the earlier profits and receive refunds of the income taxes they previously paid; those refunds will reduce receipts from corporate income taxes in 2009.16
Federal Debt. In most years, the amount of debt that the Treasury issues roughly equals the annual budget deficit, although a number of other factors also affect the government’s need to borrow money from the public. In a typical year, those factors might total $10 billion to $30 billion. However, the Treasury’s actions aimed at stabilizing the financial markets added more than $300 billion to the Treasury’s borrowing needs in 2008 (on top of the borrowing necessary to finance the budget deficit) and will boost them by about an estimated $200 billion in 2009 (see Table 6).
CBO’s Baseline Projections of Federal Debt
Source: Congressional Budget Office.
Notes: TARP = Troubled Asset Relief Program; MBS = mortgage-backed security; GDP = gross domestic product.
Debt issued by Fannie Mae and Freddie Mac is not included in any of the above figures.
a. Preliminary.
b. Transactions related to the TARP and purchases of MBSs are accounted for in CBO’s budget estimates using procedures similar to those used for federal credit programs. However, borrowing requirements are based on the cash flows of those programs.
c. CBO’s calculations of federal borrowing requirements do not include the net subsidy costs for Fannie Mae and Freddie Mac. However, the calculations do include cash infusions from the Treasury.
e. Differs from the gross federal debt primarily because it excludes most debt issued by agencies other than the Treasury and the Federal Financing Bank. The current debt limit is $11,315 billion.
In 2008, the Treasury borrowed about $300 billion to deposit at the Federal Reserve to help it finance initiatives to enhance liquidity in the credit markets. CBO anticipates that the Treasury will withdraw those balances later this year, thereby reducing borrowing needs for 2009 by the amount deposited last year.
In the other direction, the cash flows for two programs will lift the Treasury’s borrowing needs by more than $700 billion. For the TARP, CBO’s baseline includes outlays of about $180 billion for 2009, but the Treasury is likely to have to borrow $460 billion more than that to cover the capital purchases, loans, and other activities of the program this year.17 Additionally, the Treasury is purchasing mortgage-backed securities from the private market; CBO assumes that such purchases will total nearly $250 billion this year, thereby necessitating additional borrowing of a similar amount (although the budgetary impact of the purchases, shown as an estimated subsidy amount in 2009, is relatively small).
One other factor affects the gap between the projected deficit and anticipated borrowing. Although CBO is treating Fannie Mae and Freddie Mac as part of the federal budget, most of the cost recorded for 2009 reflects a present-value calculation rather than a cash outflow; consequently, the projected deficit overstates borrowing requirements in that respect by about $220 billion.
The Budget Outlook for 2010 to 2019
Under the assumptions that CBO uses for its baseline, the budget deficit would fall to about $700 billion in 2010. Revenues would increase by $176 billion that year, rebounding from declines in the previous two years. Outlays would be substantially lower than in 2009, largely because of the projected drop in outlays recorded for the TARP and for the subsidy costs related to Fannie Mae and Freddie Mac; with those two factors excluded, outlays would grow by 2.8 percent in 2010.
At 4.9 percent of GDP, the deficit in 2010 would be significantly lower than the one for this year but about twice as high as the average deficit over the past 40 years. Under current laws and policies, CBO projects, the deficit would fall to 3.3 percent of GDP in 2011, when certain tax provisions originally enacted in 2001 and 2003 are scheduled to expire, and to 1.6 percent in 2012, when the full effect of those expirations on revenues occurs. The decline in the deficit would be greater in those years but for the likelihood that interest rates will rise in conjunction with economic recovery, thereby boosting interest payments. Over the following few years, the deficits projected in CBO’s baseline decline slightly from the level in 2012; by 2019, under the assumptions used for the baseline, the deficit would represent about 1.1 percent of GDP.
Outlays. Under the assumptions governing the construction of CBO’s baseline, total outlays would decline from this year’s level of 24.9 percent of GDP. By 2012, outlays would total 21.1 percent of GDP and would stay around that level through 2019, although they would increase by about 5 percent per year in nominal terms over that period. That increase is expected to result from higher interest costs and from the continued growth of Medicare and Medicaid at a pace significantly faster than the rate of growth of the economy. In contrast, discretionary spending is assumed to grow much more slowly—at the rate of inflation—as specified in the rules for producing baseline projections.
Net interest costs are projected to change little from 2009 to 2010, as interest rates are expected to remain relatively low. However, such costs are projected to grow rapidly over the next several years as a result of extraordinarily large accumulations of debt over the 2008–2011 period and an anticipated rise in rates beginning in 2011. Debt held by the public, which was $5.0 trillion at the end of fiscal year 2007, already exceeds $6 trillion, and under CBO’s baseline projections, would grow to $8.2 trillion by the end of 2011. In the baseline, the government’s interest payments grow by 16 percent in 2011, 31 percent in 2012, and 24 percent in 2013 before leveling off near the end of the 10-year projection period.
In CBO’s baseline, the growth of both Medicare and Medicaid averages about 7 percent annually from 2010 through 2019. Under current law, Medicare outlays will be constrained in 2010 and subsequent years by the rate-setting system (the “sustainable growth rate”) that controls the fees paid for physicians’ services. Under that system, CBO projects, those fees will be reduced by about 21 percent in 2010 and by additional amounts thereafter. If legislation was enacted to override those reductions (as has happened in every year since 2003), spending on Medicare would be significantly greater than is projected in CBO’s baseline. For example, if the scheduled reductions in physicians’ fees were delayed one year so that payment rates in 2010 remained at the 2009 level (before dropping roughly 25 percent in 2011), outlays would increase by $12 billion in 2010 and by a total of $14 billion over the 2010–2019 projection period. Maintaining the 2009 payment rates through 2019 would add $324 billion in outlays over that period.
Total discretionary outlays, as projected in the baseline, grow at an average annual rate of 1.8 percent, rising from $1.2 trillion next year to $1.4 trillion in 2019. Such projections are based on the assumption that discretionary funding grows at specified rates of inflation and reflect the most recent funding provided. Relative to GDP, discretionary outlays fall from 8.2 percent in 2010 to 6.3 percent in 2019; at that point, defense outlays would, as a share of GDP, be at about the level that they were in 2001, but nondefense discretionary outlays would be lower than at any point in the past 40 years.
Revenues. After 2009, receipts are projected to begin growing again as the economy recovers and certain scheduled changes in tax law take effect. In CBO’s baseline, revenues are projected to rise by 7.5 percent in 2010; over 40 percent of that growth stems from the assumed expiration of temporary relief from the AMT. For both 2011 and 2012, revenues are projected to increase by more than 10 percent; roughly half of that increase is attributable to the scheduled expiration of reductions in the individual income and estate taxes enacted in 2001 and 2003.
Under current laws and policies, revenues would grow faster than GDP in every year after 2009: They would reach 19.5 percent of GDP in 2012 and continue to rise, to 20.2 percent by 2019, the highest level since 2000. Since World War II, revenues have reached or exceeded 20.0 percent of GDP only three times—each year from 1998 to 2000.
In the baseline, most of the projected increase in revenues relative to GDP stems from individual income taxes. In addition to the effects that scheduled changes in tax law have over the 2010–2012 period, revenues from individual income taxes increase faster than GDP each year after 2009 because of three factors: the phenomenon known as real bracket creep, in which the overall growth of real income causes more income to be taxed in higher tax brackets; increases in revenues from the AMT, which will affect more taxpayers over time because it is not indexed for inflation, unlike important parts of the regular income tax; and increases in taxable distributions from tax-deferred retirement accounts as the population ages.
Federal revenues include remittances to the Treasury from the Federal Reserve, based on the latter’s earnings. Until recently, those earnings consisted largely of interest on Treasury securities held for the conduct of monetary policy; the Federal Reserve paid no interest on its currency issues or the deposited reserves of banks. In response to the turmoil in the financial markets, the Federal Reserve’s portfolio has expanded significantly in recent months through various loans and asset acquisitions; those assets now generate earnings for the Federal Reserve but also pose some risk of losses if the firms involved fail or if the posted collateral is insufficient to cover the losses. The Federal Reserve now pays interest on both required and excess reserves—the latter much increased as a part of the portfolio expansion—which reduces its earnings. Relative to previous projections, CBO’s current estimates of the Federal Reserve’s earnings are very similar for 2009 and lower for 2010 through 2018 by a total of about $90 billion. After 2009, the earnings-increasing effects of a larger portfolio will be insufficient to cover the earnings-reducing effects of lower interest rates, expected losses on the portfolio, and the payment of interest on reserves.18
Budget Projections Under Alternative Scenarios
To illustrate how different fiscal policies might affect the baseline, CBO estimated the budgetary impact of some alternative policy actions (see Table 7). The discussion below focuses on their direct effects on revenues and outlays; such changes would also affect projected debt-service costs (which are shown separately in Table 7).
The Budgetary Effects of Selected Policy Alternatives Not Included in CBO’s Baseline
Sources: Congressional Budget Office; Joint Committee on Taxation.
Note: GDP = gross domestic product; EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax; * = between -$500 million and $500 million.
a. This alternative does not extrapolate the $68 billion in funding for military operations and associated costs in Iraq and Afghanistan provided for 2009. However, it incorporates the assumption that an additional $82 billion in budget authority will be provided in 2009 to carry out operations in those countries. Future funding for operations in Iraq, Afghanistan, or elsewhere would total $92 billion in 2010, $42 billion in 2011, and then about $32 billion a year from 2012 on—for a total of $388 billion over the 2010–2019 period.
c. This alternative does not extrapolate the $68 billion in funding for military operations and associated costs in Iraq and Afghanistan provided for 2009. However, it incorporates the assumption that an additional $87 billion in budget authority will be provided in 2009 to carry out operations in those countries. Future funding for operations in Iraq, Afghanistan, or elsewhere would total $149 billion in 2010, $129 billion in 2011, $95 billion in 2012, and about $70 billion a year from 2013 on—for a total of $867 billion over the 2010–2019 period.
d. Under this alternative, appropriations for 2009 for operations in Iraq and Afghanistan (as well as other emergency appropriations) are extrapolated according to rules for the baseline.
e. When this report went to press, the Joint Committee on Taxation’s (JCT’s) most recent estimates of the effects of extending expiring tax provisions were based on CBO’s baseline projections from February 2008, updated for laws enacted through August 2008. Therefore, CBO has adjusted those estimates to take into account its updated economic projections and recent changes in law. JCT is currently updating its estimates to reflect CBO’s new projections, and CBO will make those estimates available when they are completed.
f. These estimates do not include the effects of extending the increased exemption amount or the treatment of personal credits for the AMT that expired at the end of 2008. The effects of that alternative are shown separately.
g. This alternative incorporates the assumption that the exemption amount for the AMT (which was increased through 2008 in P.L. 110-343) is extended at its higher level and, together with the AMT tax brackets, is indexed for inflation after 2008. In addition, the treatment of personal credits against the AMT (which was also extended through the end of 2008) is assumed to be extended. The estimates shown are relative to figures under current law. If this alternative was enacted jointly with the extension of the expiring tax provisions, an interactive effect would occur after 2010 that would make the combined revenue loss over the 2011–2019 period greater than the sum of the two separate estimates by $635 billion (plus $126 billion in debt-service costs).
Activities Related to Operations in Iraq and Afghanistan and the War on Terrorism. CBO’s projections of discretionary spending for future years include outlays for operations in Iraq and Afghanistan and for other activities related to the war on terrorism; those outlays arise from funding provided in 2008 and prior years, from the $68 billion already provided for 2009, and from the $744 billion in budget authority for those purposes that is projected over the 2010–2019 period (under an assumption that funding each year is set at $68 billion plus adjustments for inflation). However, the funding provided for 2009 represents only a portion of what will be needed for those operations throughout this year and probably does not indicate the likely amount of spending in future years.
In subsequent years, the annual funding required for military operations in Iraq and Afghanistan or in other locations may eventually be less than the amounts in the baseline if the number of troops and pace of operations diminish over time. Because of considerable uncertainty about those future operations, CBO has formulated two budget scenarios involving the deployment of U.S. forces to Iraq, Afghanistan, and elsewhere in support of the war on terrorism. (Many other outcomes—some costing more and some less—are also possible.) Under both scenarios, reductions in force levels in Iraq beginning in 2009 are partially offset by a temporary increase in forces deployed to Afghanistan. As a result, the number of deployed troops declines from an average of 210,000 in 2008 but, under the two scenarios, at different rates and to different sustained levels. The amount of spending for the support of indigenous security forces in Iraq and Afghanistan and for diplomatic operations and foreign aid is the same under both scenarios.
Under the first scenario, troop levels would be rapidly reduced over a two-year period; deployed forces decline to an average of roughly 180,000 in 2009 and 90,000 in 2010, until 30,000 military personnel remained overseas in support of the war on terrorism at the start of 2011. That number of deployed troops would be sustained through 2019, although not necessarily in Iraq and Afghanistan. Under such a scenario, discretionary outlays for 2009 would be about $24 billion higher than the amount in the baseline, but annual outlays would be lower beginning in 2012. In total, over the 2010–2019 period, discretionary outlays would be $281 billion less than the amount recorded in the current baseline.
Under the second scenario, the number of troops would decline more gradually over a four-year period, dropping to an average of about 190,000 in both 2009 and 2010, then to 150,000 in 2011, and falling steadily throughout 2012, until 75,000 remained overseas by 2013 and each year thereafter. Under such a scenario, discretionary outlays for 2009 would increase by $26 billion compared with the amount in the current baseline, but annual outlays would fall slightly below the amounts projected beginning in 2016. During the 2010–2019 period, total outlays for activities related to the war on terrorism would exceed the amount reflected in the baseline by about $165 billion.
Other Discretionary Spending. There are many possible alternative assumptions about the future growth of discretionary spending. For example, if appropriations (other than those for operations in Iraq and Afghanistan) were assumed to grow through 2019 at the same rate as nominal GDP instead of at the rate of inflation, total projected discretionary spending would be $1.5 trillion higher than the amount in the current baseline. In contrast, if lawmakers did not increase appropriations after 2009 to account for inflation, cumulative discretionary outlays would be $1.2 trillion lower. Under that latter scenario (sometimes referred to as a “freeze” in appropriations), total discretionary spending would fall from 8.0 percent of GDP in 2008 to 5.1 percent in 2019.
Revenues. The baseline assumes that the major provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003—such as the introduction of the 10 percent tax bracket, increases in the child tax credit, the repeal of the estate tax, and lower rates on capital gains and dividends—will expire as scheduled at the end of 2010. On balance, the tax provisions that are set to expire during the 10-year projection period reduce revenues; thus, under a scenario in which they were extended, projected revenues would be lower than the amounts indicated in the current baseline. For example, if all expiring tax provisions (except those related to the amount of the exemption for the AMT) were extended, total revenues over the 2010–2019 period would be about $3.0 trillion lower than in the projection in the current baseline.19
Another change in policy that could affect revenues involves the modification of the AMT, which many observers believe will not be maintained in its current form. Because the AMT’s exemption amount and brackets are not indexed for inflation, the impact of the tax will grow in coming years as more taxpayers become subject to it. If the AMT was indexed for inflation after 2008 and no other changes were made to the tax code, federal revenues over the next 10 years would be about $0.6 trillion lower than the amount in the baseline.
Because the number of taxpayers who are subject to the AMT will depend on whether the tax provisions originally enacted in 2001 and 2003 remain in effect, the combination of indexing the AMT for inflation and extending the expiring provisions would reduce revenues by more than the sum of the effects of each policy enacted alone. The interactive effect would lower revenues by an additional $0.6 trillion between 2011 and 2019.
The Treatment of the Troubled Asset Relief Program in the Federal Budget
The TARP was created by the Emergency Economic Stabilization Act of 2008 in October 2008 to enable the Secretary of the Treasury to purchase or insure troubled assets. Under the legislation, the authority to enter into agreements to purchase such assets is set to expire on December 31, 2009, but can be extended until October 3, 2010, upon certification by the Secretary that the extension is necessary.
The purchase price of all assets outstanding at any one time cannot exceed $700 billion (though cumulative gross purchases could exceed $700 billion as previously purchased assets are sold). Currently, the Secretary has the authority to purchase $350 billion in assets; the remaining $350 billion will become available if the Administration requests it and the Congress does not take action to deny that request.
As of December 19 (when CBO finalized its baseline), the TARP had used $198 billion to purchase equity in 116 financial institutions (including $40 billion for AIG). Between December 19 and December 31, the Treasury purchased another $40 billion in equity from 100 more banks (including a second purchase from Citigroup) and disbursed $9 billion in loans to the automakers. The Treasury has also announced plans for the following additional actions:
- Purchase of $10 billion for equity in Merrill Lynch (upon completion of its acquisition by Bank of America);
- A guarantee of a pool of assets owned by Citigroup, at a cost of up to $5 billion;
- Credit protection against debtors that do not pay because of insolvency or protracted default as part of the Federal Reserve’s Term Asset-Backed Securities Loan Facility, at a cost of up to $20 billion;
- Loans to General Motors and Chrysler of another $8.4 billion; and
- The purchase of $5 billion in equity from GMAC (a financial services company) and an agreement to lend up to an additional $1 billion to General Motors to help GMAC reorganize as a bank holding company.
The Treasury has indicated that it will use the remainder of the initial $350 billion for additional equity purchases in financial institutions.
The legislation that created the TARP requires that the federal budget display the costs of purchasing or insuring troubled assets using procedures similar to those specified in the Federal Credit Reform Act but adjusting for market risk (in a manner not reflected in that law). In particular, the federal budget should not record the gross cash disbursement for the purchase of a troubled asset (or cash receipt for its eventual sale) but instead should reflect an estimate of the government’s net cost for the purchase. Broadly speaking, the net cost is the purchase cost minus the present value—calculated using an appropriate discount factor that reflects the riskiness of the asset—of any estimated future earnings from holding the asset and the proceeds from the eventual sale of the asset.
Following that directive, CBO has estimated the present value of the net costs of the TARP’s activities, accounting for the specific actions taken before December 19. In its estimates, CBO assumed that the full $700 billion of available purchasing authority will eventually be used (by the end of calendar year 2009) and that future disbursements will have a subsidy rate similar to the average for the transactions that occurred until December 19 (about 25 percent). All told, CBO estimates that the subsidy costs related to the TARP’s transactions will total more than $180 billion in 2009 and about $5 billion in 2010 (some transactions may not take place until the next fiscal year begins in October).20
The Treatment of Fannie Mae and Freddie Mac in the Federal Budget
On September 6, 2008, exercising authority provided under the Housing and Economic Recovery Act of 2008 (P.L. 110-289), the Director of the Federal Housing Finance Agency (FHFA) and the Secretary of the Treasury placed Fannie Mae and Freddie Mac into conservatorship and took an ownership interest in each company. The Treasury received ownership interest in the form of senior preferred stock in exchange for any future contributions necessary to keep the GSEs solvent. The support agreements between the Treasury and the GSEs include several forms of compensation for the Treasury—most notably, warrants that, if exercised, would represent an ownership stake of 79.9 percent of each enterprise.
Although the GSEs have had a unique legal status and a long history linking them closely to the federal government, they have been considered private firms owned by their shareholders. However, because of the extraordinary degree of management and financial control that the government has now exercised, CBO concludes that the entities should now be considered federal operations. Although the GSEs are not legally government agencies and their employees are not civil servants, CBO believes it is appropriate and useful to policymakers to account for and display the GSEs’ financial transactions alongside all other federal activities in the budget.
That view is consistent with the principles expressed by the 1967 President’s Commission on Budget Concepts, which asserted that “the federal budget should, as a general rule, be comprehensive of the full range of federal activities. Borderline agencies and transactions should be included in the budget unless there are exceptionally persuasive reasons for exclusion.”21 The commission suggested certain broad criteria to help make such determinations. For example, who owns an entity and selects the managers? Do the Congress and the President have control over an entity’s program and budget, or are its policies set primarily in response to private owners and not to accomplish some broader public purpose? Clearly, Fannie Mae and Freddie Mac are currently controlled and operated by the federal government and heavily dependent on the government for their access to the credit markets.
CBO accounts for the GSEs’ operations in the federal budget using the same procedure that it applies in valuing the Treasury’s purchases under the TARP (that is, computing the present value of anticipated cash flows using an appropriate discount factor that recognizes the riskiness of those cash flows). On the basis of projections of the entities’ assets and liabilities over the long term, including their operations on the budget would increase the federal deficit by nearly $240 billion in 2009 and by about $70 billion between 2010 and 2019.
In CBO’s baseline, most of the cost recorded in 2009 stems from the existing assets and liabilities of the GSEs at the time of their takeover. CBO estimates that the value of the GSEs’ mortgage loans and guaranteed assets falls short of their liabilities by about $200 billion (on a present-value basis); that amount is included in CBO’s estimate of the deficit calculated for 2009. Nearly $40 billion in 2009 and smaller annual amounts thereafter represent the estimated annual subsidy costs (on a net-present-value basis) associated with the GSEs’ new business after the takeover. The combined subsidy rate for both GSEs’ credit activities is estimated to be about 2.5 percent in 2009 and to decline to about 0.3 percent after 2014. The decline in the subsidy rate reflects CBO’s forecast that housing and mortgage markets will stabilize over that period.
CBO has long held that the federal government has subsidized the operation of Fannie Mae and Freddie Mac by providing what some have called an “implicit guarantee” of the GSEs’ debt.22 However, the federal government has never recognized the cost of the subsidy in its budget. The value of that guarantee (the existence of which has now been explicitly demonstrated by the Treasury) is a large component of the estimated cost of the GSEs’ operations that CBO has included in its baseline projections.
Because CBO considers the GSEs’ activities part of the federal budget, the anticipated cash infusions from the Treasury are essentially intragovernmental transfers that have no net effect on the budget. CBO estimates that such transfers will total nearly $18 billion in 2009 ($13.4 billion has already been provided by the Treasury to Freddie Mac) and close to $80 billion between 2010 and 2015.
Changes in the Budget Outlook Since September 2008
Economic conditions and policy actions have generated substantial changes to CBO’s baseline since the previous one was published in September 2008.23 Overall, CBO’s estimate of the baseline deficit for 2009 has risen by nearly $750 billion; for the 2009–2018 period, projected deficits are about $1.8 trillion higher than previously estimated (see Table 8). Economic and technical revisions boost the cumulative deficit by $2.6 trillion over the 10-year period, but changes related to legislation diminish that figure by about $800 billion.
Changes in CBO’s Baseline Projections of the Deficit
Since September 2008
Source: Congressional Budget Office.
Note: TARP = Troubled Asset Relief Program; COLA = cost-of-living adjustment; SNAP = Supplemental Nutrition Assistance Program;
* = between -$500 and $500 million.
a. Receipts from leases for resource development on the Outer Continental Shelf.
b. Negative numbers indicate an increase in the deficit.
Economic Changes. Revisions attributable to changes in CBO’s economic forecast since September have led to an average increase in the projected deficit of almost $145 billion a year. In the current baseline, projected revenues have been decreased by an average of $200 billion a year and outlays by nearly $60 billion annually.
Reflecting both lower real growth and lower inflation anticipated in the new economic assumptions, CBO has lowered its projections of nominal GDP and the components of taxable income, most importantly wages, salaries, and corporate profits. Those downward revisions were most significant for 2009 through 2011, but lower prices and lower nominal income continue through the end of the projection period. In sum, those changes caused CBO to reduce its projection of revenues by $106 billion in 2009, $204 billion in 2010, and a total of $2.0 trillion over the 2009–2018 period.
A portion of the drop in projected revenues has been offset on the outlay side of the budget. Economic factors have reduced projected outlays by $580 billion between 2009 and 2018. In the current baseline, substantially lower inflation for the next few years reduces the anticipated cost-of-living adjustments for Social Security and other benefit programs. (CBO anticipates that the year-over-year change in consumer prices for the third quarter of 2009 will show a decline, which implies that next year’s cost-of-living adjustment for Social Security and most other benefit programs will be zero.) In addition, lower inflation diminishes the projected growth of discretionary spending in the baseline. CBO has also reduced its projections of net interest payments by $431 billion over the 10-year period because of its expectation of lower inflation and lower interest rates. However, some of that decrease is offset by additional projected borrowing costs as a result of lower estimated revenues.
The changed economic outlook affects projected outlays in a number of other ways. CBO now anticipates that the unemployment rate for the next few years will be higher (by as much as 3 percentage points) than it forecast in September, which boosts the projected costs of unemployment compensation and nutrition assistance by $54 billion and $86 billion, respectively, over the 10-year period.24 Also, the decline in projected oil and gas prices reduces estimated receipts from federal leases on the Outer Continental Shelf by $77 billion between 2009 and 2018.
Legislative Changes. Since September, the effects of legislation have added about $280 billion to CBO’s projection of the deficit for 2009 but reduced its estimate of the cumulative deficit by about $800 billion over the 10-year period. The largest effects in 2009 stem from the Emergency Economic Stabilization Act of 2008 and its creation of the TARP. On a net-present-value basis adjusted for market risk, outlays for the program will total more than $180 billion in 2009 and $5 billion in 2010, CBO estimates. That legislation also included some tax provisions, most notably, extending relief from the AMT for a year. Altogether, legislative changes have caused CBO to reduce its estimate of revenues in 2009 by $104 billion and have had little impact on projected revenues thereafter.
The Unemployment Compensation Extension Act of 2008 (P.L. 110-449), enacted in November 2008, provides additional unemployment compensation to individuals who exhaust their regular benefits before March 31, 2009. CBO estimates the additional compensation will increase outlays by $9 billion in 2009.
The timing of appropriation actions can have a significant impact on CBO’s baseline projections. Because baseline projections of discretionary spending are derived from the most recent appropriations, CBO based its September projections on appropriations for 2008, which included $186 billion for military and diplomatic operations in Iraq and Afghanistan and other activities in the war on terrorism. To date, less than $70 billion has been provided for 2009 for such activities; the effect of extending that smaller amount of enacted appropriations (as well as other differences in the amounts appropriated last year and this year) has reduced projected discretionary outlays from 2009 to 2018 by more than $1 trillion from the amount estimated in September.25
Technical Changes. Factors not directly attributable to changes in CBO’s economic forecast or legislation—that is, technical changes—have increased projected deficits for 2009 through 2018 by $1.1 trillion from the amounts projected in September. About 55 percent of those changes have occurred on the revenue side of the budget.
Changes in factors affecting the amount of revenue yielded by a given amount of GDP and its income components have caused CBO to lower its projection of revenues by $152 billion for 2009, $138 billion for 2010, and by more than $600 billion for the 2009–2018 period. Those technical factors are largely related to the current economic environment but are not specifically addressed in the economic forecast.
The recent decline in the stock market is the most important cause of the reduction in projected revenues attributable to technical factors. That change has caused CBO to significantly lower its projections of realizations of capital gains by individuals and corporations, distributions received by individuals from their tax-deferred retirement accounts, and the amount of wealth subject to the estate tax. To some extent, those downward adjustments persist throughout the 10-year projection period to reflect a permanently lower amount of wealth. Technical factors that are not related to the current economic environment, such as updates to certain models to reflect new research and data, have caused a relatively small change to the revenue outlook in the near term and have caused changes that offset some of the downward adjustments in the later part of the projection period.
For 2009 through 2018, CBO has increased its projection of outlays by $498 billion to reflect technical changes. The largest contributor to that figure is the agency’s decision to include the operations of Fannie Mae and Freddie Mac as part of the federal budget; subsidy costs for those entities have added $279 billion to the baseline over the 10-year period. (In its previous baseline, which was developed before the takeover of the two GSEs, CBO had included $25 billion for potential payments to keep them solvent.)
Net outlays for deposit insurance are now projected to be about $19 billion higher over the next five years than the amount estimated in September because of an expected increase in the number of failed banks, thrifts, and credit unions. The net increase over the 10-year period is much smaller ($3 billion) because the near-term costs should eventually be offset by proceeds from the sale of liquidated assets and higher premiums for deposit insurance.
Projections for Social Security, Medicare, and Medicaid include relatively small technical adjustments based on changes in expected caseloads and other new information. CBO has raised its projection of Social Security outlays over the 2009–2018 period by $86 billion (or by 1 percent), nearly all of which is attributable to an increase in the number of beneficiaries participating in the Disability Insurance program; CBO has reduced its projections by similar amounts for Medicare (primarily because of lower-than-expected outlays in 2008 for prescription drugs under Part D of the program and for hospital inpatient and post-acute services under Part A) and Medicaid (largely because of lower-than-expected outlays in 2008).
CBO’s current baseline includes receipts (negative outlays) of $17 billion in 2009 from auctions held in 2008 of licenses for the commercial use of radio frequencies that are currently used for television broadcasts. Those receipts were originally expected to be recorded last year but were delayed pending the issuance of the licenses.
Debt service on other technical changes and small adjustments to certain assumptions about the Treasury’s borrowing have caused CBO to raise projected outlays for net interest between 2009 and 2018 by $261 billion.
High deficits in the near term may be inevitable in the face of the financial crisis and severe economic weakness, However, once the nation gets past this downturn, it will still face 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 over time would probably constrain long-term economic growth by reducing national savings and investment, which in turn would cause productivity and wage growth to gradually slow.
The rate of growth of spending on health care is the single greatest threat to budget balance over the long run, and such spending will have to be controlled in order for the fiscal situation to be sustainable in future decades.26 Together, outlays for Medicare and Medicaid (not including offsetting receipts) currently account for about 5 percent of GDP. Spending for those programs is expected to rise at a rapid pace over the next 10 years, outstripping the growth of GDP. By 2019, spending for those programs combined is projected to total about 6.3 percent of GDP. By 2050, it could reach 12 percent. Without changes to federal fiscal policy, those rising costs would drive the amount of debt held by the public significantly higher as a percentage of GDP than it is today.
That calculation differs from CBO’s estimate of the budgetary effects of all economic factors, primarily because it reflects only the direct effects of the business cycle, as measured by the deviation of GDP and unemployment from their potential levels. It does not include budgetary effects from changes in inflation and interest rates. See Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2008 to 2018 (January 2008), Box C-1.
A number of significant tax provisions originally enacted in 2001 and 2003 are scheduled to expire at the end of December 2010, which would affect economic growth. However, because CBO does not attempt to forecast cyclical developments more than two years ahead, it has not incorporated in its projections an estimate of the short-term restraint from the tax increase.
Those two large firms were originally created as federally chartered institutions but were privately owned and operated. Designed to facilitate the flow of investment funds to the housing market, they pool mortgages purchased from mortgage lenders and sell them as mortgage-backed securities, collecting annual guarantee fees on the mortgages they securitize. In return, Fannie Mae and Freddie Mac cover any losses that occur if the underlying mortgage loans default. The companies also hold mortgage loans in their portfolios and purchase mortgage-related securities (their own or those of other institutions), from which they earn a return.
Calculations of the number of households with negative equity vary from 7.8 million to 11.7 million households, amounting to a total of between $676 billion and $846 billion in outstanding loans. See Christopher Mayer and R. Glenn Hubbard, “House Prices, Interest Rates, and the Mortgage Market Meltdown” (working paper, Columbia Business School and the National Bureau of Economic Research, October 2008).
Ginnie Mae, a government-owned corporation, guarantees securities backed by federally insured or guaranteed loans, mainly loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs.
That revision results from a reevaluation of the short-term surge in the growth of TFP earlier in the decade. CBO now treats more of that growth as transitory and therefore has lowered its estimate of the trend growth in TFP.
In the December survey, participants in the Blue Chip consensus reported that they expected fiscal stimulus of between $400 billion and $800 billion; 52 percent of the respondents expected the figure to be $500 billion.
CBO’s estimate of those outlays is the projected net cost of the program’s transactions on a discounted present-value basis.
Those provisions were originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003.
Conservatorship is the legal process in which an entity is appointed to establish control and oversight of a company to put it in a sound and solvent condition.
Another housing-related GSE, the Federal Home Loan Bank System (FHLB), which provides low-cost loans to home mortgage lenders, has not been taken over by the government. However, some of the FHLB’s activities, specifically those related to affordable housing, are recorded in the federal budget.
CBO’s calculations related to Fannie Mae and Freddie Mac are done by estimating the present value of all future cash flows, including an adjustment for market risk.
CBO’s calculation of the cost of the TARP has been done by estimating the present value of all future cash flows, including an adjustment for market risk (as specified by the Emergency Economic Stabilization Act of 2008, Division A of Public Law 110-343). Thus far, the Administration is accounting for capital purchases made under the TARP on a cash basis rather than on the present-value basis that was specified in the law. That treatment will show more outlays for the TARP this year and then substantial receipts in future years.
A basis point is one-hundredth of a percentage point.
The projected decline in revenues for 2009 is greater when receipts are compared with those in 2008 excluding the direct effect of tax rebates sent to individuals under the Economic Stimulus Act of 2008; those rebates reduced revenues in 2008 by about 0.4 percent of GDP.
Under current law, firms with losses generally can receive refunds of income taxes paid in the two previous years.
CBO assumes that the TARP will also disburse about $20 billion in 2010 and that dividend payments received by the Treasury will offset some borrowing needs this year and in the future.
Beyond 2013, the reduction in projected revenues becomes less significant, with the remaining effect stemming largely from lower interest rates on long-term Treasury securities purchased by the Federal Reserve in the near term and held to maturity.
That estimate reflects the fact that the effect of lowering the amount of taxpayers’ regular tax liabilities would be partially offset by an increase in the number of taxpayers subject to the AMT. The estimate does not include any macroeconomic effects—unlike CBO’s baseline projections, which incorporate the effects that the tax provisions’ expiration would have on the economy. However, any macroeconomic effects are likely to be small relative to GDP. In addition, when this report went to press, the Joint Committee on Taxation’s (JCT’s) most recent estimates of the effects of extending expiring tax provisions were based on CBO’s baseline projections from February 2008, updated for laws enacted through August 2008. Therefore, CBO has adjusted those estimates to take into account its updated economic projections and recent changes in law. JCT is currently updating its estimates to reflect CBO’s new projections, and CBO will make those estimates available when they are completed.
The Treasury thus far has recorded its purchases of equity in financial institutions on a cash basis.
President’s Commission on Budget Concepts, Report of the President’s Commission on Budget Concepts (October 1967).
See Congressional Budget Office, Assessing the Public Costs and Benefits of Fannie Mae and Freddie Mac (May 1996) and Federal Subsidies and the Housing GSEs (May 2001).
See Congressional Budget Office, The Budget and Economic Outlook: An Update (September 2008).
Over 10 years, the effect of higher unemployment compensation on the budget is largely offset by higher revenues. States are assumed to replenish their depleted trust fund balances by increasing unemployment taxes, which are recorded as federal revenues.
If regular or supplemental appropriations are enacted in place of or in addition to the current continuing resolution, subsequent baseline projections will incorporate their effects.
In December 2008, CBO released two volumes that focus on health care issues: Key Issues in Analyzing Major Health Insurance Proposals and Budget Options, Volume 1: Health Care. Those reports, which build upon CBO’s previous analytical work on health insurance and other issues in financing health care, are intended to assist the Congress as it contemplates possible changes—both large and small—to federal health programs and the nation’s health insurance and health care systems.
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