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September 13, 2011
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Long-Term Budget Projections
Although most of CBO's budget projections and cost estimates cover a 10-year window, the agency regularly conducts studies of the nation's long-term budget picture. The Long-Term Budget Outlook is produced annually, and other studies on long-term issues in Social Security, federal health care programs, and other parts of the budget are produced periodically.
Highlights
The federal government is confronting significant and fundamental budgetary challenges. If current policies are continued in coming years, the aging of the population and the rising cost of health care will boost federal spending, as a share of the economy, well above the amount of revenues that the federal government has collected in the past. As a result, putting the federal budget on a sustainable path will require significant changes in spending policies, tax policies, or both. The task of addressing those formidable challenges is complicated by the weakness of the economy and the large numbers of unemployed workers, empty houses, and underused factories and offices. Changes that might be made to federal spending or tax policies could have a substantial impact on the pace of economic recovery during the next few years as well as on the nation’s output and people’s income over the longer term.
The Economic Outlook
The financial crisis and recession have cast a long shadow on the U.S. economy. Although output began to expand again two years ago, the pace of the recovery has been slow, and the economy remains in a severe slump. CBO expects that the economic recovery will continue but that output will stay well below the economy’s potential output—an amount that corresponds to a high rate of use of labor and capital—for several years. CBO published its most recent economic forecast in August; that forecast was initially completed in early July and was updated in August only to reflect the policy changes enacted in the Budget Control Act. Incoming data and other developments since early July, as well as the latest Blue Chip consensus forecast, suggest that economic growth for the remainder of this year and next is likely to be weaker than the agency anticipated—with growth in the vicinity of 1½ percent this year and around 2½ percent next year.
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With output growing at that modest rate, CBO expects employment to expand very slowly during the rest of this year and next year, leaving the unemployment rate close to 9 percent through the end of 2012. Weakness in the demand for goods and services is the principal restraint on hiring, but structural impediments in the labor market—such as a mismatch between the requirements of existing job openings and the characteristics of job seekers—appear to be hindering hiring as well.
If economic growth occurs at the slow pace that CBO anticipates, a large portion of the economic and human costs of the recession and slow recovery remains ahead. In mid-2011, according to the agency’s estimates, the economy was only about halfway through the cumulative shortfall in output relative to its potential level that will result from the recession and the weak recovery. Between late 2007 and mid-2011, the cumulative difference between gross domestic product (GDP) and estimated potential GDP amounted to roughly $2½ trillion; by the time the nation’s output rises back to its potential level, probably several years from now, the cumulative shortfall is expected to equal about $5 trillion. Not only are the costs associated with the output gap immense, but they are also borne unevenly, falling disproportionately on people who lose their jobs, who are displaced from their homes, or who own businesses that fail.
The economic outlook remains highly uncertain, however. The recent recession was unusual compared with previous ones in terms of its causes, depth, and duration. As a result, the recovery has had unusual features that have been hard to predict, and the path of the economy in coming years is also likely to be surprising in various ways. Many developments, such as changes in the degree to which households want to further reduce their debt burdens or the adoption of fiscal policies that differ from current law, could cause economic outcomes to differ substantially, in one direction or the other, from those CBO has projected.
The Budget Outlook
If the recovery continues as CBO expects, and if tax and spending policies unfold as specified in current law, deficits will drop markedly as a share of GDP over the next few years. Under CBO’s baseline projections, which generally reflect the assumption that current law will not change, deficits fall to 6.2 percent of GDP in 2012 and to 3.2 percent in 2013, and then fluctuate within a range of 1.0 percent to 1.6 percent of GDP from 2014 through 2021. In that scenario, cumulative deficits over the coming decade will total $3.5 trillion, and by 2021, debt held by the public will equal 61 percent of GDP—well above the annual average of 37 percent recorded between 1971 and 2010. (The weaker economy that CBO now anticipates for the remainder of this year and next would imply, all else being equal, a slightly larger federal deficit during that period.)
CBO’s baseline projections incorporate the assumption that current law remains in place so they can serve as a benchmark for policymakers to use in considering possible changes to the law. But those baseline projections understate the budgetary challenges facing the federal government because changes in policy that will take effect under current law will produce a federal tax system and spending for some federal programs that differ noticeably from what people have become accustomed to. Specifically, CBO’s baseline projections include the following policies specified in current law:
- Provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312, referred to in this testimony as the 2010 tax act) that reduced the payroll tax for one year and limited the reach of the alternative minimum tax (AMT) for two years are set to expire on December 31, 2011.
- Several other key provisions of the 2010 tax act—including the extension of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and the American Recovery and Reinvestment Act (ARRA, P.L. 111-5)—are set to expire on December 31, 2012.
- Medicare’s payments for physicians’ services are scheduled to be reduced by nearly 30 percent after December 31, 2011.
- Discretionary appropriations between 2012 and 2021 will be subject to statutory caps set in the Budget Control Act of 2011 (P.L. 112-25) that will reduce discretionary spending in real (inflation-adjusted) terms over time.
- Additional budgetary savings of more than $1 trillion required by the Budget Control Act will occur as a result of legislation produced by this Committee or, if lawmakers fail to enact such legislation, by means of automatic cuts in spending that will then be triggered.
Changing provisions of current law so as to maintain major policies that are in effect now would produce markedly different budgetary outcomes. For example, if most of the provisions in the 2010 tax act were extended, if the AMT was indexed for inflation, and if Medicare’s payment rates for physicians’ services were held constant, then cumulative deficits over the coming decade would total $8.5 trillion, and debt held by the public would reach 82 percent of GDP by the end of 2021, higher than in any year since 1948.
Beyond the coming decade, the fiscal outlook worsens, as the aging of the population and the rising costs of health care exert significant and increasing pressure on the budget under current law. When CBO issued its most recent long-term projections in June 2011, debt held by the public was projected to reach 84 percent of GDP in 2035 under an extension of current law. In those projections, rising federal spending relative to GDP kept debt high even though federal revenues reached significantly larger percentages of GDP than ever seen before in the United States. The agency also examined an alternative scenario in which the tax provisions enacted since 2001 that were extended most recently in 2010 were assumed to be extended, the reach of the AMT was assumed to be restrained to stay close to its historical extent, and tax law was assumed to evolve over the long term so that revenues remained near their historical average of 18 percent of GDP. CBO projected in June that, under that alternative scenario, revenues would increase much more slowly than spending, and debt held by the public would balloon to nearly 190 percent of GDP by 2035.
Although new long-term projections reflecting the latest 10-year projections would differ, the amounts of federal borrowing that would be required under those policy assumptions clearly would be unsustainable. Interest payments on that debt would rise dramatically relative to the size of the tax base that would be available for generating revenues to cover those payments, consuming an ever-growing share of the federal budget. Even before the interest burden became unsupportable, a fiscal crisis could arise if participants in financial markets lost confidence in the government’s ability to manage its budget and became unwilling to lend to the government at affordable rates. Thus, under current policies, the federal budget is quickly heading into territory that is unfamiliar to the United States and to most other developed countries as well.
Fiscal Policy Choices
The budgetary and economic challenges facing the nation present policymakers with difficult choices about fiscal policy. As this Committee considers its charge to recommend policies that would reduce future budget deficits, its key choices fall into three broad categories:
- How much deficit reduction should be accomplished?
- How quickly should deficit reduction be implemented?
- What forms should deficit reduction take?
The Magnitude of Deficit Reduction. There is no commonly agreed upon level of federal debt that is sustainable or optimal. Under CBO’s current-law baseline, which incorporates $1.2 trillion in expected deficit reduction related to this Committee’s work, as well as significant increases in tax revenues relative to GDP, debt held by the public is projected to fall from 67 percent of GDP at the end of 2011 to 61 percent by 2021. However, stabilizing the debt at that level would leave it larger than in any year between 1953 and 2009.
Lawmakers might determine that debt should be reduced to amounts lower than those shown in CBO’s baseline—in order to reduce the burden of debt on the economy, relieve some of the long-term pressures on the budget, diminish the risk of a fiscal crisis, and enhance the government’s flexibility to respond to unanticipated developments. Accomplishing that objective would require larger amounts of deficit reduction. If, for example, this Committee chose to make recommendations that would lower debt held by the public in 2021 to 50 percent of GDP, roughly the level recorded in the mid-1990s, it would need to propose changes in policies—relative to those embodied in current law, which underlie CBO’s baseline projections—that reduced deficits by a total of about $3.8 trillion over the coming decade.
Furthermore, lawmakers might decide that some of the current policies that are scheduled to expire under current law should be continued. In that case, achieving a particular level of debt could require much larger amounts of deficit reduction through other changes in policy. For example, if most of the provisions in the 2010 tax act were extended, if the AMT was indexed for inflation, and if Medicare’s payment rates for physicians’ services were held constant, then reducing debt held by the public in 2021 to the 61 percent of GDP projected under current law would require other changes in policy to reduce deficits over the next 10 years by a total of $6.2 trillion, rather than the $1.2 trillion in deficit reduction that this Committee would have to accomplish to avoid the automatic budget cuts required by the Budget Control Act.
The Timing of Deficit Reduction. Policymakers face difficult trade-offs in decisions about how quickly to implement policies to reduce budget deficits. On the one hand, cutting spending or increasing taxes slowly would lead to a greater accumulation of government debt and might raise doubts about whether the longer-term deficit reductions would ultimately take effect. On the other hand, implementing spending cuts or tax increases abruptly would give families, businesses, and state and local governments little time to plan and adjust. In addition, and particularly important given the current state of the economy, immediate spending cuts or tax increases would represent an added drag on the weak economic expansion.
However, credible steps to narrow budget deficits over the longer term would tend to boost output and employment in the next few years by holding down interest rates and by reducing uncertainty and enhancing business and consumer confidence. Therefore, the near-term economic effects of deficit reduction would depend on the balance between changes in spending and taxes that take effect quickly and those that take effect gradually. According to CBO’s analysis, credible policy changes that would substantially reduce deficits later in the coming decade and over the long term—without immediate cuts in spending or increases in taxes—would both support the economic expansion in the next few years and strengthen the economy over the longer term.
There is no inherent contradiction between using fiscal policy to support the economy today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential. If policymakers wanted to achieve both a short-term economic boost and medium-term and long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade. Such an approach would work best if the future policy changes were sufficiently specific and widely supported so that households, businesses, state and local governments, and participants in the financial markets believed that the future fiscal restraint would truly take effect.
The Composition of Deficit Reduction. As policymakers consider the composition of policy changes to be used to reduce budget deficits, many factors may play a role. The amount and composition of federal spending and revenues affect the total amount and types of output that are produced and consumed in the country, the distribution of those material resources among various segments of society, and people’s well-being in a variety of ways.
In considering the challenge of putting fiscal policy on a sustainable path, many observers have wondered whether it is possible to return to policies regarding federal spending and revenues that, in earlier years, usually generated deficits that were small relative to GDP and kept the amount of debt held by the public to between about one-quarter and one-half of GDP. Unfortunately, however, the past combination of policies cannot be repeated when it comes to the federal budget: The aging of the population and rising costs for health care have changed the backdrop for federal budget policy in a fundamental way.
Under current law, spending on Social Security and the major health care programs—Medicare, Medicaid, the Children’s Health Insurance Program, and insurance subsidies to be provided through exchanges in coming years—is projected to be much higher than has historically been the case, reaching 12.2 percent of GDP in 2021, compared with 10.4 percent of GDP in 2011 and an average of 7.2 percent of GDP during the past 40 years. Most of that spending goes to benefits for people over age 65, with smaller shares for blind and disabled people and for nonelderly able-bodied people.
In contrast, under current law, all spending apart from that for Social Security, the major health care programs, and interest payments on the debt is projected to decline noticeably as a share of the economy. That broad collection of programs includes defense (the largest single piece), the Supplemental Nutrition Assistance Program (formerly known as Food Stamps), unemployment compensation, other income-security programs, veterans’ benefits, federal civilian and military retirement benefits, transportation, health research, education and training, and other programs. Such spending has averaged 11.5 percent of GDP during the past 40 years and totals 12.0 percent in 2011. Expected improvement in the economy and the caps on discretionary spending instituted in the Budget Control Act are projected to reduce such spending to 7.7 percent of GDP in 2021, the lowest level as a share of GDP in the past 40 years.
Thus, according to CBO’s projections under current law, even with the new constraints on discretionary spending, federal spending excluding net interest will grow to 19.9 percent of GDP in 2021—compared with the 40-year average of 18.6 percent. And the composition of that spending will be noticeably different from what the nation has experienced in recent decades: Spending for Social Security and the major health care programs will be much higher, and spending for all other federal programs and activities, except for net interest payments, will be much lower. Alternatively, if the laws governing Social Security and the major health care programs were unchanged, and all other programs were operated in line with their average relationship to the size of the economy during the past 40 years, total federal spending excluding net interest would be much higher in 2021—nearly 24 percent of GDP. That amount exceeds the 40-year average for revenues as a share of GDP by nearly 6 percentage points—even before interest payments on the debt have been included.
At the same time, the sharp increase in federal debt and a return to more-normal interest rates will boost the government’s net interest costs. They are projected to reach 2.8 percent of GDP in 2021, compared with only 1.5 percent of GDP in 2011 and an average of 2.2 percent of GDP during the past 40 years.
What do those numbers imply about the choices that policymakers—and citizens—confront about future policies? Given the aging of the population and the rising costs for health care, attaining a sustainable budget for the federal government will require the United States to deviate from the policies of the past 40 years in at least one of the following ways:
- Raise federal revenues significantly above their average share of GDP;
- Make major changes to the sorts of benefits provided for Americans when they become older; or
- Substantially reduce the role of the rest of the federal government relative to the size of the economy.
The nation cannot continue to sustain the spending programs and policies of the past with the tax revenues it has been accustomed to paying. Citizens will either have to pay more for their government, accept less in government services and benefits, or both.
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CBO's 2011 Long-Term Projections for Social Security: Additional Information
Highlights
Social Security is the federal government's largest single program. About 56 million people will receive Social Security benefits this year, the Congressional Budget Office (CBO) estimates. About 69 percent are retired workers, their spouses, and children, and another 12 percent are survivors of deceased workers; all of those beneficiaries receive payments through Old-Age and Survivors Insurance (OASI). The other 19 percent are disabled workers or their spouses and children; they receive Disability Insurance (DI) benefits. CBO projects that in fiscal year 2011, Social Security's outlays will total $733 billion, one-fifth of the federal budget; OASI payments will account for about 82 percent of those outlays, and DI payments, about 18 percent.
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Social Security has two primary sources of tax revenues: payroll taxes and income taxes on benefits. This year, roughly 97 percent of tax revenues dedicated to Social Security will be collected from a payroll tax of 12.4 percent that is levied on earnings and split evenly between workers and their employers at 6.2 percent apiece (except for self-employed workers, who pay the entire 12.4 percent tax on earnings themselves). The payroll tax applies only to taxable earnings—earnings up to a maximum annual amount ($106,800 in 2011). Some Social Security benefits also are subject to taxation: This year, about 3 percent of Social Security's tax revenues will come from the income taxes that higher-income beneficiaries pay on their Social Security benefits. Tax revenues credited to the program will total $687 billion in fiscal year 2011.
Revenues from taxes, along with intragovernmental interest payments, are credited to Social Security's two trust funds—one for OASI and one for DI—and the program's benefits and administrative costs are paid from those funds. Legally, the funds are separate, but they often are described collectively as the OASDI trust funds. In a given year, the sum of receipts to a fund along with the interest that is credited on previous balances, minus spending for benefits and administrative costs, constitutes that fund's surplus or deficit.
In calendar year 2010, for the first time since the enactment of the Social Security Amendments of 1983, annual outlays for the program exceeded annual revenues excluding interest credited to the trust funds. CBO projects that the gap will continue: Over the next five years, outlays will be about 5 percent greater than such revenues. However, as more members of the baby-boom generation (that is, people born between 1946 and 1964) enter retirement, outlays will increase relative to the size of the economy, whereas tax revenues will remain at an almost constant share of the economy. As a result, the shortfall will begin to grow around 2017.
CBO projects that the DI trust fund will be exhausted in 2017 and that the OASI trust fund will be exhausted in 2040. Once a trust fund's balance has fallen to zero and current revenues are insufficient to cover the benefits that are specified in law, the corresponding program will be unable to pay full benefits without changes in law. The DI trust fund came close to exhaustion in 1994, but that outcome was prevented by legislation that redirected revenues from the OASI trust fund to the DI trust fund. In part because of that experience, it is a common analytical convention to consider the DI and OASI trust funds as combined. CBO projects that, if legislation to shift resources from the OASI trust fund to the DI trust fund was enacted, the combined OASDI trust funds would be exhausted in 2038.
The amount of Social Security taxes paid by various groups of people differs, as do the benefits that different groups receive. For example, people with higher earnings pay more in Social Security payroll taxes than do lower-earning participants, and they also receive larger benefits (although not proportionately larger). Because of the progressive nature of Social Security's benefit formula, replacement rates—annual benefits as a percentage of annual lifetime earnings—are lower, on average, for workers who have had higher earnings. As another example, the amount of taxes paid and benefits received will be greater for people in later birth cohorts because they typically will have higher earnings over a lifetime, even after an adjustment for inflation, CBO projects. However, initial replacement rates will be slightly lower, on average, for people in later birth groups because their full retirement age (the age at which they can receive unreduced retirement benefits) will be higher. The increase in that age is equivalent to a reduction in benefits at any age at which benefits are claimed.
CBO's 2011 Long-Term Projections for Social Security: Infographic
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CBO's 2011 Long-Term Budget Outlook: Testimony Before the House Budget Committee
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Abstract
This Congressional Budget Office (CBO) report presents the agency's projections of federal spending and revenues over the coming decades. Under current law, an aging population and rapidly rising health care costs will sharply increase federal spending for health care programs and Social Security. If revenues remained at their historical average share of gross domestic product (GDP), such spending growth would cause federal debt to grow to unsustainable levels. If policymakers are to put the federal government on a sustainable budgetary path, they will need to increase revenues substantially as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches. In keeping with CBO's mandate to provide objective, impartial analysis, this report makes no recommendations.
Highlights
Recently, the federal government has been recording budget deficits that are the largest as a share of the economy since 1945. Consequently, the amount of federal debt held by the public has surged. At the end of 2008, that debt equaled 40 percent of the nation's annual economic output (a little above the 40-year average of 37 percent). Since then, the figure has shot upward: By the end of this year, the Congressional Budget Office (CBO) projects, federal debt will reach roughly 70 percent of gross domestic product (GDP)—the highest percentage since shortly after World War II. The sharp rise in debt stems partly from lower tax revenues and higher federal spending related to the recent severe recession. However, the growing debt also reflects an imbalance between spending and revenues that predated the recession.
As the economy continues to recover and the policies adopted to counteract the recession phase out, budget deficits will probably decline markedly in the next few years. But the budget outlook, for both the coming decade and beyond, is daunting. The retirement of the baby-boom generation portends a significant and sustained increase in the share of the population receiving benefits from Social Security, Medicare, and Medicaid. Moreover, per capita spending for health care is likely to continue rising faster than spending per person on other goods and services for many years (although the magnitude of that gap is very uncertain). Without significant changes in government policy, those factors will boost federal outlays sharply relative to GDP in coming decades under any plausible assumptions about future trends in the economy, demographics, and health care costs.
According to CBO's projections, if current laws remained in place, spending on the major mandatory health care programs alone would grow from less than 6 percent of GDP today to about 9 percent in 2035 and would continue to increase thereafter. Spending on Social Security is projected to rise much less sharply, from less than 5 percent of GDP today to about 6 percent in 2030, and then to stabilize at roughly that level. Altogether, the aging of the population and the rising cost of health care would cause spending on the major mandatory health care programs and Social Security to grow from roughly 10 percent of GDP today to about 15 percent of GDP 25 years from now. (By comparison, spending on all of the federal government's programs and activities, excluding interest payments on debt, has averaged about 18.5 percent of GDP over the past 40 years.) That combined increase of roughly 5 percentage points for such spending as a share of the economy is equivalent to about $750 billion today. If lawmakers ultimately modified some provisions of current law that might be difficult to sustain for a long period, that increase would be even larger.
Long-Term Scenarios
In this report, CBO presents the long-term budget outlook under two scenarios that embody different assumptions about future policies governing federal revenues and spending. Neither of those scenarios represents a prediction by CBO of what policies will be in effect during the next several decades, and the policies adopted in coming years will surely differ from those assumed for the scenarios. Moreover, even if the assumed policies were adopted, their economic and budgetary consequences would undoubtedly differ from those projected in this report because outcomes also depend on economic conditions, demographic trends, and other factors that are difficult to predict. The report focuses on the next 25 years rather than a longer horizon, because budget projections grow increasingly uncertain as they extend farther into the future.
The Extended-Baseline Scenario
One long-term budget scenario used in this analysis, the extended-baseline scenario, adheres closely to current law. Under this scenario, the expiration of the tax cuts enacted since 2001 and most recently extended in 2010, the growing reach of the alternative minimum tax, the tax provisions of the recent health care legislation, and the way in which the tax system interacts with economic growth would result in steadily higher revenues relative to GDP. Revenues would reach 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and would grow to larger percentages thereafter. At the same time, under this scenario, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.
That significant increase in revenues and decrease in the relative magnitude of other spending would offset much—though not all—of the rise in spending on health care programs and Social Security. As a result, debt would increase slowly from its already high levels relative to GDP, as would the required interest payments on that debt. Federal debt held by the public would grow from an estimated 69 percent of GDP this year to 84 percent by 2035. With both debt and interest rates rising over time, interest payments, which absorb federal resources that could otherwise be used to pay for government services, would climb to 4 percent of GDP (or one-sixth of federal revenues) by 2035, compared with about 1 percent now.
The Alternative Fiscal Scenario
The budget outlook is much bleaker under the alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. Most important are the assumptions about revenues: that the tax cuts enacted since 2001 and extended most recently in 2010 will be extended; that the reach of the alternative minimum tax will be restrained to stay close to its historical extent; and that over the longer run, tax law will evolve further so that revenues remain near their historical average of 18 percent of GDP. This scenario also incorporates assumptions that Medicare's payment rates for physicians will remain at current levels (rather than declining by about a third, as under current law) and that some policies enacted in the March 2010 health care legislation to restrain growth in federal health care spending will not continue in effect after 2021. In addition, the alternative scenario includes an assumption that spending on activities other than the major mandatory health care programs, Social Security, and interest on the debt will not fall quite as low as under the extended-baseline scenario, although it will still fall to its lowest level (relative to GDP) since before World War II.
Under those policies, federal debt would grow much more rapidly than under the extended-baseline scenario. With significantly lower revenues and higher outlays, debt held by the public would exceed 100 percent of GDP by 2021. After that, the growing imbalance between revenues and spending, combined with spiraling interest payments, would swiftly push debt to higher and higher levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2023 and would approach 190 percent in 2035.
Many budget analysts believe that the alternative fiscal scenario presents a more realistic picture of the nation's underlying fiscal policies than the extended-baseline scenario does. The explosive path of federal debt under the alternative fiscal scenario underscores the need for large and rapid policy changes to put the nation on a sustainable fiscal course.
The Impact of Growing Deficits and Debt
CBO's projections in most of this report understate the severity of the long-term budget problem because they do not incorporate the negative effects that additional federal debt would have on the economy, nor do they include the impact of higher tax rates on people's incentives to work and save. In particular, large budget deficits and growing debt would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States. Taking those effects into account, CBO estimates that under the extended-baseline scenario, real (inflation-adjusted) gross national product (GNP) would be reduced slightly by 2025 and by as much as 2 percent by 2035, compared with what it would be under the stable economic environment that underlies most of the projections in this report. Under the alternative fiscal scenario, real GNP would be 2 percent to 6 percent lower in 2025, and 7 percent to 18 percent lower in 2035, than under a stable economic environment.
Rising levels of debt also would have other negative consequences that are not incorporated in those estimated effects on output:
- Higher levels of debt imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.
- Rising debt would increasingly restrict policymakers' ability to use tax and spending policies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, the effects of such developments on the economy and people's well-being could be worse.
- Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government's ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices. To restore investors' confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.
To keep deficits and debt from climbing to unsustainable levels, policymakers will need to increase revenues substantially as a percentage of GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches. Making such changes while economic activity and employment remain well below their potential levels would probably slow the economic recovery. However, the sooner that medium- and long-term changes to tax and spending policies are agreed on, and the sooner they are carried out once the economy recovers, the smaller will be the damage to the economy from growing federal debt. Earlier action would permit smaller or more gradual changes and would give people more time to adjust to them, but it would require more sacrifices sooner from current older workers and retirees for the benefit of younger workers and future generations.
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