Yesterday I gave a talk over lunch to the National Economists Club. If Id known when I was invited how much legislative activity would be occurring this week, I wouldnt have agreedbut I enjoyed the chance to talk with the group.
My topic was CBOs outlook for the federal budget and the economy, drawing on our August report The Budget and Economic Outlook: An Update and our June report The Long-Term Budget Outlook. You can read the slides from my remarks.
CBO estimates that, if current laws remained in place, the federal deficit would shrink significantlyfrom about 11 percent of GDP this fiscal year to around 3 percent of GDP between 2013 and 2019. The country has experienced persistent large deficits before; for example, deficits averaged about 4 percent of GDP during the economic expansion of the 1980s. However, the budget challenge facing policymakers during the coming decade will be more acute than the challenge they faced during the 1980s in three important respects:
First, federal debt held by the public will exceed 50 percent of GDP at the end of this fiscal year, compared with roughly 30 percent when the expansion of the 1980s began. As a result, further large deficits and increases in the debt will raise more serious economic risks. Under current law, CBO projects that debt held by the public will reach 68 percent of GDP by 2019, the highest level since 1950, and will be continuing on an upward trajectory.
Second, the difference between current law (which underlies CBOs baseline projections) and current policy as perceived by many people (in particular, the personal income tax rates now in effect) is especially large now. For example, most of the tax cuts enacted in 2001 and 2003 are scheduled to expire at the end of December 2010, and the exemption amount for the alternative minimum tax (AMT) is scheduled to fall back sharply; those provisions of current law are reflected in CBOs baseline projections, adding to projected revenues. If, instead, the tax cuts were extended and the AMT exemption was indexed for inflation after 2009, the revenue loss and the resulting increase in interest payments on the federal debt would widen the deficit to more than 6 percent of GDP by 2019.
Third, the aging of the U.S. population and rising costs for health care are making federal spending on Social Security, Medicare, and Medicaid a much larger burden relative to GDP. During the expansion of the 1980s, federal spending on those three programs stayed close to 7 percent of GDP; in the 2013 to 2019 period, CBO projects that spending on those programs will rise from just over 10 percent of GDP to a little below 12 percent. Beyond the 10-year budget window, CBO expects that this share would continue to rise rapidly under current law.
This sobering outlook for the federal budget is likely to weigh on policy decisions for some time. High deficits in the near term may be an inevitable consequence of the severe economic downturn and the turmoil in the financial markets. However, continued large deficits and increases in federal debt over time would adversely affect the nations economic growth by lowering saving and investment.