CBO Releases Its Annual Summer Update of the Budget and Economic Outlook

August 19, 2010

CBO estimates, in its annual summer update of the budget and economic outlook, that the federal budget deficit for 2010 will exceed $1.3 trillion—$71 billion below last year’s total and $27 billion lower than the amount that CBO projected in March 2010 when it issued its previous estimate. Relative to the size of the economy, this year’s deficit is expected to be the second largest shortfall in the past 65 years: At 9.1 percent of gross domestic product (GDP), it is exceeded only by last year’s deficit of 9.9 percent of GDP. As was the case last year, this year’s deficit is attributable in large part to a combination of weak revenues and elevated spending associated with the economic downturn and the policies implemented in response to it.

This report presents CBO’s updated budget and economic projections spanning the 2010–2020 period. Those projections reflect the assumption that current laws affecting the budget will remain unchanged—and thus the projections serve as a neutral benchmark that lawmakers can use to assess the potential effects of policy decisions. As such, CBO assumes that tax reductions enacted earlier in this decade that are currently set to expire at the end of this year do so as scheduled; it also assumes that no new legislation aimed at keeping the alternative minimum tax (AMT) from affecting many more taxpayers is enacted. In addition, CBO assumes that the measures enacted in the past two years to provide fiscal stimulus to the weakened economy will expire as currently scheduled and that future annual appropriations will be kept constant in real (inflation-adjusted) terms. Under those assumptions, the federal budget deficit would decline substantially over the next two years—to 4.2 percent of GDP in 2012—and, consequently, the budget would provide much less support to the economy than has been the case for the past two years.

According to CBO’s projections, the recovery from the economic downturn will continue at a modest pace during the next few years. Growth in the nation’s output since the middle of calendar year 2009 has been anemic in comparison with that of previous recoveries following deep recessions, and the unemployment rate has remained quite high, averaging 9.7 percent in the first half of this year. Such weak growth is typical in the aftermath of a financial crisis. The considerable number of vacant houses and underused factories and offices will be a continuing drag on residential construction and business investment, and slow income growth as well as lost wealth will restrain consumer spending.

All of those forces, along with the waning of federal fiscal support, will tend to restrain spending by individuals and businesses—and, therefore, economic growth—during the recovery. CBO projects that the economy will grow by only 2.0 percent from the fourth quarter of 2010 to the fourth quarter of 2011; even with faster growth in subsequent years, the unemployment rate will not fall to around 5 percent until 2014.

In CBO’s current-law projections, once the economy has recovered, the federal budget deficit amounts to between 2.5 percent and 3.0 percent of GDP from 2014 to 2020. Projected deficits total $6.2 trillion for the 10 years starting in 2011, raising federal debt held by the public to more than 69 percent by 2020, almost double the 36 percent of GDP observed at the end of 2007.

Those projections, which are similar in many respects to the ones that CBO prepared in March, reflect assumptions about spending and revenues that may significantly underestimate actual deficits. Because the projections presume no changes in current tax laws, they result in estimates of revenues that, as a percentage of GDP, would be quite high by historical standards. Because of the assumption that future annual appropriations are held constant in real terms, the projections yield estimates of discretionary spending relative to GDP that would be low by historical standards. Of course, many other outcomes are possible. If, for example, the tax reductions enacted earlier in the decade were continued, the AMT was indexed for inflation, and future annual appropriations remained the share of GDP that they are this year, the deficit in 2020 would equal about 8 percent of GDP, and debt held by the public would total nearly 100 percent of GDP.

A different fiscal policy would also yield different economic outcomes. For example, CBO estimates that under an alternative fiscal path similar to the one mentioned above, real growth of GDP in 2011 would be 0.6 to 1.7 percentage points higher than it is in the baseline forecast, and the unemployment rate at the end of 2011 would be 0.3 to 0.8 percentage points lower. However, later in the coming decade, real GDP would fall below the level in CBO’s baseline because the larger budget deficits would reduce investment in productive capital.

Beyond the 10-year budget window, the nation will face daunting long-term fiscal challenges posed by rising costs for health care and the aging of the population. Continued large deficits and the resulting increases in federal debt over time would reduce long-term economic growth. Putting the nation on a sustainable fiscal course will require policymakers to restrain the growth of spending substantially, raise revenues significantly above their average percentage of GDP of the past 40 years, or adopt some combination of those approaches.