Each January, CBO prepares "baseline" budget projections spanning the next 10 years. Those projections are not a forecast of future events; rather, they are intended to provide a benchmark against which potential policy changes can be measured. Therefore, as specified in law, those projections generally incorporate the assumption that current laws are implemented.
But substantial changes to tax and spending policies are slated to take effect within the next year under current law. So CBO has also prepared projections under an "alternative fiscal scenario," in which some current or recent policies are assumed to continue in effect, even though, by law, they are scheduled to change. The decisions made by lawmakers as they confront those policy choices will have a significant impact on budget outcomes in the coming years.
CBO's Current-Law Baseline
CBO projects a $1.1 trillion federal budget deficit for fiscal year 2012 if current laws remain unchanged. Measured as a share of the nation’s output (gross domestic product, or GDP), that shortfall of 7.0 percent is nearly 2 percentage points below the deficit recorded in 2011, but still higher than any deficit between 1947 and 2008. Over the next few years, projected deficits in CBO's baseline decline markedly, dropping to under $200 billion and averaging 1.5 percent of GDP over the 2013-2022 period.
Much of the projected decline in the deficit occurs because, under current law, revenues are projected to shoot up by almost $800 billion, or more than 30 percent, between 2012 and 2014—from 16.3 percent of GDP in 2012 to 20.0 percent in 2014. That increase is mostly the result of of the recent or scheduled expirations of tax provisions, such as those initially enacted in 2001, 2003, and 2009 that lower income tax rates and those that limit the number of people subject to the alternative minimum tax (AMT).
Under current law, CBO projects that revenues will continue to rise relative to GDP after 2014 largely because increases in taxpayers' inflation-adjusted income will push more income into higher tax brackets and subject more of it to the AMT.
Outlays in CBO's baseline projections decline modestly relative to GDP over the next several years before turning up again later in the decade. The modest declines are the result of an expanding economy and statutory caps on discretionary appropriations. The aging of the population and rising costs for health care drive increases in spending in later years.
Projected spending in CBO's baseline averages 21.9 percent of GDP over the 2013-2022 period. That figure is less than the 23.2 percent CBO estimates for 2012, but it remains elevated by historical standards. As a share of GDP, discretionary spending is projected to decline to its lowest level in the past 50 years by 2022, but that decline will be partially offset by increases in spending for mandatory programs, which are projected to climb from 13.3 percent of GDP in 2013 to 14.3 percent in 2022. Driven by higher interest rates and additional accumulation of debt, net interest costs will grow significantly—from 1.4 percent of GDP this year to 2.5 percent in 2022.
CBO's Alternative Fiscal Scenario
CBO's baseline projections are heavily influenced by changes in tax and spending policies that are embodied in current law—changes that in some cases represent a significant departure from recent policies.
CBO's alternative fiscal scenario shows the budgetary consequences of maintaining certain tax and spending policies that have recently been in effect. That scenario incorporates the following assumptions:
Expiring tax provisions (other than the payroll tax reduction) are extended [under current law, those expirations will boost individual income taxes in a variety of ways by amounts totaling $3.8 trillion from 2013 through 2022];
The AMT is indexed for inflation after 2011 [under current law, its parameters are fixed, and the number of taxpayers affected by the AMT will jump from 4 million in calendar year 2011 to 30 million in 2012];
Medicare's payment rates for physicians' services are held constant at their current level [under current law, those rates are scheduled to drop by 27 percent this March and more in later years]; and
The automatic spending reductions required by the Budget Control Act do not take effect [under current law, they will impose reductions totaling about $109 billion a year starting in January 2013].
Under that alternative fiscal scenario, far larger deficits and much greater debt would result than are shown in CBO's baseline. Deficits would average 5.4 percent of GDP over the 2013-2022 period, rather than the 1.5 percent reflected in CBO's baseline projections. Debt held by the public would climb to 94 percent of GDP in 2022, the highest figure since just after World War II.
The Economic Outlook
In part because of the dampening effect of the higher tax rates and curbs on spending scheduled to occur this year and next, CBO expects that the economy will continue to recover slowly, with real GDP growing by 2.0 percent this year and 1.1 percent next year (as measured by the change from the fourth quarter of the previous calendar year). CBO expects economic activity to quicken after 2013 but to remain below the economy's potential until 2018.
In CBO's forecast, the unemployment rate remains above 8 percent both this year and next, a consequence of continued weakness in demand for goods and services. As economic growth picks up after 2013, the unemployment rate will gradually decline to around 7 percent by the end of 2015, before dropping to near 5½ percent by the end of 2017.
While the economy continues to recover during the next few years, inflation and interest rates will remain low. In CBO's forecast, the price index for personal consumption expenditures increases by just 1.2 percent in 2012 and 1.3 percent in 2013, and rates on 10-year Treasury notes average 2.3 percent in 2012 and 2.5 percent in 2013. As the economy's output approaches its potential later in the decade, inflation and interest rates will rise to more normal levels.
Many developments could produce economic outcomes that differ from CBO's forecast. For example:
The forces that have restrained the economy's recovery could fade more rapidly than anticipated.
A significant worsening of the banking and fiscal problems in Europe could spill over to U.S. financial markets and greatly weaken the economy here.
Changes in fiscal policy that diverge from those in CBO's baseline could affect economic growth.
CBO's alternative fiscal scenario represents one possible set of changes in fiscal policy. Under that scenario, real GDP would be noticeably higher in the next few years than it is in CBO's baseline economic forecast: CBO estimates that, with such changes in policy, real GDP in the fourth quarter of 2013 would be between 0.5 percent and 3.7 percent greater than in the baseline forecast, and that the unemployment rate would be between 0.3 and 1.8 percentage points lower. But, over time, the resulting larger deficits would reduce private investment in productive capital and result in real GDP that would fall increasingly below the level in CBO's baseline projections.