Looming Policy Decisions May Have a Substantial Effect on the Budget Outlook

Posted by
Doug Elmendorf
February 6, 2013

Yesterday CBO released The Budget and Economic Outlook: Fiscal Years 2013 to 2023. In that report, CBO projects that the federal deficit will drop to $845 billion in 2013—its smallest size since 2008. Even so, under current law annual deficits and federal debt will stay at historically high levels relative to the economy through 2023, and lawmakers face key budgetary decisions this year that could have a substantial effect on that budget outlook.

Key Budgetary Decisions Facing Lawmakers Over the Next Few Months

By changing some income tax rates and making permanent changes to the alternative minimum tax, among other things, the American Taxpayer Relief Act has reduced the uncertainty surrounding federal fiscal policy. Nevertheless, many key budget issues remain unresolved.

Automatic Spending Reductions

The provisions of the Budget Control Act that established automatic procedures to restrain discretionary and mandatory spending are set to take effect on March 1; if fully implemented, they will reduce total funding in 2013 by $85 billion. (The American Taxpayer Relief Act delayed the reduction by two months and reduced it by $24 billion.) CBO estimates that, in 2013, discretionary funding (which is provided through annual appropriations) will decline by $71 billion and funding for mandatory programs (which is not subject to annual appropriations) will be reduced by $14 billion, as a result of those procedures.

By CBO’s estimate, budgetary resources for defense (other than spending for military personnel) will be cut by around 8 percent across the board, and nondefense funding that is subject to the automatic reductions will be cut by between 5 percent and 6 percent. According to that estimate, discretionary outlays will drop by $35 billion and mandatory spending will be reduced by $9 billion this year as a direct result of those procedures; additional reductions in outlays attributable to the cuts in 2013 funding will occur in later years. The deficit for 2013 will depend in part on whether those cuts are allowed to take place, are canceled (in whole or in part), or are replaced with other measures designed to reduce the deficit.

If lawmakers chose to prevent those automatic cuts each year without making other changes that reduced spending by offsetting amounts, the deficit would total nearly $900 billion in 2013, more than $40 billion higher than under current law. Over the 2014–2023 period, total deficits would exceed $8 trillion—over $1 trillion more than is projected in CBO’s current baseline.

Continuing Resolution

Federal agencies are now operating under the Continuing Appropriations Resolution, 2013 (P.L. 112-175), which set discretionary funding for 2013 at an annual rate of $1.047 trillion, the sum of the caps established by the Budget Control Act (before the American Taxpayer Relief Act reduced the caps by $4 billion). That funding will expire on March 27, although following the rules in the Balanced Budget and Emergency Deficit Control Act of 1985, CBO’s baseline incorporates the assumption that such funding will be extended at the current amount for the remainder of the fiscal year. If no additional appropriations are provided, nonessential functions of the government will cease operations after March 27. If final appropriations differ from those provided in the continuing resolution, CBO’s projections of discretionary outlays will be affected for 2013 and future years.

Statutory Limit on Federal Debt

Until recently, the amount of debt that the Department of the Treasury could issue to the public and to other government accounts was capped at $16.394 trillion; that limit was reached at the end of December 2012. At that time, the Treasury began using what are known as extraordinary measures for managing cash and borrowing in order to continue funding the operations of the federal government. Lawmakers have recently suspended the limitation on borrowing through May 18, 2013, and on May 19, the existing debt limit will be raised by the amount of borrowing that occurred while the limitation was suspended (that is, from early February to May 18). If no further action is taken before May 19, the Treasury will once again resort to extraordinary measures to allow the government to continue operating normally. To avoid defaulting on the federal government’s obligations, including possibly defaulting on the government’s debt obligations, the debt ceiling will need to be adjusted before those extraordinary measures are exhausted later in the year.

Other Important Budgetary Decisions

Budgetary outcomes will also be affected by decisions about whether to continue certain policies that have been in effect in recent years. Such policies could be continued, for example, by extending some tax provisions that are scheduled to expire (and that have routinely been extended in the past) or by preventing the 25 percent cut in Medicare’s payment rates for physicians that is due to occur in 2014.

If, for instance, lawmakers eliminated the automatic spending cuts scheduled to take effect in March (but left in place the original caps on discretionary funding set by the Budget Control Act), prevented the sharp reduction in Medicare’s payment rates for physicians, and extended the tax provisions that are scheduled to expire at the end of calendar year 2013 (or, in some cases, in later years), budget deficits would be substantially larger over the coming decade than in CBO’s baseline projections. With those changes, and no offsetting reductions in deficits, debt held by the public would rise to 87 percent of GDP by the end of 2023 rather than to 77 percent in CBO’s baseline.

In addition to those decisions, lawmakers will continue to face the longer-term budgetary issues posed by the substantial federal debt and by the implications of rising health care costs and the aging of the population. Even under current law, federal debt will remain far above the average of 39 percent of GDP that the United States experienced between 1973 and 2012—and it will be trending upward by the end of the decade. Debt that is high by historical standards and heading higher will lead to rising interest costs, less domestic investment and lower incomes, less flexibility to respond to unexpected challenges, and a greater likelihood of a fiscal crisis in which the government would be unable to borrow funds at affordable interest rates. Those consequences could be mitigated if policies were enacted that reduced federal debt relative to GDP during the coming decade and beyond.