I testified twice this week about CBO’s latest projections for the economy and the budget—on Tuesday to the Senate Budget Committee, and on Wednesday to the House Budget Committee. In my prepared remarks, I told the Members that our analysis shows that the country continues to face very large economic and budget challenges.
We anticipate that economic growth will remain slow this year, because the gradual improvement we see in underlying economic factors will be offset by a tightening of federal fiscal policy scheduled under current law. The good news is that the effects of the housing and financial crisis appear to be gradually fading. We expect that an upswing in housing construction, rising real estate and stock prices, and increasing availability of credit will help to spur a virtuous cycle of faster growth in employment, income, consumer spending, and business investment over the next few years.
However, several policies that will help to bring down the budget deficit will represent a drag on economic activity this year: The expiration of the 2 percentage-point cut in the Social Security payroll tax, the increase in tax rates on income above certain thresholds, and the cuts in federal spending scheduled to take effect next month will mean reduced spending by both households and the government. We project that inflation-adjusted gross domestic product (GDP) will increase by about 1½ percent in 2013, but that it would increase roughly 1½ percentage points faster than that if not for the fiscal tightening.
With that slow growth, we expect that, under current laws, the unemployment rate will stay above 7½ percent through next year. That would make 2014 the sixth consecutive year with unemployment so high, the longest such period in 70 years.
We expect that growth in real GDP will pick up after this year, to about 3½ percent per year in 2014 and the following few years. But the gap between the nation’s GDP and what it is capable of producing on a sustainable basis (what we call potential GDP) still will not close quickly. Under current law, we expect output to remain below its potential level until 2017—almost a decade after the recession started in December 2007. The nation has paid, and will continue to pay, a big price for the recession and slow recovery: We estimate that the total loss of output relative to the economy’s potential, between 2007 and 2017 will be equivalent to nearly half of the output that the United States produced last year.
Turning to the budget, under current laws, the federal budget deficit will shrink in 2013 for the fourth year in a row. At an estimated $845 billion, the deficit would be the first in five years below $1 trillion; and at 5¼ percent of GDP, it would be only about half as large, relative to the size of the economy, as the deficit was in 2009.
Our projections based on current laws show deficits continuing to fall over the next few years before turning up again by the end of the decade—and totaling nearly $7 trillion for the decade as a whole. Federal revenues are projected to reach 19 percent of GDP in 2015 and beyond, because of both the expanding economy and scheduled changes in tax rules. That 19-percent figure compares with an average of about 18 percent over the past 40 years.
At the same time, under current laws, federal spending will fall relative to the size of the economy over the next several years and then rise again. The decline can be traced to the caps on discretionary funding and a drop-off in spending that goes up when the economy is weak—like unemployment benefits. But later in the decade, the return of interest rates to more-normal levels will push up interest payments to nearly their highest share of GDP in 50 years. And throughout the decade, the aging of the population, a significant expansion of federal health care programs, and rising health care costs per person will push up spending on the largest federal programs. By 2023, spending reaches about 23 percent of GDP in our projection, compared with a 40-year average of 21 percent.
What does this mean for federal debt? We project that debt held by the public will reach 76 percent of GDP this year, the largest percentage since 1950. And, under current laws, we project that debt in 2023 will be 77 percent of GDP—far higher than the 39 percent average seen over the past 40 years—and will be on an upward path.
First, policymakers face budgetary decisions that will affect First, high debt means that the crowding out of capital investment will be greater, that lawmakers will have less flexibility to use tax and spending policies to respond to unexpected challenges (like a recession or war), and that there will be a heightened risk of a fiscal crisis in which the government would be unable to borrow at affordable interest rates.
Second, debt would be even larger if current laws were modified to delay or undo certain scheduled changes in policy. For example, if lawmakers eliminated the automatic spending cuts scheduled to take effect in March (but left in place the original caps on discretionary funding); prevented the sharp reduction in Medicare’s payment rates for physicians scheduled for next January; and extended the tax provisions that are scheduled to expire—and made no other changes to spending or taxes with offsetting budget effects—then budget deficits would be substantially larger than in our baseline projections, and debt held by the public would rise to 87 percent of GDP by 2023 rather than the 77 percent under current law.
Third, debt might also be larger than in our projections because even the original caps on discretionary funding set by the Budget Control Act would reduce such spending to just 5.8 percent of GDP in 2023—a smaller share than for any year in at least the past fifty. Because the allocation of discretionary funding is determined by annual appropriation acts, lawmakers have not yet decided which specific government services and benefits will be constrained to satisfy those caps—and doing so might be quite difficult.
Fourth, projections for the 10-year period covered in this report do not fully reflect long-term budget pressures. Because of the aging of the population and rising health care costs, a wide gap exists between the future cost of the benefits and services that people are accustomed to receiving from the federal government—especially in the form of benefits for older people—and the tax revenues that people have been sending to the government. It is possible to keep tax revenues at their historical average percentage of GDP—but only by making substantial cuts relative to current policies in the large benefit programs that aid a broad group of people at some point in their lives. Alternatively, it is possible to keep the policies for those large benefit programs unchanged—but only by raising taxes substantially for a broad segment of the population. Deciding now what combination of policy changes to make to resolve the budget imbalance would allow for gradual implementation, which would give households and businesses time to adjust their behavior.