The Long-Term Budget Outlook Under Alternative Scenarios for the Economy and the Budget

The Congressional Budget Office projects that if current laws governing revenues and spending generally remained unchanged, the federal budget deficit would increase significantly in relation to gross domestic product (GDP) over the next 30 years, driving up federal debt.1 Debt held by the public would soar from 99 percent of GDP in 2024 to 166 percent of GDP in 2054—exceeding any previously recorded level and on track to increase further. Those projections are not predictions of budgetary outcomes; rather, they give lawmakers a benchmark for measuring the effects of policy options or proposed legislation.

Economic conditions that differ from those that CBO projects and fiscal policy that differs from current law could yield noticeably different results. To show how changes in economic conditions or in fiscal policy might affect budgetary and economic outcomes, CBO analyzed eight scenarios that differ from those underlying the agency’s extended baseline—six that vary economic conditions and two that vary budgetary conditions.

• If the productivity of labor and capital in the nonfarm business sector grew 0.5 percentage points per year more quickly or more slowly than CBO projects, federal debt held by the public in 2054 would be 124 percent of GDP or 211 percent of GDP, respectively.
• If the average interest rate on federal debt was higher or lower than the baseline projection by an amount that started at 5 basis points in 2024 and changed by that amount in each year thereafter, federal debt held by the public in 2054 would be 217 percent of GDP or 129 percent of GDP, respectively. (A basis point is one-hundredth of a percentage point.)
• If government borrowing reduced private investment by twice as much as it does in CBO’s long-term projections or had no effect on that investment, federal debt held by the public in 2054 would exceed 250 percent of GDP or would be 130 percent of GDP, respectively.
• If, between 2024 and 2054, discretionary spending and revenues equaled their 30-year historical averages measured as a percentage of GDP, federal debt held by the public in 2054 would exceed 250 percent of GDP.2 Under that scenario, discretionary spending is set to 7.0 percent of GDP and revenues are set to 17.2 percent of GDP in every year—1.9 percentage points more and 1.0 percentage point less, respectively, than they average in CBO’s projections.
• If, between 2024 and 2054, fiscal policy was set to maintain federal debt held by the public at 99 percent of GDP (its level in fiscal year 2024), primary deficits (which exclude net outlays for interest) would average 0.4 percent of GDP over that period. Under that scenario, primary deficits are reduced each year by decreasing noninterest spending or increasing revenues relative to CBO’s extended baseline by an average of 1.9 percent of GDP. (Primary deficits could also be reduced through a combination of changes to spending and revenues that would have an equivalent effect.)

In this analysis, CBO reports specific economic or budgetary outcomes only for scenarios in which debt is less than 250 percent of GDP. That approach is not an indication that the agency considers that level of debt to be a fiscal tipping point. (CBO cannot predict with any confidence whether or when abrupt macroeconomic changes or sudden shifts in financial markets might occur in response to the amount and trajectory of federal debt.) Rather, assessing the economic effects of debt that exceeds 250 percent of GDP would require CBO to reevaluate the economic relationships in its current models.3 The agency’s long-term budget and economic projections are subject to significant uncertainty, and that uncertainty increases as projected debt expands far beyond historical experience, in part because of the potential economic effects of debt in that case.

Projecting Different Economic Conditions

CBO’s long-term budget projections depend on its forecasts of economic factors, including productivity growth and interest rates, and on the sensitivity of private investment to budget deficits. If economic conditions differed from those in CBO’s forecast, budgetary outcomes would diverge from those in the agency’s extended baseline.

To illustrate the effects of such differences on federal debt, CBO analyzed how its budget and economic projections would change if productivity growth, interest rates, or private investment’s sensitivity to deficits were higher or lower than they are in the agency’s extended baseline (see Figure 1).

To illustrate the effects of those differences on the economy, CBO focused on gross national product (GNP) rather than on the more commonly cited GDP (see Figure 2). GNP includes income that U.S. residents earn abroad and excludes income that foreigners earn from domestic sources; thus, GNP per person is a better measure than GDP per person of the resources available to U.S. households.4

Faster or Slower Growth of Total Factor Productivity

The growth of total factor productivity (TFP)—the average real output (that is, output adjusted to remove the effects of inflation) per unit of combined labor and capital services in the nonfarm business sector—is a key contributor to the growth of GDP. As such, it directly affects budget deficits and federal debt measured as a percentage of GDP. Furthermore, GDP growth affects the growth of income earned by workers and owners of capital. Because that income determines both tax revenues and spending on some mandatory programs that are linked to wage growth, the growth rate of TFP indirectly affects budget deficits and federal debt.5 For those reasons, CBO examined the effects of changes in the annual growth rate of TFP on its projections of federal debt measured as a percentage of GDP.

The agency projected budgetary and economic outcomes using rates of growth for TFP in the nonfarm business sector that are 0.5 percentage points per year higher and lower than the rates underlying its extended baseline projections. (In those projections, TFP grows at an average annual rate of 1.1 percent over the next 30 years.) After accounting for the effects of the alternative growth rates of TFP on capital and other macroeconomic factors, CBO projected the following:

• If TFP in the nonfarm business sector grew 0.5 percentage points more quickly than CBO projects in each year, federal debt held by the public would be 124 percent of GDP in 2054 instead of the 166 percent it amounts to in the extended baseline. The average interest rate on federal debt in 2054 would be 4.5 percent—0.5 percentage points higher than the rate in the agency’s baseline forecast. Real GNP per person would be 17 percent (or $20,800, in 2024 dollars) higher in that year than it is in CBO’s extended baseline.
• If TFP in the nonfarm business sector grew 0.5 percentage points more slowly than projected in each year, then federal debt held by the public would be 211 percent of GDP in 2054. The average interest rate on federal debt in 2054 would be 3.5 percent—0.5 percentage points lower than the rate in the agency’s baseline forecast. Real GNP per person would be 14 percent (or $17,400) lower in that year than it is in CBO’s extended baseline.

The budgetary effects of faster or slower TFP growth are highly uncertain. That is because of uncertainty in the responses of economic variables to changes in TFP growth and in how those responses would affect spending and revenues.

Higher or Lower Interest Rates on Federal Debt Held by the Public

CBO also projected budgetary and economic outcomes under two scenarios in which interest rates on federal debt are higher or lower than the rates underlying the agency’s extended baseline. For the first scenario, CBO boosted the average interest rate on federal debt above the baseline rate by an amount that starts at 5 basis points in 2024 and increases by that amount in each year thereafter (before incorporating macroeconomic effects, which are described below).6 For the second scenario, the average interest rate on federal borrowing was set below the baseline rate by those same amounts each year.

• Under the scenario with higher interest rates, federal debt held by the public would reach 217 percent of GDP in 2054 instead of the 166 percent of GDP it equals in the extended baseline. Real GNP per person would be 3 percent (or $3,900) lower in that year than it is in CBO’s extended baseline.
• Under the scenario with lower interest rates, federal debt held by the public would be 129 percent of GDP in 2054. Real GNP per person would be 2 percent (or $3,000) higher in that year than it is in the extended baseline.

The boost to interest rates under the first scenario increases projections of the government’s interest costs and thus deficits. Larger deficits—and the increased federal borrowing required to finance them—reduce the amount of resources available for private investment.7 The decrease in private investment reduces the amount of capital and increases the return on investment because more workers make use of each unit of capital. When the return on capital grows, interest rates—including the rates that the federal government pays on debt held by the public—rise further. Thus, macroeconomic effects push interest rates above the initial boost that was built into the scenario.

Under the scenario with higher interest rates, the average interest rate on federal debt is 5.8 percent in 2054, instead of the 4.0 percent that year in the extended baseline. Of the 1.8 percentage-point difference between the rates in 2054, about three-tenths (0.3) of a percentage point results from macroeconomic effects (larger deficits, less investment and capital, and additional increases in interest rates) rather than from the initial boost to interest rates.

The lower interest rates under the second scenario result in smaller interest payments and smaller deficits than those in CBO’s extended baseline. Those smaller deficits spur private investment, increasing the amount of capital per worker and decreasing the return on capital—and, ultimately, interest rates. The average interest rate on federal debt declines to 2.2 percent in 2054 under that scenario. That rate is 1.8 percentage points lower than it is in that year in the extended baseline. Of that 1.8 percentage-point difference, about 0.2 percentage points results from macroeconomic effects.

The budgetary and economic effects of higher or lower interest rates are uncertain because they depend on the amount of debt accrued at those rates and on the macroeconomic effects of the rates. Furthermore, any particular effects (in relation to CBO’s baseline projections) would depend on the circumstances that caused interest rates to change. For simplicity—and to avoid presuming which circumstances caused interest rates to change—CBO’s analysis does not account for those particular effects on the economy or the budget.

Greater or Lesser Sensitivity of Private Investment to Deficits

When the federal government borrows money in financial markets, it decreases the amount of resources available for private investment. In CBO’s assessment, every additional dollar of deficit-financed spending reduces private investment by 33 cents.8 The decline in private investment reduces the stock of private capital and economic output over time.

CBO examined two cases in which the sensitivity of private investment to deficits differs from that in the agency’s extended baseline:

• First, CBO examined the economic and budgetary outcomes that would occur if government borrowing had twice the effect on private investment as it does in CBO’s long-term projections. In the case of greater sensitivity to deficits, every dollar of change in the deficit would reduce private investment by 66 cents. Under that scenario, federal debt held by the public would exceed 250 percent of GDP beginning in 2051.
• Second, CBO examined outcomes under a scenario in which government borrowing had no effect on private investment. Under that scenario, federal debt held by the public would be 130 percent of GDP in 2054 instead of the 166 percent it amounts to in the extended baseline.

Those different degrees of sensitivity have economic and budgetary implications because they alter the relationship between private investment and government borrowing. Under the first scenario, in which debt held by the public exceeds 250 percent of GDP beginning in 2051, private investment would be smaller than projected in CBO’s extended baseline. The reduction in private investment would, over time, lower the stock of private capital and reduce output. Lower economic output would reduce federal revenues and lead to even larger deficits as the effect on private investment compounded. Reductions in private investment would also decrease the amount of capital used by each worker, thereby increasing the return on capital and the return on investments (including government bonds).

In CBO’s assessment, that greater sensitivity of private investment to deficits would increase the average interest rate on federal debt in 2051 by 2.0 percentage points in relation to the agency’s extended baseline. Real GNP per person would be 18 percent (or $21,300) lower in that year than it is in CBO’s extended baseline.

Under the second scenario, private investment would be larger than projected in CBO’s extended baseline. The increase in private investment would, over time, boost the stock of private capital and output. It would also increase the amount of capital used by each worker, thereby reducing the return on capital and the return on investments (including government bonds). In CBO’s assessment, the reduced sensitivity of private investment to deficits would lower the average interest rate on federal debt by 0.7 percentage points in 2054 in relation to the agency’s extended baseline. Real GNP per person under that scenario would be 7 percent (or $8,700) higher in that year than it is in CBO’s extended baseline.

Projecting Different Budgetary Conditions

In CBO’s extended baseline, current laws governing taxes and spending generally remain unchanged. Fiscal policy that differed from current law could yield noticeably different budgetary outcomes.9

To illustrate the effects of differences in fiscal policy on federal debt, CBO analyzed how its budget and economic projections would differ under two scenarios. In the first scenario, discretionary spending and revenues each equal their average amounts, measured as a percentage of GDP, over the past 30 years. (In that scenario, discretionary spending would be larger and revenues would be smaller than they are in CBO’s extended baseline.)10 In the second scenario, from 2024 to 2054, the path of primary deficits ensures that federal debt held by the public remains at 99 percent of GDP throughout the projection period—its level in fiscal year 2024.

Keeping Discretionary Spending and Revenues at Their Historical Averages

Under this scenario, discretionary outlays are set to 7.0 percent of GDP, an amount that exceeds the amount in the extended baseline by an average of 1.9 percentage points between 2024 and 2054. Discretionary spending (measured as a percentage of GDP) under this scenario exceeds such spending in the extended baseline by 0.8 percentage points in 2024; that difference increases to 2.1 percentage points in 2054.11

Also under this scenario, revenues are set to 17.2 percent of GDP, an amount that is less than the amount in the extended baseline by an average of 1.0 percentage point between 2024 and 2054.12 Measured as a percentage of GDP, revenues under this scenario are lower than they are in the extended baseline by 0.3 percentage points in 2024 and by 1.6 percentage points in 2054.13

Outcomes Under the Scenario. Under the historical-average scenario, debt held by the public would amount to 244 percent of GDP in 2049 (92 percentage points larger than in the agency’s extended baseline projections for that year) and would exceed 250 percent of GDP beginning in 2050 (see Figure 1). The primary deficit would be 4.0 percentage points larger in 2049 than it is in CBO’s extended baseline. Once the increasing costs of debt service were added, the total deficit in 2049 under this scenario would be 8.4 percentage points larger than (or roughly double) the baseline amount. In terms of output, under the historical-average scenario, real GNP per person would be 5 percent (or $6,200) lower in 2049 than it is in CBO’s extended baseline (see Figure 2).

How CBO Projected Those Outcomes. Fiscal policy underlying the historical-average scenario would differ significantly from current law. For simplicity—and to avoid presuming which fiscal policies lawmakers might implement to alter the deficit—CBO analyzed the scenario without specifying the underlying policies affecting revenues and spending. Under the scenario, transfer payments to people are the same as they are under current law, and the effective marginal tax rates on labor and capital income decline proportionally for all households as revenues are reduced to meet the specified targets.

Those changes in fiscal policy would affect the economy in ways that would feed back into the budget. CBO has not analyzed every way in which that could occur. Instead, for the simplified analysis presented in this report, the agency accounted for these three effects:

• Effective marginal tax rates on income from labor would be lower under the historical-average scenario than they are in the extended baseline. Those lower rates would encourage people to work and save more and would thus increase output.14
• Effective marginal tax rates on income from most types of capital would also be lower under the historical-average scenario. Those lower rates would encourage saving and investment and would thus further boost output.15
• Federal debt would be larger under the historical-average scenario than it is in the extended baseline. The increase in federal borrowing would draw money away from investment in capital goods and services, thus reducing the stock of private capital and decreasing output.

Changes to fiscal policy also could alter incentives in other ways, possibly affecting the economy significantly in the long term. For example, changes to tax policy might affect businesses’ choices about how they were structured, and those choices might, in turn, alter the effective marginal tax rate on capital income. Similarly, changes in the tax treatment of mortgage debt would affect households’ decisions about how much to save.

Maintaining a Debt-to-GDP Ratio of 99 Percent After 2024

Under this scenario, primary deficits are reduced each year so that debt remains at 99 percent of GDP (its level in fiscal year 2024) throughout the projection period. Primary deficits could be reduced by decreasing noninterest spending or increasing revenues (or through a combination of such changes that would have an equivalent effect). Because CBO does not specify the changes to fiscal policy that would cause primary deficits to decrease, outcomes under this scenario do not include any effects on households’ incentives to work and save that could result from such policy changes. Since primary deficits fluctuate over time in CBO’s extended baseline, the size of the required changes to primary deficits varies in each year.

Outcomes Under the Scenario. Under the scenario with a constant debt-to-GDP ratio, primary deficits would average 0.4 percent of GDP from 2024 to 2054, falling from an average of 0.9 percent of GDP from 2024 to 2028 to 0.2 percent of GDP from 2050 to 2054 (see Figure 3). From 2024 to 2028, primary deficits would need to be cut by about 1.4 percent of GDP, on average. The amount of the reduction to primary deficits would increase later in the projection period, averaging 2.1 percent of GDP from 2050 to 2054.

If those changes were entirely attributable to increased revenues, total revenues would average 19.0 percent of GDP from 2024 to 2028 and 20.9 percent of GDP from 2050 to 2054, instead of the 17.6 percent and 18.7 percent, respectively, projected in the extended baseline. If the changes were attributable to decreased noninterest spending, such spending would average 18.4 percent of GDP from 2024 to 2028 and 18.9 percent of GDP from 2050 to 2054, instead of the 19.8 percent and 21.0 percent, respectively, projected in the baseline.

In terms of output, under the scenario with a constant debt-to-GDP ratio, real GNP per person would be 4 percent (or $5,500) higher in 2054 than it is in CBO’s extended baseline (see Figure 2).

How CBO Projected Those Outcomes. Fiscal policy underlying the scenario with a constant debt-to-GDP ratio would differ significantly from current law. As in the historical-average scenario, CBO analyzed this scenario without specifying the underlying policies affecting revenues and spending. The analysis also did not account for any changes in individuals’ or businesses’ incentives or activities that might result from changes to effective marginal tax rates. CBO did, however, account for the effect that reducing deficits would have on private investment.

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