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CBO on the Fiscal Outlook: Doing Nothing Is Not an Option

June 29th, 2009 . by economistmom

steering-lever

Last Thursday the Congressional Budget Office released its analysis of the long-term budget outlook. (I think I got distracted for a few days by the news about Michael Jackson–a different “sustainability” problem…)  The basic shape and scope of the long-term fiscal challenge hasn’t changed since CBO’s last long-term report (a year and a half ago), and neither has the lesson for policymakers, as CBO director Doug Elmendorf explains on his blog (emphasis added):

Under current law, the federal budget is on an unsustainable path—meaning that federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the U.S. population will cause federal spending to increase rapidly under any plausible scenario. Unless tax revenues increase just as rapidly, the rise in spending will produce growing budget deficits and accumulating debt. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States.

Keeping deficits and debt from reaching levels that could cause substantial harm to the economy would require increasing revenues significantly as a percentage of gross domestic product (GDP), decreasing projected spending sharply, or some combination of the two. Making such changes sooner rather than later would lessen the risks that current fiscal policy poses to the economy.  Although the policy choices that will be necessary are difficult, CBO’s long-term budget projections make clear that doing nothing is not an option: Legislation must ultimately be adopted that raises revenue or reduces spending or both. Moreover, delaying action simply exacerbates the challenge

The message that we need to start to bring the spending and revenue lines closer together, and soon, isn’t new.  Neither are the implications from the numbers in the CBO analysis which show what might be considered feasible alternative policy paths to take going forward–where CBO compares the outlook under their “extended-baseline scenario” (basically policy as specified in current law) with that under their “alternative fiscal scenario” (basically extending “current practice” versus current law).  We know the greatest fiscal challenge is rising health care spending, and that the growth in that spending is due to two factors:  (i) the aging of the population–which we cannot do anything about (or at least should not try to!), and (ii) rising per-capita health care costs–which we hope to get a handle on, but frankly don’t exactly know how to do it nor how fast it will work.  But I’ve said many times before that tax policy is a much more reliable policy lever that we can do something about very soon, because the 2001 and 2003 tax cuts expire under current law at the end of 2010.  And CBO’s numbers corresponding to their two scenarios–one assuming the tax cuts expire and the other assuming they are extended without being paid for–show that the tax policy lever is a pretty large one at that:

  • Comparing the year 2080 spending and revenue levels under the extended-baseline scenario with those under the alternative fiscal scenario (see Table 1-2 on page 6), the difference between primary (non-interest) spending in the two scenarios is 2.7% of GDP, and most of this spending gap is due to non-health spending (accounting for 1.9% of GDP) rather than spending on Medicare and Medicaid (just 0.8% of GDP).  But the difference between revenues under the two scenarios is 4.0% of GDP, which means revenue policy accounts for about 60 percent (4.0/(2.7+4.0)) of the difference between the two scenarios when it comes to policy choices (leaving out the interest component).
  • Box 1-1 on page 7 shows that the 75-year fiscal gap under the extended-baseline scenario (where the tax cuts expire) is 3.2% of GDP, while the gap under the alternative fiscal scenario is 8.1% of GDP.  (Note that the 8.1% figure is consistent with the recent Auerbach and Gale analysis which found a gap of 7 to 9 percent–my blog post on that here.)  The difference in the 75-year fiscal gap under the two scenarios is 4.9% of GDP, while the difference in 75-year revenues is 2.8%, and the difference in 75-year outlays (including all spending on interest, even that associated with the tax cuts) is 2.1%.  So this calculation also shows that revenue policy is responsible for about 60 percent of the difference between the two scenarios, and that extension of the tax cuts basically doubles the fiscal gap. (60 percent of the 4.9% of GDP difference between the two scenarios is 2.9%, which is nearly as large as the 3.2% of GDP gap under the extended-baseline scenario.)
  • Although what we do about the 2001 and 2003 tax cuts makes a huge difference in terms of the fiscal gap, the CBO analysis also shows it’s not a huge difference in terms of the likely effect of that policy choice on economic incentives.  Page 11 of the report (and Table 5-2 on page 58) says that the effective marginal tax rate on labor income would be 35% if the tax cuts were allowed to expire as scheduled, versus 33% if they were extended. (The effective marginal tax rate on capital income would be just 19% even if the tax cuts expired, and under 17% if they were extended.)

I think policymakers should be paying attention to this CBO report and what it says about the policy levers available to us:  how can we reverse course quickly before we crash into that fiscal iceberg?  And with each possible turn of the steering wheel (pull of the levers), what are the costs versus the benefits?  Which levers will work the most reliably to improve the fiscal outlook, with the lowest economic cost?  It seems to me we are very focused and intent on grabbing a lever that is still pretty veiled and slippery right now–the one labeled “health care reform”–while totally ignoring the big sturdy lever labeled “Bush tax cuts.”

2 Responses to “CBO on the Fiscal Outlook: Doing Nothing Is Not an Option”

  1. comment number 1 by: Larry

    Isn’t the real issue the coming spending explosion, however we choose to pay for it? Not that I think accelerating debt isn’t something to worry about, but isn’t it likely that borrowing costs will explode at some point, causing the spending edifice to collapse? Didn’t we just see another Ponzi scheme implode recently?

  2. comment number 2 by: Rodger Malcolm Mitchell

    It widely is believed large federal deficits are unsustainable, cause negative economic effects and will be paid for by our grandchildren through higher taxes. I am looking for data to support these beliefs. If you have such data, please send it to me at rmmadvertising@yahoo.com. Thank you for your assistance.