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What a Potentially Sustainable Budget Outlook Looks Like

January 26th, 2010 . by economistmom

cbo-baseline-revs-and-outlays-jan2010

This is a chart from CBO’s new outlook report.  Note that deficits get down to the 2 1/2 to 3 percent of GDP range within five years.  Note that revenues rise and spending falls, but that revenues do most of the heavy lifting (5 percent of GDP out of the 7 percent of GDP reduction in the deficit).  Note that this assumes CBO’s “current law baseline” where tax cuts expire as written in current law.  Hold that thought.

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[**UPDATE 6 pm Tuesday:  Here's Concord's press release reacting to the CBO report.  More to say tomorrow, but here's the one-minute version:  to get to sustainability, within the first five years it's all about revenue policy and avoiding the deficit-financed extension of tax cuts, and beyond that (but still, ideally sooner rather than later), we'll have to figure out how to bend that darned health cost curve, because even with a reformed tax system, we won't be able to keep up with health spending on its current path.]

16 Responses to “What a Potentially Sustainable Budget Outlook Looks Like”

  1. comment number 1 by: SteveinCH

    Note that it also assumes domestic discretionary spending growing at inflation and not GDP or the historical average of nearly 8 percent. It further assumes no doc fix under Medicare. These two items taken together are nearly the size of the addressable portion of letting the Bush tax cuts expire, and in my view, more unlikely to happen.

    Furthermore, the underlying economic assumptions, per my point below are extremely unlikely as well. Sub 2% inflation, allowing for less growth in programs and lower interest rate forecasts is an extremely unlikely outcome.

    Finally, I’m quite surprised you describe the graph above as sustainable. If you run 3% deficits will full employment, low inflation, and strong GDP growth, in what world is that sustainable since it would represent the deficit as the most advantageous part of the cycle.

  2. comment number 2 by: SteveinCH

    One more thing, this chart provides nothing but ammunition to the people who are going to push on the spending side of the ledger. It basically says we’ll push receipts well above the historical average but run larger than average deficits because we’ve pushed spending even further above its historical average.

  3. comment number 3 by: economistmom

    Steve: but there’s nothing magical in those “historical averages.” What would it mean to try to keep mandatory spending–despite the demographic changes we’re confronting–at historical averages? And by the way, revenues/GDP in this CBO baseline (allowing all the tax cuts to expire as scheduled under current law, or be extended with offset) would bring us to a range entirely within the range that existed at the end of the Clinton Administration (1997-2001), when revenues were 19.2-20.6 percent of GDP. In my mind it is not at all an unreasonable level of revenues/GDP, especially in a growing (real) economy that can afford a larger government.

  4. comment number 4 by: AMTbuff

    The spending baseline and the revenue baseline are both wildly optimistic: Medicare cuts will not happen, and the current law revenue baseline is far to the left of even the Obama administration’s proposals to retain most Bush tax cuts and continue patching the AMT. As Steve says, the economic assumptions are also wildly optimistic in any scenario that has such high fiscal deficits.

    The saddest part is that even in CBO fantasy land the gap is huge, persistent, and growing. This will not end well.

    I’m beginning to agree with those who would prefer not to delay the inevitable. If the whole edifice of government debt and promises has to come crashing down, is it really better to keep adding weight to the structure? Or is it better to help it crash earlier or in a more orderly way?

    The real estate bubble would have caused a lot less damage if Greenspan had popped it back in 1995. As bad as the government bond market crash will be, and as painful as the spending cuts will be, it’s only going to be worse the more we postpone the day of reckoning.

  5. comment number 5 by: Brooks

    Diane,

    I assume CBO still keeps the same set of assumed GDP growth rates under all fiscal scenarios — Is that correct?

    If so, doesn’t that mean that, under a (larger) tax increase scenario they overstate revenues (by not factoring in negative revenue feedback effect) and overstates GDP (assuming higher taxation means lower GDP growth, ceteris paribus), thus understating the numerator (debt) and overstating the denominator (GDP) of debt/GDP — and thus understating debt/GDP — in that scenario?

    If so, do you have any suggestion as to how to roughly adjust projections?

  6. comment number 6 by: SteveinCH

    Diane,

    Your last comment may be the most revealing philosophical point, you say “…in a growing (real) economy that can afford a larger government.”

    I’ve spent most of my life in the private sector despite having a public policy education and in my world, a larger base results in costs going down as a percent of sales. To take that to government, a larger base (economy) should result in costs as a percentage of the base declining. Thus, to me, as GDP increases, spending as a percent of GDP should be declining. Thus, staying flat is actually an increase from what “should” be.

    Also, as I read the data, revenues increase to the top end of the Clinton range by 2019 and we still wind up with a deficit of 3% of GDP instead of a surplus as we had in the 90s, assuming of course that the spending baseline is remotely accurate when in fact it’s probably off by about a trillion dollars.

    As to the historical averages, my only point is that government should be striving not to expand but, as it lacks an incentive to do so, it doesn’t. As a consequence, people who argue for tax increases can never win my support until they agree to hold the line somewhere on spending. Said differently, if I waved a magic wand and said the Federal government can never raise more than 18% of GDP through cycle (some might say this is true), do you really believe spending would stabilize at 24%? I do not, it would stabilize somewhere lower because it would need to.

  7. comment number 7 by: economistmom

    Brooks: The CBO economic forecast is that which is consistent with their baseline budget forecast (and tax cuts expiring as scheduled). So, I think what you are suggesting is that we should not believe that the costs of deficit-financed extension of the tax cuts would be as high as what CBO’s Table 1-5 would suggest, because those costs don’t change the economics, and maybe the tax cuts would cause faster economic growth. I think that’s a tough call to make, and the safest (most prudent) assumption is that economic growth under “dynamic scoring” would not be any different from the “static” scoring–because some economists would say that deficit-financed tax cuts could in fact harm economic growth if the negative effects of lower national saving outweigh any positive effects of reduced marginal tax rates and improved economic incentives. And remember, not all tax cuts of the same cost have the same economic effect in the growth regard: many tax cuts do very little to reduce the distortionary effects of taxes on economic behavior–and some even increase those distortions (particularly expanded tax preferences that have no economic justification).

  8. comment number 8 by: Brooks

    Thanks Diane. I forgot to consider the possibility that the effect of higher interest rates due to larger deficits (”crowding out”) could completely offset the incremental incentive from lower taxes. Thanks for pointing that out. It would be helpful to have an estimate or range of estimates for net effect, but I see your point that we shouldn’t presume one way or another (or at least I shouldn’t, since I just don’t know).

    And I should also have mentioned the higher interest expense in the lower tax scenario.

  9. comment number 9 by: SteveinCH

    Just flipped through the “plausible baselines” historically only to note that 18 months ago it was a mere $7.8 trillion over 10 years instead of the $15 trillion it is now. Pretty shocking how quickly the situation has deteriorated.

    Diane, the only part of the release I really struggle with is the part about health care reform. Most people read those words and think about coverage and rules on insurance companies. The only health care reform that will bend the curve is the type that hurts rather than helps. The harm can be direct (rationing) or indirect (price controls leading to worse care and less innovation) but that’s the only kind that will address the fiscal situation. Relative to that bar, health care reform as we currently see it is a fiscal travesty.

    The private sector has already almost completely eliminated defined benefit pensions but that’s what Medicare is and that’s why expanding the number of people for whom the government is responsible is fiscally unwise and risky.

  10. comment number 10 by: SteveinCH

    Given his vote on the commission, a bit surprised to see this but there you have it.

    http://thehill.com/blogs/blog-briefing-room/news/78063-mccain-bayh-introduce-spending-freeze-package

  11. comment number 11 by: Brooks

    Steve,

    It’s not inconsistent with his (McCain’s) vote against the commission. This thing he’s supporting is only on the spending side.That’s exactly what he would like to fight against the primary threat from the right that J.D. Hayworth represents.

    Re: earmarks, small potatoes.

    Re: line item veto, last I checked (if memory serves) SCOTUS said it was unconstitutional.

    Seems to me that anything very substantial (vis a vis the size of our long-term fiscal imbalance) in terms of reductions in projected non-Defense spending (vs. post-stimulus levels) only has a chance of enactment if part of a package deal including tax increases, and once that’s added, it’s tough to pass due to opposition from the right, all leading us back to the need for the political cover (and P.R.) of a commission.

  12. comment number 12 by: Brooks

    I should add another thought regarding eliminating earmarks until some deficit (or debt/GDP) goal is met: If the idea is to take away from members of Congress (unless/until they get more fiscally responsible) something they use as lollipops to give out to constituents to get re-elected, perhaps it could help more than it would directly in terms of the dollar savings.

  13. comment number 13 by: SteveinCH

    Earmarks bother me on principle not as a matter of policy. There aren’t enough dollars there to make a difference. Still the whole situation is somewhat irksome.

  14. comment number 14 by: SteveinCH

    Diane,

    One more thing for Concord to think about. Why has the plausible baseline eroded so far in the last 18 months? It doesn’t appear to be the assumptions about taxes since they have been the same since 9/08.

    Undoubtedly some of it, maybe a lot, is the economic forecast but it would be interesting to see a sources of change analysis. If the picture has really gotten $7 trillion worse in 18 months, thinking about why that happened might be a good source of insight into potential solutions.

  15. comment number 15 by: economistmom

    Steve: two main factors for the huge deterioration in Concord’s “plausible baseline” in the past 18 months. #1 is the same reason for the deterioration in the CBO baseline over the past 18 months: the recession and its effect on the revenue baseline. Even without any legislated tax cuts, the projection of revenues over the ten-year window under current tax law declined by $3 trillion! This shows the revenue system is in crisis; we don’t just have the crises facing our federal retirement programs (Medicare and to lesser extent Social Security). #2 is a reason that affects the adjustment in getting from the current-law baseline to the current-policy, deficit-financed baseline that is Concord’s “plausible” one–which has increased over the past 18 months because of the accounting for the permanent cost of temporary tax cuts: (i) the Bush tax cuts expire at the end of 2010, and as we’ve gotten closer to that, the length of the budget window affected by the adjustment to the Concord baseline has gotten larger, and (ii) for the tax cuts that were enacted w/in the past 18 months as part of stimulus (as temporary), CBO calculates the permanent cost in their “policy alternatives not in the CBO baseline” table, and Concord includes the permanent, deficit-financed extension of these tax cuts in our plausible baseline.

  16. comment number 16 by: SteveinCH

    Thanks Diane, that makes a lot of sense