In the Nation's Interest

The Latest CBO Budget Outlook: Why No News is Bad News for America’s Debt Problem

This week the Congressional Budget Office (CBO) released their updated outlook for the federal budget.  As always, their forecast for the paths of federal revenue and spending are based on current law stretching over the next ten years. Every time the CBO updates their outlook for the economy, there are corresponding effects on the federal budget outlook, even if hardly anything has changed with regard to legislated tax and spending policies (which in fact hardly anything has).  These are the “economic factors” that lead to changes in projected revenues and spending. Since CBO’s last budget outlook report in January 2016, however, not a lot has changed in the economic outlook.  The most significant changes were downward revisions to Gross Domestic Product (GDP) (by 2026 potential and actual real GDP are 1.6 percent lower than previously projected) and to interest rates (by 2026 short-term and long-term rates are 0.4 and 0.5 percentage points lower, respectively). These may be decent-sized revisions individually, but they largely offset each other in terms of the effect on the deficit, so that the net updates to the projections of deficits and debt were small.

In a “big picture” sense, then, it turns out that very little has changed in CBO’s budget outlook—looking ahead over the next ten years—since their January report.  The longer-term “big picture” shown above shows the paths of federal revenues and spending (“outlays”), and separates the past (to the left of the vertical dotted line) from the 10-year budget outlook (to the right). From this we can see that since 1966 there have been periodic episodes of “big news” (or turning points) on the federal budget. The most recent ones are:

  • Early 1990s to 2001, when large deficits turned to surpluses
  • First half of the 2000s decade, when surpluses went back to deficits
  • 2008-11, when deficits exploded in midst and immediate aftermath of the “Great Recession”
  • 2012-15, when deficits started coming down to more “normal” levels as the economy slowly got back to “normal”

Looking ahead to the next ten years, however, the revenue or spending lines have barely changed since CBO’s projections as of January 2016: they are on their “same old, same old” trajectories. Yet these “same old” trends are still important to understand:

  1. Revenues grow steadily with the economy. In CBO’s outlook, revenues rise from 17.8 percent of GDP in 2016 to 18.5 percent of GDP in 2026—an increase of 0.7 percentage points. Federal revenues as a share of our economy naturally grow as real incomes rise, because our current income tax system is “progressive” and taxes higher incomes at higher marginal rates. Note that if we just left the federal income tax system on “auto pilot” and made no legislative changes to tax laws, revenues—even as a share of GDP—would continuously rise as the economy grows.
     
  2. But spending grows faster. Total federal spending rises from 21.1 percent of GDP in 2016 to 23.1 percent of GDP in 2026—an increase of 2.0 percentage points. This is a far larger increase than the growth in revenues. What drives this increase is the trend in mandatory spending (including Social Security and Medicare, the retirement-age benefit programs), which grows by 1.9 percentage points of GDP, and net interest, which rises by 1.2 percentage points of GDP. Discretionary spending as a share of GDP actually falls over the ten-year window, from 6.4 percent to 5.3 percent. The story about mandatory spending has been foretold for decades, but we are now in the thick of it. Part 1 of that story is the “demographic” chapter: it’s the aging of the population and particularly the Baby Boomers—who have been quickly filling in the ranks of the retired—coupled with the relatively smaller numbers of younger people to “replace” them in the (tax-paying) workforce. Part 2 of the story is the “health care costs” chapter: the cost of providing health care to each one of us is rising faster than the economy is growing. The story about net interest is really a coda to the story about the debt and interest rates, below.
     
  3. Debt grows faster than the economy. The annual budget deficit (the difference between spending and revenues) has declined, thankfully, to a more manageable level of just over 3 percent of GDP. (This compares to 8 to 10 percent over 2009-11). The 3-percent-of-GDP deficit level is often used as a “rule of thumb” for what is considered an economically “sustainable” deficit, because as long as the economy grows at least as fast as the debt is growing, the economy would be able to “keep up” with the debt. Economists have often remarked that because a 3 percent economic growth rate is fairly “average,” then a 3-percent-of-GDP deficit is approximately sustainable. But technically, for the debt-to-GDP to be stable or declining, GDP needs to grow faster than the deficit is adding to the debt: deficit/debt = (deficit/GDP)/(debt/GDP). That ratio is now over 4 percent (3.2/76.6) based on CBO’s numbers for 2016. CBO’s economic forecast shows that projected economic growth will be right on the knife’s edge of this contest in the early part of the current ten-year budget window, with nominal GDP growing in the high 3’s to low 4’s range. That causes debt-to-GDP to remain fairly stable and even drop a bit in 2018. But later in the ten-year window the deficit rises into the 4+ percent of GDP range, and the economy can no longer achieve the required 5+ percent growth rate to keep pace with the debt. Debt-to-GDP thus rises from below 77 percent today to 85.5 percent by 2026. Take these calculations still further out, and you get to CBO’s long-term budget outlook that shows a debt-to-GDP ratio of 141 percent by 2046. This is what “unsustainable” looks like; under current law at least, our economic capacity can’t keep up with the debt, and a larger and larger share of our resources has to go toward not just those growing retirement-age programs, but the costs of servicing the growing debt—i.e., interest.
     
  4. And interest grows fastest of all. Net interest is a direct cost of servicing the debt. (An indirect but large cost comes from interest and principal payments on the debt squeezing out essential government spending—the activities and services of the government that provide real benefits to people.) Even with today’s very low interest rates, and even with CBO’s revised forecast that has interest rates rising less than in their previous forecast, CBO says net interest as a share of GDP will double from last year’s 1.3 percent, to 2.6 percent by 2026. (By 2046, CBO’s long-term outlook shows net interest will more than double again, to 5.8 percent of GDP.) This makes net interest the single fastest growing category of federal spending in percentage terms; even the major health care programs, which make up a much larger share of federal spending, grow “only” by 22 percent over the budget window.

None of these key takeaways from the new CBO report are really “new news.” These budget trends have been built into our major tax and spending policies for many, many years. Economists have been predicting these trends for many, many years as well. Their projections tend to barely change from report to report unless there are major changes to the economic outlook. Policies do not impact the projections in these CBO reports unless there are actual fundamental reforms to these major tax and spending programs—which of course we have not seen for many, many years now. The lack of really new news in this report is bad news, precisely because it shows how little progress has been made to proactively (rather than accidentally) get the federal budget on a better track.