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In the Nation's Interest

What You Need to Know: The New CBO Budget Outlook

Move along, folks.  There’s nothing to see here.

Truth be told, there is little or nothing new in CBO’s new annual Budget and Economic Outlook volume.

Last year, the “blockbuster” (after a fashion) news was an improvement in the outlook for healthcare spending.  That did not change the fundamental character of the outlook; the debt still exploded in the out-years.  But it did postpone the bang.  Perhaps some observers hope that last year’s good news will become a regular feature of the annual January Outlook volumes (and their August Update companions), and that the long-term budget problem would evanesce on its own.  That still could happen – conceivably – but not so far, and frankly, I’m not holding my breath.

The bottom line of the budget outlook is, of course, our debt burden.  That is best expressed as a percentage of the GDP – in other words, our debt as a percentage of the flow of income out of which we must service it.  So, following is a chart that shows the projection for the public debt as a percentage of the GDP as of last August’s Update, and in the new Outlook released yesterday.  See the difference?  Neither did we.

Measured in nominal dollars, the new projected deficits range from a low of $467 billion (in the budget year – the coming fiscal year, 2016) to a high of $1,088 billion (for 2025, the last fiscal year in the estimating window).  Looking at the year-by-year changes in estimates compared with the August Update, which ran through 2024, the revisions for each of the last six years (2019 through 2024) are in single-digit billions.  In other words, each year’s revision in the projected deficit is 1.4 percent or less.  Very small.

Furthermore, most of the change in the projected deficits – 52 percent of the $175 billion cumulative net change over the 10-year budget estimating horizon – comes from enacted legislation.  That legislation, of course, is a known factor, already baked in the cake, and highly unlikely to change in its influence.  If you are looking for something in those deficit revisions to portend a strong future trend – either way – you have to dig deep into a very shallow pile of tea leaves to find it.

CBO provides another perspective on where we stand in a reprise of a now-frequently-presented chart, shown below.  This chart shows the average levels of revenue and spending as percentages of the GDP over some historical period.  In this year’s volume, CBO extends this historical period to the last 50 years (they used to use 40).  The averages are 20.1 percent for outlays, and 17.4 percent for revenues – and so those of you with higher-order mathematical skills might infer that over the last 50 years the budget has been in deficit by on average 2.7 percent of GDP.  Superimposed on those averages are the actual levels of spending and revenues in each year.  And so it happens that for the just-completed fiscal year, 2014, revenues were 17.5 percent of GDP, and spending 20.3 percent – almost bang on the 50-year average.

Now, some folks are almost reflexively conditioned to conclude that if some indicator is close to its historical average, we are OK.  After all, we are still here; so how bad could the last 50 years of history have been?  You should not leap to any such conclusion.  Think of it this way:  Fifty years ago, at the end of fiscal year 1965, the debt held by the public was equal to 36.7 percent of the GDP, and it was falling like a stone.  Today, after the last 50 years of on-average history, the debt burden is more than twice that – 74.1 percent of GDP.  So the last 50 years of average is not good enough – not by a long shot.

If CBO’s projections hold true, the debt-to-GDP ratio will drop through 2018 – barely – to 73.3 percent.  Thereafter, it will begin to climb again.  By the end of the 10-year forecast horizon, the debt will be up to 78.7 percent of GDP – the highest since 1950, more than triple the post-World War II low of the mid 1970s, and higher than the 60-percent limit set in the Maastricht Treaty that established the now-much-troubled European Monetary Union.  (The budget deficit in nominal dollars will fall only through 2016, and will climb thereafter.)  In other words, we have a leaky roof, and a forecast of rain showers beginning in three years.  Will we fix the roof while the sun is still shining?

Admittedly, the forecast is far from a certainty.  The economy drives the budget – now, as much as at any time in history.  And having stepped through the looking glass of the financial crisis, we cannot be sure what the future holds.  To illustrate the uncertainty, consider another chart from the CBO Outlook.  CBO’s economic forecast is based on analysis suggesting that our economy has closed most of the shortfall relative to its potential output that yawned open in the financial crisis, and that this output gap will be essentially fully closed within months.  That is actually a rather sobering forecast; in other words, this is as good as it gets.  The recovery is over, and future growth will only equal on average – not exceed, as it does in the expansion phase of a business cycle – the long-term trend rate of increase of productive capacity.

Could we get a favorable surprise?  Well, yes.  We added to the CBO chart that shows the narrowing current output gap an additional line that shows what CBO thought potential output was back in 2007, before the financial crisis.  Clearly, those numbers were in another economic universe; by the end of 2017, potential output was estimated in 2007 to be 6.5 percent higher than it is estimated to be today.  If somehow the economy could regain that trend, there would be lots more output, lots more tax revenue, and a much lower budget deficit.

Now, the 2007 economy was in the late stages of an unsustainable housing bubble.  We would not want to go back to that level of production of residences without residents.  But with resources reallocated, we could in theory produce more of other goods and services instead to make up for a lesser level of housing construction.

Could it happen?  Yes.  Will it happen?  The best age-old advice is to hope for the best but plan for the worst.  Counting on a miracle is what got us into this budget mess in the first place.

The bottom line of the CBO report is an analog to a pennant race in baseball.  Your team lags several games behind.  You wake up one morning and check the papers to learn that your team won last night – but your rival team won, too.  So on net, there is one fewer game for your team to make up the same amount of ground.

The budget deficit is projected to fall in 2015, and again – by a smidge – in 2016.  But like your favorite baseball team in the story above, we are running out of time.  We don’t know for sure how much more time we have.  The rest of the world – Europe, Japan, and so on – may continue to perform even more poorly than we do, keeping our debt instruments the least bad alternative for investors.  But sooner or later on our current path, our debt will grow so large that those investors will doubt our ability or willingness to service our debts.  This CBO report is just one more milestone on that downhill road.