CBO's Long-Term Budget Projections Show a Substantial Imbalance in the Federal Budget

July 17th, 2014
in econ_news, syndication

from the Congressional Budget Office

On Tuesday CBO released its latest report on the long-term budget outlook. (To get a quick overview of the report, check out The 2014 Long-Term Budget Outlook in 26 Slides.) In that report, we noted that although the gap between federal spending and revenues has narrowed recently, CBO’s long-term projections show a substantial imbalance in the federal budget, with revenues falling well short of spending if current laws stayed generally the same.

Follow up:

By 2039, total federal spending would be nearly 26 percent of gross domestic product (GDP) if current laws remained generally unchanged—compared with about 20 ½ percent this year and, on average, over the past 40 years (see the figure below). Revenues would also constitute a larger percentage of GDP in the future than they have, on average, over the past few decades—totaling about 19 ½ percent in 2039—but they would not keep pace with the growth in spending. As a result, the deficit in 2039 would be about 6 ½ percent of GDP, more than twice its average over the past four decades. In that same year, debt held by the public would exceed 100 percent of GDP, a level only seen once before in U.S. history (just after World War II).

Spending, Revenues, and Deficits Under CBO's Extended Baseline, Compared With Past Averages

What Is the Outlook for Spending Over the Next 25 Years?

Federal spending is projected to rise noticeably relative to the size of the economy because of growth in a few of the largest programs and escalating interest costs.

Spending for the Major Health Care Programs and Social Security

Mandatory programs have accounted for a rising share of the federal government’s noninterest spending (that is, spending excluding interest payments) over the past few decades, averaging 60 percent in recent years. (Funding for those programs is generally determined by rules for eligibility, benefit formulas, and other parameters rather than by appropriating specific amounts each year.) Most of the growth in mandatory spending has involved the three largest programs—Social Security, Medicare, and Medicaid. Federal outlays for those programs together made up more than 40 percent of the government’s noninterest spending, on average, during the past 10 years, compared with less than 30 percent four decades ago.

Most of the anticipated growth in spending (beside interest payments) as a share of GDP over the long term is expected to come from the government’s major health care programs: Medicare, Medicaid, the Children’s Health Insurance Program, and the subsidies for health insurance purchased through the exchanges created under the Affordable Care Act (ACA). CBO projects that, under current law, total outlays for those programs would grow much faster than the overall economy, increasing from just below 5 percent of GDP now to 8 percent in 2039 (net of Medicare premiums and certain other offsetting receipts). Spending for Social Security also would increase relative to the size of the economy, but by much less—from almost 5 percent of GDP in 2014 to more than 6 percent in 2039 and beyond.

Those projected increases in spending for Social Security and the government’s major health care programs are attributable primarily to three causes: the aging of the population, rising health care spending per beneficiary, and the ACA’s expansion of federal subsidies for health insurance. Tomorrow’s blog post will go into greater detail about those factors.

Other Spending (Excluding Interest Payments)

In CBO’s projections, which generally reflect current law, total federal spending for everything other than the major health care programs, Social Security, and net interest declines to a smaller percentage of GDP than has been the case for more than 70 years. Such spending has been more than 8 percent of GDP each year since the late 1930s, including about 12 percent of GDP in 1974 and about 10 percent in 1994; CBO estimates that it will be about 9 percent of GDP in 2014. Under the assumptions used for this analysis, that spending is projected to fall below 8 percent of GDP in 2020 and then to decline further, dropping to about 7 percent of GDP in 2039.

Spending for discretionary programs (which are funded annually in appropriation acts) is projected to decline significantly over the next 10 years relative to GDP—from roughly 7 percent to roughly 5 percent—because of the constraints on discretionary funding imposed by the Budget Control Act. For its long-term projections, CBO assumed that discretionary outlays would remain at their 2024 share of GDP.

Spending for mandatory programs other than the major health care programs and Social Security also is projected to decline relative to the size of the economy during the next 10 years. That spending accounts for about 2½ percent of GDP today and, under current law, is projected to fall to about 2 percent of GDP in 2024. That decline would occur in part because the improving economy would reduce the number of people eligible for some programs in this category (for example, the Supplemental Nutrition Assistance Program and unemployment compensation) and in part because payments per beneficiary under some programs tend to rise with prices (which usually increase more slowly than GDP). By 2039, CBO projects other mandatory spending would fall to less than 2 percent of GDP—lower than at any point at least since 1962 (the first year for which comparable data are available).

Interest Payments

CBO expects interest rates to rebound in coming years from their current unusually low levels. As a result, the government’s net interest costs are projected to more than double relative to the size of the economy over the next decade—from 1¼ percent of GDP in 2014 to more than 3 percent by 2024—even though, under current law, federal debt would be only slightly larger relative to GDP at the end of that decade than it is today.

Beyond 2024, interest rates are assumed to remain close to their projected levels in 2024, so net interest payments would change roughly in line with changes to the amount of federal debt held by the public. By 2039, interest payments would reach nearly 5 percent of GDP under current law. The growth in net interest payments and debt is mutually reinforcing: Rising interest payments push up deficits and debt, and rising debt pushes up interest payments.

What Is the Outlook for Revenues Over the Next 25 Years?

Over the past 40 years, federal revenues have fluctuated between 14½ percent and 20 percent of GDP, averaging 17½ percent, with no evident trend over time. After amounting to nearly 18 percent of GDP in 2007, federal revenues fell sharply in 2009, to 14½ percent of GDP, primarily because of the recession. With an improving economy and changes in certain tax rules that have resulted in higher tax rates, revenues have rebounded to 17½ percent of GDP in 2014, CBO estimates.

Individual income taxes account for the bulk of federal revenues—almost half of all revenues in 2013—payroll taxes (also known as social insurance taxes) account for about one-third of all revenues, and corporate income taxes and excise taxes account for most of the remainder.

CBO projects that, under current law, revenues would grow slightly faster than the economy over the coming decade, reaching a little more than 18 percent of GDP by 2024. Individual income taxes would rise as a percentage of GDP because of structural features of the individual income tax system and the continued economic recovery. That increase would be partially offset by declines in other taxes relative to GDP, most notably receipts from the Federal Reserve and corporate income taxes.

Over the long run, revenues would keep growing slightly more rapidly than GDP under current law. In particular, with rising real income, a greater proportion of income would be taxed in higher income tax brackets because tax brackets are indexed for inflation but not for growth in real income. By 2039, total revenues would be 19½ percent of GDP, CBO projects. Increases in receipts from individual income taxes account for more than the 2 percentage-point rise in total revenues as a percentage of GDP over the next 25 years; receipts from all other sources, taken together, are projected to decline slightly as a percentage of GDP.

Even if no changes in tax law were enacted in the future, the effects of the tax system in 2039 would differ in significant ways from what those effects are today. Average taxpayers at all income levels would pay a greater share of income in taxes than similar taxpayers do now, primarily because a greater share of their income would be taxed in higher tax brackets. Moreover, the effective marginal tax rate on labor income (the percentage of an additional dollar of labor income paid in federal taxes) would be about 34 percent, compared with the current 29 percent, and the effective marginal tax rate on capital income (the percentage of an additional dollar of income from investments paid in federal taxes) would be about 19 percent, compared with about 18 percent today.

Julie Topoleski is an analyst in CBO’s Health, Retirement, and Long-Term Analysis Division. Joshua Shakin is an analyst in CBO’s Tax Analysis Division.

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