CBO:  Faster Real GDP Growth, Lower Revenues, Higher Deficits and Interest Costs Ahead 
Jeff Lemieux
Preliminary January 26, 2004

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The Congressional Budget Office (CBO) now projects the federal deficit will be $477 billion in 2004, about 4.2 percent of GDP.  CBO revised its economic projections higher for 2004 and 2005, but lowered its projections of federal revenues throughout the 10-year budgeting period. 

CBO now forecasts real GDP growth of 4.8 percent in 2004, up from the prior projection of 3.8 percent.  (CBO also raised its forecast of GDP growth in 2005 by a similar amount.)   However, revenues have been revised lower by $790 billion over the next 10 years.  In 2004, federal taxes will be 15.8 percent of GDP, the lowest figure since the 1950s.  Overall, CBO's new projections show a $1 trillion increase in deficits over the next 10 years, and a rapid increase in federal interest payments needed to service the national debt.

CBO's new projections will be the talk of Capitol Hill over the next several days, as members of Congress and their staffs study the numbers and work out various interpretations.

Here is a preliminary analysis:

1.  Discretionary spending continues to surge.  CBO projects that discretionary spending (that is, outlays for defense and domestic programs for which Congress annually appropriates funds) will rise by 8.6 percent in 2004, after increases of 12.4 percent in 2003 and 13.1 percent in 2001.

Figure 1 shows the basic trends in discretionary spending since 1990.  After staying roughly flat in current dollars from 1991 through 1998, spending started growing in 1999 and began to surge in 2000.  In five years, discretionary spending increased by $324 billion, from $572 billion in 1999 to $896 billion in 2004.  (By contrast, discretionary spending grew by $31 billion -- less than a tenth as much -- during the previous five years.)

Figure 1.


Figure 2 shows the growth rates of discretionary spending since 2000 broken down into defense and non-defense categories.  (The non-defense category includes a significant amount of spending designated for homeland security.)

Although defense spending surged after September 11, 2001, it had been growing faster than GDP even prior to that time.  Growth in non-defense spending has also exceeded nominal GDP growth throughout this period.

Figure 2.

Growth in Discretionary Outlays (percent)
	2000	2001	2002	2003	2004
Defense	7.1	3.8	14.0	16.0	11.5
Non-Defense	7.0	7.3	12.3	9.3	5.8
Total	7.5	5.6	13.1	12.4	8.6
Memo:
Nominal GDP	6.4	3.4	3.3	4.4	5.9
Source: Congressional Budget Office.

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2.  Interest costs are down, but not for long.  Interest spending actually fell in 2003, even though the national debt soared (see Figure 3, below).  The federal deficit in 2003 was $375 billion, and the debt increased from $3.5 trillion in 2002 to $3.9 trillion last year.  CBO projects the debt will grow to over $6 trillion by 2010; using more conservative assumptions, Centrists.Org projects the debt level will approach $8 trillion by that time.

Ultra-low interest rates allowed federal interest payments to drop from $171 billion in 2002 to $153 billion in 2003.

However, interest rates won't keep falling forever, and the Treasury won't be able to refinance old debts at favorable rates.  As it is, short-term interest rates are about 1 percent, nearly as low as they can go (see Figure 4, below).

CBO projects that interest costs will more than double to $316 billion by 2010.  Centrists.Org, assuming that tax cuts don't expire on their sunset dates, and that discretionary spending rises at the same rate as GDP, estimates that by 2010 interest costs will grow to $380 billion (see Figure 5).


Figure 3.




Figure 4. 



Figure 5. 

Interest Costs (billions)
	CBO	Centrists.Org
2000	223	223
2001	206	206
2002	171	171
2003	153	153
2004	156	156
2005	180	181
2006	219	227
2007	255	273
2008	281	311
2009	300	346
2010	316	380
Sources, Congressional Budget Office, Centrists.Org (Jan. 26, 2004)
Note: Centrists.Org (like most outside forecasters) assumes
tax cuts do not expire on "sunset dates, and discretionary
spending grows faster than inflation.

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3.  Deficits are worsening (at least by CBO's measure).  By statute, CBO has to assume that discretionary spending grows slowly, that tax cuts expire on their sunset dates, and that current law is unchanged.  Therefore, CBO's January 2004 baseline recognized the cost of the Medicare drug benefit for the first time (the law was enacted in December 2003, after CBO's most recent projections from last August).

The easiest way to interpret changes in CBO's projections is to compare them with previous forecasts.  Figure 6 breaks down the main changes in CBO's projections since last August, based on the reason for the change:  legislation, economic assumptions, or technical.  That is, did the revision result from a change in the law, a change in the economic projections, or just a modeling or technical improvement to the projections?

CBO's deficit projections worsened by almost $1 trillion over the ten-year budget period from 2004-2013.  Legislative changes led to much higher entitlement spending (mostly the Medicare drug benefit), and discretionary spending (exclusively in the non-defense category.) 

CBO estimates the extra debt service payments resulting from legislative changes would total $115 billion over the decade.

However, changes to the economic assumptions reduced both revenues and outlays.  This was mostly due to a lowered forecast of the inflation rate.  It is notable that CBO expects the economic changes to reduce revenues more than outlays.  Therefore, the economic changes increased CBO's deficit projection by $171 billion in net.  Finally, CBO revenue estimators made some modeling improvements that reduced revenues by about $130 billion over this period.  (The technical changes to the outlay projections were a wash, with reductions in entitlements offset by increases in interest payments.)


Figure 6. 

Changes to CBO's Baseline since August 2003 (billions)
(2004-2013)
		Legislative	Economic	Technical	Total
Revenues		0	-659	-130	-790
Outlays
Discretionary		124	-144	3	-17
Entitlements		442	-257	-28	157
Interest		115	-87	29	57
Total, Outlays		681	-488	4	197
Deficit		681	171	134	986

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4.  The biggest question mark on the economy is jobs.  Although the data on the number of payroll jobs will probably be revised upward, for now the employment picture looks bleak (see Figure 7).  If CBO is right that real economic growth will be almost 5 percent in 2004 and over 4 percent in 2005, then job growth would be almost certain to follow.  (There is little chance productivity could be improved fast enough to support that rate of growth without additional employment.)

Figure 7.



5.  The biggest question mark on the budget is that some conservatives are starting to talk like conservatives again.  One of the most heartening signs for deficit hawks is that some conservative think tanks and members of Congress are starting to challenge the orthodoxy of the more virulent anti-tax groups (who assume deficits are good for their cause, despite their negative impact on the U.S. economy and global position).

If the conservatives become interested in deficit and debt reduction again -- as they did so emphatically in the mid-1990s -- there is a chance spending trends will be reduced.  It seems less likely that taxes will be raised soon, but perhaps conservatives in Congress will help push through tax reforms that close loopholes and improve tax collections.  Either way, revenues would begin to rise as a percent of GDP and the budgetary situation would be improved.

Links:
Centrists.Org No-BS Long-Term Budget Baseline (Jan. 2004) 

Congressional Budget Office The Budget and Economic Outlook, Fiscal Years 2005-20114  (January 2004)

 

Centrist Policy Network Some Bigger Ideas for the Presidential Race (January 26, 2004)

Centrists.Org A Closer Look at the Latest Jobs Figures -- Plenty of Stimulus, a Scarcity of Confidence (January 11, 2004)

Centrists.Org Preparing for CBO's Updated Baseline Projections and the President's New Budget
(January 10, 2004)

Centrists.Org Commentary:  CBO's New Long-Term Budget Projections (December 22, 2003)

Centrists.Org The Fourth Entitlement:  Interest (December 1, 2003)

Centrists.Org No-BS Long-Term Baseline Homepage