Where Will The Deficit Go From Here? New Long-Term Budget Projectionsrevised June 5, 2004
(a minor editorial correction). Originally published June 3, 2004.
It's June. The House and Senate have not agreed on a budget. Even if they do, it will probably hurt, not help, the federal deficit. Popular personal and business tax cuts are set to expire in December. Overseas military spending remains high. Domestic non-defense outlays have not been restrained (although talk of cuts is in the wind). Medicaid spending for the poor and elderly continues to pressure both federal and state budgets. Medicare spending is poised to soar with the introduction of a patchwork drug benefit that may require additional funds. And the huge baby boom generation will start to join the Social Security and Medicare rolls in just a few years.
Centrists.Org's projections attempt to depict a realistic budget trajectory, in light of these trends. We believe the annual federal deficit is poised to hover around $400 billion through 2007, between 3 and 4 percent of GDP. After that, the deficits grow as the first waves of baby boomers leave the workforce and join the entitlement rolls. Unless Congress reduces entitlement spending, raises taxes, or cuts discretionary (defense and domestic) spending, the budget deficit will become economically untenable by about 2020, with the national debt approaching 100 percent of GDP by 2025.
Outline:
Outlook for 2004
10-Year Baseline, 2005-2014
Does Congress "Get It" on Fiscal Discipline?
Tax Cuts, "Discretionary" Spending, and Medicare Payments
Long-Term Projections, 2015-2030
Medicare and Social Security
Taxation of Retirement Savings
Centrists.Org, No-BS Budget Baseline Tables:
Table 1. Federal Budget in Billions of Dollars, 2000-2030
Table 2. Federal Budget as a Percent of GDP, 2000-2030
Table 3. Summary Table, 2000-2030 in 10-Year Intervals
Outlook for 2004: Centrists.Org projects that the budget deficit will total about $440 billion in fiscal year 2004, about 4 percent of GDP. The deficit is now projected to be about $30 billion lower than the $471 billion estimate from January 2004.
However, the deficit for 2004 is still expected to be considerably worse than last year's $375 billion total (see Figure 1).
Figure 1.
In the short run, Centrists.Org projections follow very closely from the official baseline projections of the Congressional Budget Office (CBO). The reduced deficit forecast for 2004 reflects a rough read of income tax refunds contained in CBO's Monthly Budget Review for April.
On the surface, the CBO revenue baseline seems to be coming in right on track. However, reading the tea leaves of tax refunds, tax specialists at CBO implied they expect a small upward revision in tax revenues when the fiscal year is through.
However, even with the slight improvement, revenues are at the lowest point in decades relative to the size of the economy (see Figure 2).
Figure 2.
On the spending side, CBO's earlier estimates seem to be coming in about right, so no revisions to CBO's official March baseline for outlays were made.
Federal non-interest outlays have been growing faster than GDP since 2001 (see Figure 3). Much of the upward spike reflects post-September 11 military spending, but other federal expenditures have been rising rapidly as well.
Figure 3.
For example, non-defense, non-homeland security spending is projected to grow by almost 6 percent in 2004, and its average growth rate over the last five years has been almost 7 percent.
Again, some of that spending was related to September 11 relief. And some was due to unemployment benefits and other "automatic stabilizers" in the economy, where outlays are intended to rise when the economy is in recession.
However, a big part of the spending increase just reflects the "we can have it all" mentality in Congress. Beginning in about 1998, when the federal budget went into surplus, Congress started to relax fiscal discipline on the spending side of the budget.
This trend accelerated in 2001, when President Bush announced the prospect of huge surpluses and proposed very large tax cuts. If there was plenty of money for tax cuts, then surely there was plenty of room in the budget for new spending as well, legislators reasoned.
Figure 4 shows the level of discretionary spending for defense and domestic programs in recent years. Non-defense discretionary spending is now $100 billion higher than it was in 2000. (And there has been very little inflation over the last 4 years to account for that increase.)
Figure 4.
10-Year Adjusted Baseline, 2005-2014: Over the next ten years, however, Centrists.Org's projections differ dramatically from those of CBO. We expect the budget deficit to total $5.3 trillion, much worse than CBO's baseline projection of just over $2 trillion (see Figure 5).
Figure 5.
Centrists.Org projects that the national debt owed to the public will double between 2002 and 2010, from 3.5 trillion to almost $7.2 trillion. The debt will approach 50 percent of GDP by 2010.
Even under CBO's less realistic projections, the debt is projected to nearly double, to $6.2 trillion in 2010 (see Figure 6).
Figure 6.
CBO is required by law and budgetary custom to assume tax cuts expire on their scheduled "sunset" dates, that problems with the Alternative Minimum Tax (AMT) and Medicare payments are not fixed, and that Congressional appropriators will suddenly ratchet down the growth of defense and domestic spending.
By contrast, Centrists.Org uses alternative assumptions within the 10-year budget period, in an attempt to give policymakers a more realistic view of the budgetary trends.
Sometimes these alternative assumptions are easy. For example, it is all but certain that Congress will spend more money to prevent Medicare's physician fees from plummeting.
However, the other assumptions are more subjective. Assumptions about whether or not Congress will extend tax cuts or slow the growth of discretionary spending are not certain at all.
It depends to a large degree on the legislators' will to reinstate fiscal discipline and reduce deficits. At this point, that political will still seems lacking.
Does Congress "Get It" on Fiscal Discipline? Earlier this year, there was a lot of talk about getting the budget under control. Congress would start to "pay for" our tax cuts and spending initiatives. We would begin to control the "discretionary" appropriations, especially for domestic non-defense programs.
It isn't happening. The House continues to pass popular tax cuts without any funding mechanisms.
The Senate is doing a little better. A handful of Republican moderates are holding off the leadership's attempt to use expedited budget procedures to make it easier to enact unfunded tax cuts.
On the other hand, there isn't much enthusiasm for spending cuts.
Moreover, a recent trade and tax act that cleared the Senate displayed how legislators can craft bills that are nominally "paid for" over the 10-year budgeting period, but which are nevertheless likely to increase the budget deficit in the longer-run.
The Foreign Sales Corporation/Extraterritorial Income (FSC/ETI) bill was originally intended to comply with a world trade ruling, substituting some business tax cuts for trade subsidies deemed unfair.
The good news is that the Senate came close to "paying for" the bill -- at least technically -- by offsetting its myriad tax cuts with $90 billion (over 10 years) worth of various loophole closings and reductions in tax preferences, mostly on the corporate side.
The bad news is that the final Senate bill used "sunset" provisions within some of its numerous narrow tax provisions -- which range from the taxation of imported archery products to the exclusion of horse-racing and dog-racing gambling winnings from the income of nonresident aliens, to bonus depreciation for certain aircraft not used in the transportation industry (corporate jets?) -- to help reduce its apparent long-term cost (see Figure 7).
Figure 7.
It's safe to say that some members of Congress are thinking about fiscal discipline, and some -- especially fiscally conservative Republicans -- may be able to force some deficit reducing actions this summer and fall. Moderate Republicans may advocate allowing some business tax cuts to expire this winter, and conservative Republicans are likely to push for reducing the rate of growth of discretionary, non-defense spending.
However, the deck is stacked against them. The Congressional leadership is committed to spending more and taxing less -- regardless of the deficits -- and the President is not complaining about that strategy (except for a faint peep of protest on the stalled transportation bill).
On balance, it seems premature to assume that a major movement torward fiscal discipline is taking hold. However, Centrists.Org deficit projections for 2005-2014 have been reduced a little bit, reflecting the greater probability that some business tax cuts will be allowed to expire, and the increased likelihood that Congressional appropriators will slow the growth of non-defense spending.
In a sense, these slightly more optimistic assumptions for the 2005-2014 period may reflect the triumph of hope over experience. Congress hasn't yet taken action to significantly slow the underlying growth of spending, and the decisions to allow some tax cuts to expire have not yet been made. However, those actions seem a little more likely in mid-2004 than they did earlier this year.
Tax Cuts, "Discretionary" Spending, and Medicare Payments. Centrists.Org assumes that the personal tax cuts enacted in 2001 and 2003 will not expire on their sunset dates.
We also assume the AMT fixes enacted in the law on a temporary basis will be extended permanently.
These extensions and fixes in the tax code seem very likely.
On the other hand, the extension of business tax cuts is very uncertain. The largest business tax cut, an acclerated depreciation provision enacted in 2002 and expanded in 2003, is scheduled to expire in December. We assume this tax cut will be extended, but only at half of its current level of generosity.
It's hard to get a political fix on this. On the one hand, the political gurus in the White House and Congressional leadership wouldn't mind if businesses feared their tax cuts would indeed expire in December. That way, they would be more likely to push forward any marginal investment decisions from 2005 into 2004, when they could still get a tax break. This would help boost economic activity in the months prior to the November elections.
On the other hand, by mid-summer or fall, once it's too late for businesses to implement any more construction projects or large-scale investments in 2004 anyway, Congress might extend the tax cuts so that businesses do not face an effective tax increase in 2005.
On balance, we assume that the main business tax cut is extended, but at only half its current degree of generosity.
Discretionary spending continues to grow at a solid pace. It is certainly possible that overseas expenditures will fall sharply if U.S. forces in Iraq are reduced. But that doesn't seem likely.
We assume that overseas military spending continues at approximately its current level, and that defense and homeland security outlays continue to grow at the same rate as GDP growth throughout the projections period.
However, there will be considerable pressure to reduce non-defense spending in 2005, no matter who wins the Presidency this fall. Senator Kerry would have to find budgetary savings to fund his signature initiatives, and President Bush has signaled a desire for cuts in the growth of non-defense spending after the election.
It seems plausible to lower the growth of projected non-defense discretionary spending to the rate of inflation after 2005. House and Senate appropriators are starting to consider lowered growth targets for non-defense spending.
On the other hand, Congress is virtually certain to find a way to increase Medicare payments to physicians, which are otherwise scheduled for continued deep cuts (see Figure 8). Centrists.Org assumes fixing this fee problem will cost about $120 billion over 10 years between 2005 and 2014.
Figure 8.
Long-Term Projections: Extending the projections to 2030 illustrates the real budgetary problem the U.S. faces.
Under Centrists.Org's assumptions that tax cuts are extended and spending grows at a moderate pace, the budget essentially disintegrates after 2015 (see Figure 9).
By 2025, the projected budget deficit is nearly 10 percent of GDP, and the national debt would be about 100 percent of GDP. At those levels, economic growth would be severely threatened.
Figure 9.
The main culprits are the four great entitlements: (1) Social Security, (2) Medicare, (3) Medicaid, and (4) Interest on the National Debt
Figure 10 below shows that after the baby boom generation starts to retire in earnest after 2010, entitlement spending mounts and the national debt balloons, with interest spending becoming the largest entitlement on the U.S. budget after 2030.
In the end, long-term projections are not intended to be forecasts of what is likely to occur. Instead, they are intended to be realistic, plausible projections of the trajectory that current spending and revenue patterns imply for the budget.
Congress will certainly be forced to change that trajectory by slowing the growth of spending and raising tax revenues after 2010, when the large baby boom generation retires and joins the entitlement rolls, and would otherwise place the budget under an untenable strain.
In the meantime, however, these long-term projections provide a middle-ground estimate of what U.S. policymakers could expect if actions are not taken.
Figure 10.
Medicare and Social Security. Centrists.Org's long run projections essentially split the difference between the more pessimistic projections of the Medicare and Social Security trustees and the slightly more optimistic estimates occasionally produced by CBO.
Centrists.Org's projections use CBO's Medicare, Medicaid, and Social Security figures through 2014 (with an upward adjustment to Medicare spending to account for the needed increase in physician fees).
After 2014, however, we make our own baseline projections, using CBO's long-term projections (which are released periodically) and the Medicare and Social Security trustees' reports as a guide.
For these projections, we increased the long-run projection of Medicare spending, to reflect the fact that the Medicare trustees believe that the cost of the drug benefit enacted in 2003 will be higher than CBO estimates.
However, these projections are somewhat more optimistic on the long-run growth of Social Security spending, reflecting new modeling by CBO, which shows a lower trend in expected benefit costs.
At this point, we can't evaluate the new CBO model, since it hasn't been released to the public. On balance, however, we expect that as the economists and actuaries at CBO and in the Administration compare modeling notes over the next several months, their long-term projections will come together somewhere between Social Security's current projections and CBO's more optimistic new estimates.
Taxation of Retirement Savings. Based on a new analysis by CBO, we assume that revenue rates will increase slightly after 2015 as baby boomers cash in retirement accounts (like traditional IRAs and 401k plans) and pay the deferred taxes.
This subject has been controversial. In June of 2003, economist Michael Boskin announced that the impact could greatly increase future revenues.
However, Boskin withdrew his estimates after discovering errors in some computations.
A new report by CBO seems quite compelling, and we expect it to become a consensus position. The bottom line is that CBO expects that the taxation of 401k and traditional IRA account redemptions will indeed boost expected future revenues, but not by very much -- roughly 0.3 percent of GDP by 2030.
Centrists.Org incorporated this assumption in our income tax revenue projections.
Links:
Joint Committee on Taxation Estimated Revenue Effects of S. 1637 (FSC/ETI among other things) (May 20, 2004)
Congressional Budget Office Tax Deferred Retirement Savings in Long-Term Revenue Projections (May 2004)
Centrists.Org Issue Summary: Medicare Modernization Act of 2003 (updated May 30, 2004)
Centrists.Org Chart: "Core" CPI (Consumer Price Index Less Food and Energy) (May 14, 2004)
Centrists.Org More Good News on Jobs -- More Bad News on the Deficit (revised May 13, 2004)
Centrists.Org A "Duck-The-Issues" Budget -- Interpreting the Congressional Budget for 2005 (revised March 19, 2004)
Centrists.Org The Fourth Entitlement: Interest (December 1, 2003)
Centrists.Org No-BS Long-Term Budget Homepage
