Debt Will Boom Under Current Policies

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The Congressional Budget Office (CBO) released its latest Budget and Economic Outlook yesterday. Its forecast? A deluge of red ink.

Under CBO’s official baseline, the United States would run a $1.35 trillion deficit in 2010 and $6.05 trillion in deficits in the following ten years. Those $7.4 trillion in deficits are the main reason that the publicly-held debt would double over the next decade, rising from $7.5 trillion at the end of 2009 to more than $15 trillion in 2020.

To put these enormous figures in context, it is helpful to compare them to the size of the U.S. economy. In 2010, CBO expects the deficit to be equivalent to 9.2% of gross domestic product (GDP). That’s the second highest since World War II, topped only by last year’s 9.9%. Under the assumptions of the official baseline, deficits would then decline relative to the size of the economy, and average about 2.6% of GDP in the middle of the upcoming decade. But then they would start increasing again, reaching 3.0% of GDP in 2019 and 2020, as rising health care costs and the aging population push up spending.

Over the same period, the public-held debt would increase to almost 67% of GDP in 2020, up from 53% at the end of 2009. That would be the highest debt level since 1951.

These projections are troubling because they imply that our debt will grow faster than the economy even after we have recovered from the Great Recession.

Unfortunately, that’s the good news in the CBO projections. The bad news is that, as CBO itself repeatedly points out, the official baseline is unrealistic and future deficits and debts are likely on track to be much worse.

By law, CBO must build its official baseline on two key assumptions: that existing laws execute exactly as written and that discretionary spending increases with inflation in future years. Those assumptions make sense for constructing a baseline that will be used to score the budget impacts of new legislation. But, as CBO itself notes, they are unrealistic if your goal is to make predictions of where current policy is leading. For example:

• Congress still has a busy agenda for 2010. As CBO notes, several items—extending unemployment insurance, increasing war funding, and enacting a jobs bill—could all widen the deficit this year.

• Under current tax law, a remarkable number of tax reductions will expire in the near future. These include the 2001 and 2003 tax cuts, the annual patch to the dreaded alternative minimum tax (which prevents the AMT from hitting more and more families), the Making Work Pay tax credit (enacted as part of the stimulus), expanded net operating loss carrybacks (enacted as part of another, smaller stimulus bill in the summer), and a panoply of other, smaller provisions (e.g., the research and experimentation tax credit). It is unthinkable that Washington will allow all these to expire.

• In recent years, discretionary spending has consistently grown faster than inflation. There is no reason to believe that will stop.

• On the other hand, the current baseline assumes that spending on the wars in Afghanistan and Iraq will continue at their 2009 pace, adjusted for inflation, over the next decade. One hopes that assumption is unrealistically high.

To help outside analysts construct alternative baselines that better show existing policy, rather than existing law, CBO provides estimates for several policy alternatives. As a rough cut at the budget implications of current policy (rather than current law), I made the following assumptions: (1) that regular discretionary spending grows at the same pace as nominal GDP in coming years (closer to recent history than the baseline assumption of growth with inflation), (2) that spending on the wars in Iraq and Afghanistan moderates somewhat in coming years (using CBO’s scenario in which troops decline to 60,000), (3) that the 2001 and 2003 tax cuts are permanently extended, and (4) that the AMT is indexed for inflation. In order to not be too alarmist, I did not make any adjustments for other expiring tax provisions (which are large), the infamous Medicare doctor payment problem, or any other policy changes that might happen this year. If you made adjustments for those, the deficit outlook would be worse still.

Under those assumptions, the budget outlook looks much more frightening.  For example, deficits would average more than $1 trillion annually over the next decade and would be around $1.7 trillion in 2020:

Under current policies, deficits would decline only to about 5.5% of GDP over the new few years and would then rise to more than 7% by 2020. That’s a recipe for an exploding debt, with the debt-to-GDP ratio rising to around 94% of GDP by the end of the decade with no sign of stopping.

Anyway you slice it, CBO’s projections confirm that we are on an unsustainable path. Under current law, which assumes large tax increases at the end of the year and historically slow growth in discretionary spending, persistent deficits would still boost our debts faster than our ability to pay them. And if Congress enacts its usual policy preferences—avoiding most tax hikes and increasing spending more rapidly—our debts will rise out of control.

Donald B. Marron is a visiting professor at the Georgetown Public Policy Institute and writes about economics and finance at dmarron.com. He previously served as a member of the Council of Economic Advisers and as acting director of the Congressional Budget Office.