Facing Facts Alert

Volume VI, Number 1 February 14, 2000


The Truth about Entitlements and the Budget A Fax Alert from The Concord Coalition Volume VI, Number 1 - February 14, 2000

Lately, the projected budget surpluses have been getting bigger and bigger-and so has the temptation to spend them. In its "current-law" January 2000 baseline, CBO projects $1.9 trillion in cumulative surpluses over the next ten years above and beyond Social Security's trust-fund surpluses. In this context, even the largest tax cuts and spending hikes now being proposed by leaders and candidates seem affordable. Affordable, that is, until one starts looking behind the numbers. CBO's current-law baseline rests on highly optimistic assumptions about future federal spending and future economic growth. Under more realistic assumptions, the CBO itself cautions that the budget could sink back into deficit again within a few years. In this context, even small tax cuts or spending hikes would merely dig a deeper hole.

An Alternative Baseline

In its most recent current-law baseline, CBO projects a colossal unified budget surplus of $4.2 trillion for FY 2001-2010, a ten-year total almost one trillion larger than it was projecting just six months ago. Much of this surplus-$2.3 trillion-is accounted for by the Social Security trust-fund surplus, which just about everybody agrees should be off limits. But that still leaves an "on-budget" balance of $1.9 trillion for FY 2001-2010. No wonder budget politics is being transformed. So what's so optimistic about the projection? To begin with, there is the assumption that legislated caps on future discretionary spending will be carried out to the letter. CBO is obliged to make this assumption because the baseline must reflect current law, and the caps are law. Carrying them out, however, would require huge programmatic cuts that few leaders in either party seriously propose and that almost no budget watcher believes will happen. CBO of course realizes this, and so has begun publishing an alternative baseline in which discretionary spending grows with inflation after 2000. This one change shrinks the projected cumulative on-budget surplus from $1.9 trillion to $838 billion. Even this projection is probably optimistic, since it merely assumes that the federal budget will spend no less on discretionary spending in real dollars ten years hence than it does now. That would still leave discretionary spending wasting away as a share of the economy, from 6.3 percent today to 5.3 percent by 2010. As a share of GDP, nondefense discretionary spending is now at its lowest level since LBJ announced his "Great Society" in 1965. Sooner or later, it is likely to grow again at least as fast as the population and real economy. (Think of schools, highways, or the federal payroll.) As for defense spending, this is now at its lowest level since before Pearl Harbor. Even relatively minor national security challenges might require it to rise as fast as GDP over the next decade. None of the CBO projections allow for this possibility.

A Huge Departure

Then there's the optimism of CBO's baseline economic assumptions. Over the past quarter-century, productivity (the CBO notes) has grown at the average annual rate of 1.6 percent per year. Since 1996, it has grown at 2.6 percent per year. In its baseline, CBO assumes that productivity will grow at the rate of 2.3 percent per year over the next decade. It may seem that CBO is assuming that most of the recent acceleration will be permanent. But in effect, it assumes that all of it will be permanent. CBO's 2.3 percent number is an average for productivity growth over the entire business cycle. Yet for the average to be 2.3, the rate during an economic expansion couldn't be less than 2.6, allowing for a minor recession every ten years or so. Unless, that is, we suppose that the "new economy" has not only permanently raised productivity, but permanently banished the business cycle as well. The extraordinary performance of the U.S. economy since the mid-1990s may well justify ratcheting up expectations about long-term productivity growth. But to assume such a huge departure from the historical trend, based on just four years of data, seems premature. As it happens, CBO publishes an alternative projection in which productivity is assumed to grow at its average historical rate. This return to trend growth-plus the assumption that health-benefit spending will increase a mere 1 percent faster than baseline-adds up to what CBO calls its "pessimistic" scenario. In this scenario, the on-budget balance for FY 2001-2010 plummets from a surplus of $838 billion to a deficit of $2.9 trillion. In other words, the change in assumptions not only wipes out all of the projected on-budget surplus over the next ten years, it wipes out more than the entire unified budget surplus as well. From FY 2001-2010, the unified budget, counting the Social Security trust-fund surplus, would run a cumulative deficit of $1.1 trillion. And this, of course, assumes there will be no tax cuts or new spending programs. It's worth stressing that this is not a worst-case scenario. As CBO explains, its pessimistic scenario merely assumes that "the economy reverts in many respects to its situation before 1996." In other words, it wouldn't take an event like a major war to return the budget to deficit-financing and trust-fund squandering. It wouldn't even take a major recession or market crash. All that's required is for the future to be average. To balance out the picture, someone ought to run a projection based on less-than-average economic conditions, like the stagflation of the 1970s. Maybe we could call it a "cataclysmic" scenario to distinguish it from mere pessimism.

At Our Peril

The closer you look at the surplus projections, the flimsier they appear. On the spending side, they are based on utterly unrealistic assumptions about discretionary spending. On the economic side, the new economy just doesn't have a long enough track record to justify the dizzying growth expectations. Moreover, even if the projections turn out to be right and all of the surpluses materialize, they are still dwarfed by the long-term fiscal liabilities that will come due when the age wave rolls in. Many leaders half understand this, which may be why even the big tax-cutters are holding back from spending the entire on-budget surplus-and why OMB is now low-balling its own projections. Straining against this caution, however, is the exuberant optimism of circa-2000 America. We've seen so many buoyant expectations exceeded over the past few years that nothing any longer seems risky-not just in financial markets, but in fiscal policy. Spending projected budget surpluses is a bit like buying stocks on margin. We succumb to the temptation at our peril.

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