The Real Deficit Outlook

Volume IX, Number 6 October 1, 2003

At a joint press conference held on Monday, the Concord Coalition, the Center for Economic Development, and the Center on Budget and Policy Priorities joined forces to urge leaders to put aside partisan differences and take decisive action to rein in the federal deficit. 

In a joint statement, the three groups warned that the budget outlook is much worse than the official CBO baseline indicates.  According to an alternate projection released at the press conference, the budget will remain mired in deficit throughout the next ten years, rather than return to surplus as it does in the CBO baseline.  Thereafter, as Boomers retire and cash in their entitlement claims, the deficit will explode to 6 percent of GDP by 2020, 12 percent by 2030, and an economy-shattering 21 percent by 2040.

Many Americans will assume that the alternate projection must be based on pessimistic assumptions.  But this is not the case.  In fact, even the alternate projection may understate the gravity of the deficit problem--and the damage that current budget policy is inflicting on future generations.

A More Realistic Scenario

Let's start with the near term.  According to the alternate projection, the federal budget will run a deficit of $5.0 trillion over the next ten years.  Like most independent projections, this one is considerably higher than the CBO baseline, which puts the ten-year deficit at $1.4 trillion.

Both projections are based on an identical economic scenario in which employment and productivity grow rapidly as the nation recovers from recession.  The difference lies in the policy assumptions.  The CBO baseline assumes that the future will unfold precisely as current law dictates.  The alternate projection factors in a number of likely legislative changes.  Its purpose is to reflect the intent and direction of today's budget policies, rather than the letter of the law.

On the tax side, the alternate projection ignores the “sunset” gimmicks included in the administration's recent tax cuts and assumes that all expiring provisions will be extended.  It also takes into account the cost of fixing the Alternative Minimum Tax, which would otherwise push a sharply rising share of middle-class families into tax brackets intended for the affluent.   On the spending side, the alternate projection includes a $400 billion prescription drug benefit, the level provided for in this year's budget resolution.   It also assumes that the administration's multi-year defense plan will be fully funded. 

This is a more realistic scenario than the official baseline, but it is hardly a worst-case scenario.  Although the alternate projection assumes that recent tax cuts will be extended, it allows for no new cuts in taxes beneath current levels.  And although it assumes that defense spending will rise to meet tomorrow's challenges, it allows for no comparable rise in domestic discretionary spending. With homeland security needs bulking large, this may be wishful thinking.

Vicious Dynamic

If today's deficits were a strictly temporary phenomenon, they would be less worrisome.   But in fact, the deficit outlook rapidly deteriorates just beyond the official ten-year budget horizon.

The reason, of course, is the looming expense of caring for an aging population.  Over the next decade, the current-law cost of Social Security, Medicare, and Medicaid is due to grow by a little over 1 percent of GDP.  But from 2013 on, the cost will be growing by 1 percent of GDP every three and one-half years.  All told, spending on the three programs will rise from 8.5 percent of GDP today to 14.9 percent in 2030 and 18.4 percent in 2050--and that's without a drug benefit.

How big will the deficit impact be?  To answer the question, the Concord Coalition and its co-hosts extended their near-term projections using the same kind of model the GAO uses.  The results are sobering: The deficit, which is projected to hover between 3 and 4 percent of GDP over the next decade, suddenly begins to rise in 2014, hitting double digits by the mid-2020s.  The public debt explodes in tandem--to 100 percent of GDP by the late 2020s, 200 percent by the late 2030s, and an impossible 400 percent by the late 2040s.  The peacetime record among modern industrial nations is about 150 percent of GDP.

The accompanying figures depict the vicious dynamic that generates these projections: rising federal expenditures, which increases the deficit, which increases the debt, which increases interest costs, which pushes up expenditures even further. 

Daunting as the projections are, the problem could be much bigger--and arrive much sooner.  For one thing, the model makes the simplifying assumption that there will be no economic feedback between deficits and interest rates, which remain the same whether the federal government is borrowing 1 percent of GDP or 10 percent.  As a practical matter, this is implausible.   There isn't enough U.S. savings to finance deficits approaching this magnitude without pushing interest rates into the stratosphere.  As for foreign savings, the United States is already running unprecedented current account deficits.  Moreover, most other developed nations will be aging more rapidly than America.  Over the next few decades, many will be in steep demographic decline, experiencing zero GDP growth, and struggling to finance a tidal wave of pension and health-care outlays.  In short, our habit of borrowing from abroad will be cut short by the overseas age wave.

The model also allows for very little feedback between deteriorating economic performance and the magnitude of the federal budget burden.  In the model, most federal spending is assumed to grow at the same rate as GDP, no matter how slowly GDP grows.  Yet in  the real world, the dollar cost of much of federal spending is fixed.  Medicare has to pay for CAT scans and heart bypasses.  The Pentagon has to buy carriers and humvees.  Every federal agency has to pay for salaries.  As economic growth slows, these costs can be expected to rise relative to GDP.  Indeed, this is what always happens during a recession.

Shortchanging Our Children

The bottom line is stark.  Unless we change course, widening federal deficits will soon be starving the economy of investable savings and shortchanging our children.  The problem with deficits is that they soak up national savings and crowd out productive investment.  Since America's savings pool is shallow, the impact of large deficits is especially harmful. The U.S. net national savings rate is already low both relative to other developed nations and to our own history.  Current fiscal policies are due to push net national savings still lower, ultimately driving it beneath zero.

This brings us to history's bottom line, as insisted on by one economic luminary after another, from Adam Smith to Karl Marx to Alfred Marshall to John Maynard Keynes: No country can enjoy sustained living standard growth without investing, and no country can sustain high investment for long without saving.

    The long-term projections show that current federal  budget policies are unsustainable.  Let's hope that we don't have to suffer a fiscal and economic crack up before changing direction.  The time to act is now, while people still have time to adjust and prepare--not ten years from now, when the trade-offs will be all the more painful.  This is the last decade before the age wave rolls over the budget.  Let's make sure it's not a lost decade.■