“In the Long Run, We’re All Dead.”

Democrats heaped praise on the Congressional Budget Office during the health care debates (remember SpeakerPelosi’s  breathless excitement over the “scoring” from the “bipartisan” Congressional Budget Office?).  The CBO’s newest “Long-term Budget Projections” have not engendered the same level of attention…but it should. The report was released about a month ago and my guess is that it fell under the radar screens of loyal Pileus readers. So here are a few highlights for your consideration (the entire document is available here, and CBO Director Elmendorf’s brief presentation to the National Commission on Fiscal Responsibility and Reform is available here).

The CBO begins with a cheery review of recent events:

Recently, the federal government has been recording the largest budget deficits, as a share of the economy, since the end of World War II. As a result of those deficits, the amount of federal debt held by the public has surged. At the end of 2008, that debt equaled 40 percent of the nation’s annual economic output (as measured by gross domestic product, or GDP), a little above the 40-year average of 36 percent. Since then, large budget deficits have caused debt held by the public to shoot upward; the Congressional Budget Office (CBO) projects that federal debt will reach 62 percent of GDP by the end of this year—the highest percentage since shortly after World War II.

Yes, I know, we are in the greatest recession since the Depression. The CBO recognizes that budget deficits will likely decline markedly in the next few years. Nonetheless, the CBO notes: “over the long term, the budget outlook is daunting.” The retirement of the baby boomers (assuming any of us can retire) will drive entitlement spending. “Without significant changes in government policy, those factors will boost federal outlays sharply relative to GDP in coming decades under any plausible assumptions about future trends in the economy, demographics, and health care costs.

The CBO develops its projections under two scenarios: an extended-baseline scenario and an alternative fiscal scenario.

The extended base-line scenario, is based on current law and the assumptions that (1) the health care legislation will have the anticipated effects on revenues and spending, the Bush tax cuts will expire as scheduled, and the alternative minimum tax (ATM) will cover a growing percentage of tax payers. Under this scenario, total revenues will increase to 23 percent of GDP by 2035 and grow substantially thereafter. On the spending side, “government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.” In other words, the US would be primarily involved in the provision of insurance and the payment of interest on the debt. Debt held by the public would increase from 62 percent this year to 80 percent in 2035 while interest payments would increase from a current level of 1 percent of GDP to 4 percent of GDP by 2035 (essentially one-sixth of federal revenues).  (page x)

The alternative fiscal scenario—in my mind, the more reasonable one—assumes that some of the Bush tax cuts will be extended, the ATM will cover about the same percentage of taxpayer as today, Medicare reimbursements for physicians would increase gradually, and spending under the alternative scenario, and “spending on activities other than the major mandatory health care programs, Social Security, and interest would fall below the average level of the past 40 years relative to GDP, though not as low as under the extended-baseline scenario.” Under this more realistic scenario, debt would hit 87 percent of GDP by 2020. “After that, the growing imbalance between revenues and noninterest spending,  combined with spiraling interest payments, would swiftly push debt to unsustainable levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2025 and would reach 185 percent in 2035.” (page x-xi)

Indeed, under this scenario, in 75 years, revenues would reach 19.5 percent of GDP, expenditures would constitute 28.2 percent of GDP, leaving a fiscal gap of 8.7 percent of GDP (Table 1-3, p. 15).

In a sobering qualification (p. xi), the CBO states:

In fact, CBO’s projections understate the severity of the long-term budget problem because they do not incorporate the significant negative effects that accumulating substantial amounts of additional federal debt would have on the economy:

  • Large budget deficits would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.
  • Growing debt would also reduce lawmakers’ ability to respond to economic downturns and other challenges.
  • Over time, higher debt would increase the probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.

The CBO elaborates on the fiscal crisis scenario (pp. 20-21):

higher debt could raise the probability of a fiscal crisis in which investors would lose confidence in the government’s willingness to fully honor its obligations, and thus, the government would be forced to pay much more for debt financing.  Interest rates might rise only gradually to reflect growing uncertainty about whether government debt would be fully honored, but other countries’ experiences suggest that a loss of investor confidence could occur abruptly instead. If interest rates on government debt spiked, the value of outstanding government debt would fall sharply. That decline in value could precipitate a broader financial crisis by causing large losses for mutual funds, pension funds, insurance companies, banks, and other holders of federal debt. Experience in other countries suggests that resolving such a crisis would require fiscal policy changes that would be far more drastic and painful than if policies had been adjusted sooner to avoid a crisis.

One might suppose that such dire predictions would force a response from the White House or Congress.  Peter R. Orszag, OMB Director, used the occasion of the release to celebrate the role of the Affordable Care Act in helping to enact “substantial, long-term deficit reduction.” To be fair, he devoted a line at the end of his comments to the long-term scenario. In Congress, the majority broke from the practice of presenting a five year budget plan and presented a one-year budget resolution, which Speaker Pelosi described as “another key step . . . in restoring fiscal responsibility.” This decision was justified by the existence of the National Commission on Fiscal Responsibility and Reform.

When in doubt, create a commission. And as the legislative history of the current financial reform legislation reveals, be certain that you do everything humanly possible to avoid its findings.

And so, we return to a central question: On the assumption that we want to avoid the bleak scenarios painted by the CBO (one that has been presented on numerous occasions in earlier years) and that whatever the benefits of growth, we simply cannot “grow our way” out of the problem,  what are the options?

  1. Dramatic reductions in the core entitlement programs
  2. Dramatic increases in taxation
  3. Some combination of 1 and 2

Will elected officials–who dance to the 24 hour news cycle and whimper in fear of voters who have been assured that they can have endless entitlements and low taxes– be able to soberly face the long-term crisis and select from the limited set of options?

Is any of this politically viable absent a significant change in the popular expectations of government’s role in society and the economy?

6 thoughts on ““In the Long Run, We’re All Dead.”

  1. In 1946, Truman and the Congress took FDR’s plan to further centralize the economy, nationalize healthcare and make government the source of a living wage for all citizens in favor of drastic reductions in spending and tax rate reductions.

    The “smarties” forecast huge unemployment and economic chaos, but it didn’t happen. Job creation in the private sector, particularly from people starting their own businesses, sopped up anyone who wanted to work far quicker than they could have imagined. The “pent up demand” from the war years was part of the success, but it would have meant nothing without a private sector unleashed.

      1. More precisely, the Full Employment Act had passed the Senate but encountered significant resistance in the House of Representatives,where a legislative coalition comprised of Southern Democrats and Midwestern Republicans proved an insurmountable obstacle. The US Chamber of Commerce, the National Association of Manufacturers, and the American Farm Bureau Federation mobilized in opposition, raising concerns about planning and the inflationary consequences of deficit spending. Representative Will Whittington (D-MS) played a decisive role as the swing vote in the subcommittee, and used this position to introduce a substitute version largely written by the Chamber of Commerce and the Council for Economic Development. It passed the House and prevailed in the joint conference committee. Thus, the Full Employment Act became the Employment Act.

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