CBO’s Latest Budget Projections_ A Deteriorating Fiscal Outlook _ Peter G. Peterson Foundation _ Our America. Our Future by LegionZ411


									CBO’s Latest Budget Projections: A Deteriorating Fiscal Outlook | Peter G. Peterson Foundation | Our America. Our Future.                 7/14/11 6:40 AM

    CBO’s Latest Budget Projections: A Deteriorating Fiscal Outlook
    Feb 01, 2011


    The Congressional Budget Office (CBO) released its latest Budget and Economic Outlook last week. According to CBO, the fiscal
    condition of the United States has deteriorated since its last report issued in August. Highlights of the new ten-year budget
    “baseline” include projections of:

    A slower economic recovery;
    An unprecedented deficit of $1.5 trillion for this fiscal year (FY), which, at 9.8 percent of the economy or gross domestic product
    (GDP), is only slightly below the post-World War II record of 10 percent recorded in FY 2009;
    Compared to August, an increase in cumulative deficits over the 2011-2020 period of more than $1.4 trillion, assuming current
    laws are maintained. When likely changes to current law (extension of the tax cuts, maintenance of Medicare’s physician payment
    rates, and a phase-out of war spending) are assumed, cumulative deficits are projected to be more than $3 trillion higher;
    Permanent cash flow deficits for Social Security;
    A doubling of spending for health care programs over the decade; and
    Interest costs that will equal non-defense discretionary spending in 2019.
    The new baseline sets the stage for this year’s budget deliberations. It does not represent CBO’s prediction of the future path of
    the budget. Instead, it establishes a neutral benchmark against which the budget proposals of the President and the Congress will
    be measured. This latest baseline reflects changes in the budget outlook that largely result from the Tax Relief, Unemployment
    Insurance Reauthorization, and Job Creation Act of 2010 (2010 tax act), which was enacted in December, as well as more
    pessimistic assumptions about the economy. But even after the economy recovers, CBO projects that deficits will remain higher
    than the average levels seen before the financial crisis and the recent recession (see Figure 1).

    Figure 1. Federal Deficits as a percent of GDP

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    The federal debt, or the cumulative total of the government’s deficits and surpluses, will also grow faster than had been projected
    in August. By 2021, under the current law scenario, the debt held by the public is projected to be 77 percent of the country’s
    economic output, or gross domestic product (GDP) (see Figure 2). Under alternative assumptions, however, that number rises to
    over 90 percent of GDP.

    Figure 2. Debt Held By the Public

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CBO’s Latest Budget Projections: A Deteriorating Fiscal Outlook | Peter G. Peterson Foundation | Our America. Our Future.                   7/14/11 6:40 AM

    Economic Outlook

    The economic outlook has deteriorated since CBO’s August report (see Figure 3). CBO now projects that the U.S. economy will
    continue to struggle with high unemployment and sluggish growth for several more years. The pace of this recovery is
    significantly different than the path to recovery following previous recessions.

    CBO expects unemployment to remain very high despite projected economic growth in 2011 driven by the tax cuts passed at the
    end of 2010. During the recent recession, the U.S. economy lost 7 million jobs. So far, the economy has only added back 70,000
    jobs. If CBO’s new projections are accurate, the economy will not recover all of the jobs lost, and unemployment will remain
    above the normal 5.3 percent level, until 2016.

    CBO believes there are several possible causes of the high levels of unemployment. These are:

    A lack of demand for workers;
    A mismatch between the skills of the unemployed and the requirements of employers looking to hire; and
    An inability of those who are underwater in their mortgages to relocate to find employment.
    In addition to these factors, the extension of unemployment insurance may contribute to higher unemployment rates. It may
    have encouraged some jobless people to stay in the work force who, without extended unemployment benefits, might have
    dropped out of the labor force altogether, retired, or applied for Social Security disability benefits. Or, the extended benefits may
    have allowed some people to search less intensively for work than they would have if their benefit eligibility ended sooner.

    Given high unemployment and other indictors of unused resources in the economy, CBO projects a low level of inflation for the
    next five years. But with interest rates on three-month Treasuries projected to be lower than inflation in 2011 and 2012,
    investors in short-term U.S debt risk actually losing money.

    Figure 3. Comparison of CBO Economic Assumptions: January 2011 and August 2010

    SOURCE: Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011-2021, January 2011.

    Health Care

    CBO projects that federal health spending will continue to be one of the fastest-growing areas of federal spending, increasing at
    an average rate of 7 percent per year over the next decade. In contrast, over that same time, GDP is expected to grow at the rate
    of only 2.4 percent per year.

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    The new baseline incorporates provisions of the 2010 health care reform act (the Patient Protection and Affordable Care Act—or
    PPACA) that would expand Medicaid, provide subsidies for health insurance coverage, and, if implemented and maintained as
    designed, restrain the growth of Medicare costs.


    Medicaid’s growth is projected to be responsible for 40 percent of the growth of federal health spending over the next
    decade. The 2009 stimulus bill (the American Recovery and Reinvestment Act of 2009—or ARRA) and other legislation
    provided states with a temporary increase in Medicaid matching funds to help offset the impact of the recession. As the higher
    federal match expires, CBO estimates that Medicaid will show little growth this year and will decrease in 2012. However,
    beginning in 2014, the expansion of eligibility for Medicaid included in the PPACA will begin. CBO projects that enrollment will
    grow from its 2011 high of 68 million people to more than 97 million by the end of the decade. With the federal government
    responsible for almost all of the cost of that expansion, Medicaid will become the fastest-growing federal health program. CBO
    estimates that spending will increase at an average annual rate of 9 percent from 2014 to 2021.


    Medicare, which has historically grown faster than Medicaid, is projected in the baseline to be responsible for 30 percent of the
    growth of federal health spending.

    Under current law, Medicare spending is projected to grow about 7 percent per year on average between 2013 and 2021.
    However, this projection reflects possibly unrealistic expectations about program growth. Under current law, Medicare physicians
    will face a 28 percent reduction in fees in January 2012 as a result of the program’s “Sustainable Growth Rate” payment formula.
    Lawmakers have overridden these reductions every year since 2003; if they do so again, CBO projects that Medicare outlays
    would increase by an additional $250 billion over the decade. Additionally, the PPACA included provisions that would constrain
    the growth in payments to other health care providers that many health policy experts believe are not sustainable. In addition,
    critics have challenged new activities—including the Independent Payment Advisory Board and the Medicare Innovation Center
    —that are intended to reduce the growth in Medicare costs.

    Health Insurance Exchanges

    Subsidies for people who enroll in new health insurance exchanges, together with operating costs for the exchanges, make up the
    lion’s share of the remainder of federal health spending growth; outlays may approach $100 billion by the end of the
    decade. CBO projects that around 7 million people will receive health insurance coverage through exchanges when they go into
    operation in 2014, and that the program will grow to 18 million participants by the end of the decade.

    Social Security

    Social Security remains the largest single program in the federal budget. In 2010, the program paid over $700 billion in benefits
    to retirees, surviving spouses and their families, and those claiming the disability benefit. This represented about 20 percent of
    all of the money spent by the federal government that year.

    Compared to previous CBO estimates, Social Security’s long-term position has worsened. Social Security is now operating with a
    cash flow deficit that CBO projects is permanent (See Figure 4). In other words, the program pays more in benefits than it brings
    in by way of payroll taxes, and the program is not expected to operate with a cash surplus again. The program is expected to run
    a cash deficit of approximately $45 billion and continue running cash deficits permanently. This contrasts with CBO’s 2010
    projections, which estimated that Social Security would generate small cash surpluses in 2013, 2014, and 2015 before running
    permanent deficits beginning in 2016.

    There are a number of factors that have contributed to the decline in Social Security’s long-term financial outlook. The after
    effects of the financial crisis and the slow economic recovery are still placing a heavy burden on the program’s long-term
    solvency. The program saw increased numbers of beneficiaries in 2010. Facing a tough labor market, more people filed for
    Social Security benefits and left the work force. CBO reports that the number of people receiving Social Security Disability
    Insurance benefits increased by almost 5 percent in 2010—much higher than in the past, even during recessions. As high
    unemployment continues through 2016, the program’s revenue base will also be affected.

    Figure 4. Social Security Cash Flow Projections

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    Social Security is financed on a pay-as-you-go basis through a payroll tax. Normally, this tax is levied on wages up to the taxable
    maximum at a rate of 12.4 percent. Currently, the payroll tax covers the first $106,800 of wages. Employees pay half of the tax
    and employers pay the other half. The 2010 tax act contained a provision that reduced the employee share of the payroll tax
    from 6.2 percent to 4.2 percent in calendar year 2011. CBO estimates that the payroll tax cut will reduce Social Security’s
    revenues by $70 billion. However, transfers from general revenues to the Social Security trust fund will make up the shortfall.
    Though the temporary payroll tax cut will provide direct tax relief to workers, this policy represents a break in the connection
    between Social Security benefits and payroll contributions.

    All Other Spending

    Defense discretionary spending

    Growth in defense spending accounts for almost all of the projected increase in discretionary—or annually appropriated—
    spending in 2011. Defense spending increased by 5 percent, or about $32 billion. That represents a slower increase than the 9
    percent average growth rate of the last decade. Nearly all of last year’s growth was driven by operations and maintenance and
    personnel costs, the two largest components of the Pentagon’s budget. Only a quarter of the growth resulted from continuing
    operations in Afghanistan and Iraq.

    The CBO baseline does not reflect anticipated changes in funding this year for war-related activities or planned future
    adjustments in the Iraq and Afghanistan missions. It assumes current funding levels continue in real terms until the end of the
    decade, even though we continue to reduce our commitments in Iraq and troop withdrawals in Afghanistan are scheduled to
    begin later this year. Current projections call for $1.8 trillion in war-related funding over the next decade. CBO constructs a
    scenario that reduces active-duty troops, which reduces projected outlays by $1.1 trillion over the next ten years.

    Nondefense discretionary spending

    Nondefense discretionary spending, like defense spending, results from annual appropriations legislation. The programs in this
    category of federal spending, representing 18 percent of the budget for 2011, are some of the most visible (other than individual
    benefit programs), and include the Congress, the White House, the Supreme Court, national parks, law enforcement, and
    programs that could help strengthen the future economy including education, research and development, and investments in
    physical infrastructure (see Figure 5).

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    Figure 5. Nondefense Discretionary Spending

    Last year, the President announced a three-year freeze on a section of the budget he called “non-security discretionary spending,”
    which is very similar to the non-defense discretionary category shown in Figure 5 above (though the President would exclude
    programs like Homeland Security from the freeze). This year, in the State of the Union Address, he pledged to extend the freeze
    for an additional two years. This has been one of the first concrete steps taken since the recovery to address our future fiscal
    challenges. However, the effect is limited and much work will remain to be done (See Figure 6).

    Figure 6. Projected savings from a five-year freeze of nondefense discretionary programs

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    Compared to CBO’s previous estimates, the new baseline includes significantly lower revenues over the coming decade. Revenues
    are projected to be $419 billion lower in 2011, $398 billion lower in 2012, and $1.9 trillion (or 5 percent) lower for the 2011-
    2020 period. The projected decline in 2011 revenues is the main reason behind the increase in this year’s deficit from $1.1 trillion
    to $1.5 trillion.

    Over $700 billion of the projected decline in revenues is due to recent legislation, specifically the 2010 tax act. That law extends
    all of the Bush income tax cuts and the estate tax through 2012, and reduces employees’ Social Security payroll taxes by 2
    percentage points for 2011.

    CBO attributes $960 billion in revenue decreases over the next 10 years to the slow economic recovery, which has resulted in
    slower employment, lower incomes for individuals and corporations, and slightly higher inflation over the next decade than CBO
    previously projected. A smaller share of the revenue reduction, $210 billion over the decade, is due to technical changes in

    These projections might still be optimistic despite being lower than CBO’s previous estimates. CBO’s baseline outlook shows that
    receipts from individual income taxes are expected to grow rapidly in the coming decade, from 6.6 percent of GDP in 2011 to 11.2
    percent of GDP in 2021. That revenue growth assumes that the 2010 tax act provisions will expire as scheduled at the end of
    2012 and that the alternative minimum tax (AMT) will not be patched again to reflect inflation. Under CBO’s alternative scenario,
    which assumes extension of the individual income tax rate cuts and gift and estate taxes beyond 2012, and continuing indexation
    of the AMT, revenues would be $4.6 trillion lower over the 2011-2021 period than revenues in the current law baseline.

    CBO’s report highlights the issue of tax expenditures, or the exemptions, credits and deductions that result in a loss of revenues
    the government would otherwise collect. In 2008, these expenditures reduced gross taxable income by a third, from $8.4 trillion
    to $5.7 trillion. CBO estimates that foregone revenues from the largest individual tax expenditure, the exclusion of employer-
    sponsored health insurance from taxable income, will total $659 billion over the 2010-2014 period. In the same period, the
    exclusion of pension contributions and earnings will result in $597 billion of lost revenue, and the mortgage interest deduction
    will result in $484 billion in lost revenues.

    The Cost of Economic Recovery

    The federal government undertook an array of actions to help the economy recover from the 2008 financial crisis and deep

    The Troubled Asset Relief Program, or TARP, included most of the industry bailouts. There have been unexpected levels of return
    on investment in the TARP program—$110 billion was paid back to the government in 2010—and CBO now estimates its final
    cost to be only $25 billion, down from the $99 billion estimate made a year ago.
    The 2009 stimulus package, or ARRA, was a sweeping bill, and the Congressional Budget Office estimates that it will have added
    $726 billion to the deficit from its enactment to the end of 2011. The federal government will spend most of the money from
    ARRA by the end of 2011, but its fiscal impact is being replaced by the 2010 tax act.
    CBO estimates that the 2010 tax act, which included tax cuts and an extension of unemployment benefits, will cost $390 billion
    in 2011, more than offsetting the drop in ARRA spending from its 2010 level. Over the course of ten years, the 2010 Tax Act will
    increase deficits more than ARRA did (see Figures 7 and 8).
    Figure 7. Comparison of Stimulus Action

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    Figure 8. Deficit Impact of Stimulus Legislation, in billions of dollars

    NOTE: Negative amounts reflect increases to the federal deficit.
    SOURCE: Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011-2021, January 2011.

    A Note about Federal Debt

    The federal debt is made up of two parts: intragovernmental debt and debt held by the public. Intragovernmental debt is
    comprised of mostly nonmarketable Treasury securities held by federal trust funds, like those of Social Security and Medicare,
    and other government accounts. Debt held by the public is comprised of marketable Treasury securities held by both domestic
    and foreign private investors. “Gross Federal Debt”—which is the number that appears on the “Debt Clock” —is the sum of both
    debt held by the public and intragovernmental debt. Almost all of the gross debt is limited by the statutory debt limit that policy
    makers will have to raise in a few months (see Figure 9).

    Figure 9. Projected Federal Debt Levels

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    Debt held by the public has a direct impact on the economy, and is thus the number we pay closest attention to. When the federal
    government borrows, it may use funds that might have been available for private uses, thus potentially “crowding out” productive
    investment that would help the economy grow.

    In addition, the government must use its resources to pay interest on its borrowing instead of using those funds for other public
    purposes such as education, R&D, or physical infrastructure that could strengthen the future economy. (The “net interest” line in
    the budget is the interest paid on the debt held by the public: the interest payments on the intragovernmental debt flow from one
    government account to another and so are netted out.) Interest rates are currently at an historic low—three-month rates are
    close to zero, while they hovered at around 8 percent as recently as 1990. Already, interest costs are the fastest growing line item
    in the federal budget over the next decade. The interest cost on our debt would increase dramatically if rates rise in the future.

    While debt held by the public is projected to rise indefinitely into the future, intragovernmental debt can only get as large as the
    trust funds within the government from which it is borrowing. Both the Social Security and Medicare trust funds—by far the two
    largest holders of intragovernmental debt—face long-term solvency issues. In fact, this report is the first to project indefinite
    cash-flow deficits in the Social Security trust fund. In addition, Medicare’s Disability Insurance and Hospital Insurance trust
    funds will be exhausted in 2017 and 2021, respectively. Future deficit spending will no longer be offset by the surpluses of these
    programs. Absent major policy changes, we will need to increase our debt held by the public as the two entitlement programs
    draw upon their trust funds to continue to support themselves.

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