The Good News and the Bad News

As of last week, the danger in the new Congressional Budget Office (CBO) deficit outlook released on Tuesday was that it might lull some people into a false sense of security.  As it transpired, the good news was that there was so little good news that it was unlikely to distract many people from the bad news.

The headlines picked up that the deficit this fiscal year is likely to fall below $1 trillion for the first time since 2008.  Those looking energetically for sunshine would point out that the deficit in 2015 under current law is projected to fall to only $430 billion – a number that would have struck terror in the heart when I was a mere lad (of 40 or so), but that today looks surprisingly reassuring.

However, that is where the good news stops.

The budget deficit is projected to rise after 2015, reaching $978 billion – just short of that $1 trillion bogeyman – in 2023.  The debt relative to the economy would hit a peak of 77.7 percent of GDP at the end of 2014, then fall slightly to 73.1 percent at the end of 2018, but then climb again to 77.0 percent at the end of 2023.  So at that point, debt and debt service would be piling up on one another in a potentially never-ending spiral – which would prove very painful to stop, the longer we allowed it to build its own momentum.

Of course, CBO makes clear that their budget outlook is not a prediction strictly defined, but rather a projection of what would happen if current law remains unchanged and the economy precisely follows the forecast.  And that leads many folks to ask:  What are the major risks (using that term neutrally, meaning reasons why it could be better or worse) to that projection?  Given that the numbers are on their face troubling, is there a significant chance that we might be saved from that adverse outcome without taking action?

In a nutshell, there always is a chance that fate will save us.  However, that chance is slim.

First of all, there are adverse risks whose probability is substantial.  The worst of the ambiguity in CBO’s baseline because of large temporary tax cuts has been excised by the American Taxpayer Relief Act, which made most of those tax cuts permanent while allowing the upper-bracket rate cuts to expire.  However, there still are temporary provisions whose expirations, assumed in the baseline as current law, would reduce the deficit – but which are most unlikely to happen.  The Medicare “doc fix” is set by law to expire, and the resulting 25-percent cut to reimbursements would save about $15 billion per year – but it is most unlikely that the Congress will allow that to happen.  There still are roughly $100 billion per year in expiring tax cuts – which are most unlikely to be allowed to expire, but whose expiration savings are counted in the baseline.  So once the Congress does what comes naturally, and throwing in additional debt service, the deficit for 2023 already will have reached close to $1.2 trillion.

And the baseline assumes that the March 1 sequester is allowed to occur.  Most Members of Congress oppose either the sequester’s domestic cuts, or its defense cuts, or both; and most economists fear its effect on employment and production.  Halting the sequester would bump the 2023 deficit by another $140 billion.  CBO reports that if the doc fix and the tax extenders were continued and the sequester were turned off, the debt at the end of 2023 would equal 87 percent instead of 77 percent of GDP.

So what are the potential upsides?  Well, the economy could grow faster.  CBO reports that, since the end of the recession, the economy has grown approximately at its rate of capacity growth, or even a little slower – in other words, there has been virtually no catch-up for all of the drop in employment and in utilization of factory and utility capacity.  CBO assumes some acceleration of growth starting in 2014.  Could the economy grow faster?  Certainly.  But there are precious few signs of a significant acceleration this year, before CBO assumes it already in the baseline.

What if the economy grows faster thereafter?  That would help, but it would seem prudent to assume that faster growth would bring with it somewhat higher interest rates.  And the federal government’s net interest costs already have eaten most of Cleveland, and are beginning to make their way south at an alarming clip.  As the following chart shows, projected discretionary outlays as a percentage of the GDP are on a downward trend for the next ten years.  (That is part of the reason why most budget wonks are at least concerned that the Congress will not be able to write and pass appropriations bills at the reduced spending caps that were enacted in the 2011 debt-limit deal – while many budgeteers fear that if those bills were made law they would harm the nation’s well-being by squeezing law enforcement, food safety, education, research, and many other priorities.)  Even with growing healthcare costs and aging of the population, mandatory spending costs barely fill in what the discretionary reductions save over the decade.  But the government’s net-interest bill is on an upward tear.  Faster economic growth unambiguously will reduce the deficit, but the higher the debt, the more of a damper higher interest rates and debt-service costs will put on the party.

DebtServiceCostChartFurthermore, few would suggest that we rely on growth, and then sit back and wait for it to appear from sheer luck.  Rather, most of the ideas that advocates put forward to increase growth would cost money – and hence increase debt – in the near term.  That simply increases the leverage that debt and debt-service cost would have over the deficit later.  And for every advocate for every idea to accelerate growth, there is a skeptic who argues that it would have no payoff, just increase the debt.

In sum, it is hard to see any good news in CBO’s new report.  We had a problem going in, and we have a problem coming out.  Like a water leak under the hood of your car, this problem won’t solve itself.  And like that water leak, it will not take kindly to being ignored.  It’s time for some serious maintenance, before it’s too late.

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