The outlook for the federal budget is deceptively benign under the
January 2006 baseline assumptions of the Congressional Budget
Office (CBO). In its latest 10-year
projections, CBO describes a budget that will reach balance in 2012 and stay
balanced through 2016, the end of the projection period (see Table 1). Indeed, unlike the genre of television
programs that highlight the intense struggles of victors despite overwhelming

The outlook for the federal budget is deceptively benign under the
January 2006 baseline assumptions of the Congressional Budget
Office (CBO). In its latest 10-year
projections, CBO describes a budget that will reach balance in 2012 and stay
balanced through 2016, the end of the projection period (see Table 1). Indeed, unlike the genre of television
programs that highlight the intense struggles of victors despite overwhelming
odds, the baseline makes budget balance appear a little too easy.

Table 1. CBO Baseline
Projections, January 2006

The Baseline: What’s
In and What’s Not

When compared with baseline projections that CBO issued last
August, the new estimates show surprising improvement. Last August, CBO estimated that deficits
would total $2.1 trillion between 2006 and 2015. In its January report, CBO now projects that
deficits will total $1.2 trillion over the same
10-year period. The change in the
10-year outlook results from two principal sources, neither of which result from
conscious policy choices:

·
Increases in revenue projections resulting from changes
in CBO’s economic assumptions. CBO has
boosted its estimates of gross domestic product (GDP) throughout the 10-year
horizon and increased is projections of corporate profits. Higher GDP means higher revenues. Greater
profits mean higher corporate tax bills. The GDP increase, however,
does not reflect stronger underlying economic activity. Instead, it stems from
accounting adjustments to GDP estimates in 2005 and increases in the rate of
inflation in 2005 due to energy price increases.

·
Decreases in estimates of discretionary spending
largely because new funding enacted so far in 2006 for activities related to
Iraq and Afghanistan ($50 billion) is lower than 2005 levels ($76
billion). The increasing use of
supplemental appropriations, rather than “upfront” budgeting for expected
costs, can create large swings in baseline projections that are
misleading. CBO expects that the
Congress and President will add more funding for Iraq and Afghanistan. However,
those amounts are not included in the new projections. Had they been included
in the 2006 appropriation bill for the Department of Defense (DOD), the
baseline would include a more realistic level of funding.

In constructing its baseline, the CBO is required to
incorporate assumptions about current laws and statutes. According the report, the baseline “…is
therefore not intended to be a prediction of future outcomes: instead it is meant to serve as a neutral
benchmark that lawmakers can use to measure the effects of proposed changes to
spending and taxes.”

The apparent shift in the budget’s outlook since last August
illustrates why the baseline cannot be interpreted as the most likely path for
the budget. CBO informally estimates
that the deficit in 2006 will be around $360 billion—$23 billion higher than the
published estimate of $337 billion—when lawmakers add funds for DOD and
hurricane-related flood insurance claims that the baseline is precluded from
incorporating.

Beyond current law, CBO bases its projections on economic
and technical assumptions that reflect past outcomes, not future events. Thus, even if the Congress were to refrain
from passing any legislation not consistent with the baseline assumptions, the
budget’s future outcome is likely to deviate from CBO’s projections. It could be better. It could be worse

Table 2 illustrates the types of pressures that will affect
the budget’s course over the next decade.

Table 2. The Baseline:
What’s In and What’s Not

Consequently, attaining and maintaining a balanced
budget—while possible given the baseline assumptions—will be far more
difficult than it looks. That is
particularly true because: (1) there is no
firm consensus within the Congress or the White House that the
budget balance is the
appropriate goal; and (2) lawmakers lack enforceable rules that
would encourage them to live
within whatever budget limits they do set for
themselves.

Over
the next 10 years there will be two presidential elections and five
congressional elections. Without a firm
commitment to fiscal discipline backed
up by budget enforcement
rules, deficits are more likely to increase than
decrease. Budget
process tools, such as statutory limits on discretionary
spending and a pay-as-you-go (PAYGO) requirement for entitlement program and
tax law changes, helped policy makers
achieve a balanced budget in 1998. The need for such rules is even more acute
now.

A More Plausible Budget Outlook

A more plausible outlook for the budget shows persistent and
growing deficits throughout the projection period (see Figure 1). That scenario would: adjust funding upward
for Iraq and Afghanistan in 2006 and 2007, but phase it down starting in out
in 2008 and leveling out beyond 2010;
incorporate spending for discretionary (annually-appropriated) programs at the
rate of GDP growth; and renew and extend relief from the AMT (without which the
number of returns subject to the AMT will jump from 4 million in 2005 to 20
million in 20106). IBut
if the White House convinces the Congress to make the 2001-2003
tax cuts permanent, the budget’s bottom line will be in far worse shape.

Demographic Delusions

CBO’s budget
projection period now extends well into the early retirement years of the
post-World II baby boomers. The oldest
boomers turn 60 this year. Over the next
two decades, assuming no change to current laws, the movement of the baby
boomers out of the active workforce and into retirement will exert enormous
pressure on the budget. CBO’s latest
long-term analyses indicate that spending for Social Security, Medicare and
Medicaid will exceed total projected revenues beginning in 2047 (see Figure 2).[1] According to CBO, spending will reach 38
percent of GDP—88 percent larger than today’s budget.

None of
those developments is new news. Not only
have policy makers failed to address long-term budget problems, they have made
them worse (see Figure 3) by adding a major new entitlement—the Medicare
prescription drug benefit—w without adding adequate financing.

Debt
levels as high as those contained in CBO’s projections would not be sustainable. The CBO report states:

A budget policy that
caused federal debt to grow continually faster than GDP could seriously harm
the economy. Rising government debt can
sap national saving, slow private capital formation, lower economic growth, and
in the extreme, produce a sustained economic contraction. Moreover, such a policy could increase the
United States indebtedness to other nations. Implying that more of the
economy’s output would have to be used to pay interest on the debt and less
would be available for U.S. residents.

Under the intermediate scenario
shown above, interest on the debt grows faster than health care costs. By 2050, if the projection shows spending for
net interest equivalent to one-third of all spending and nearly equal to the
level for Medicare and Medicaid combined.

CBO cautions that there are no
easy solutions. The U.S. in not likely
to be able to grow its way out of the imbalances between spending and revenues
implied by current policies. Under current policies, non-interest spending in
2050 is projected to be nearly 7 percent higher as a share of GDP than it is
today. Paying for that increase
exclusively by raising taxes could hurt economic growth by adversely affecting
individual incentives to work and save, while reductions of that size in
projected spending for benefits could have a large and negative impact on the
standard of living of future retirees.

The report provides some
indication of the potential impact of various policies on the gap.

·
Revenues under current law will rise by 4
percent of GDP between now and 2050, CBO projects. That assumes, however, that the income tax
rate reductions enacted in 2001 and 2003 expire and that there is no
modification to the AMT to accommodate inflation.

·
Indexing the AMT for inflation would reduce the
growth in revenues to 2 percent of GDP in 2050.
Without that type of modification, CBO estimates that 65 percent of tax
returns in 2050 would be subject to the AMT—a sharp increase from the 2 percent
of returns affected today.

·
Simply allowing the 2001 and 2003 tax cuts to
expire on schedule would raise revenues by about 1 percent of GDP throughout
the time period.

·
Reducing cost-of-living adjustments in Social
Security to the consumer price index less 0.3 percent would provide small
savings of about 0.3 percent of GDP in 2050.

·
Raising the eligibility age for full Social
Security retirement benefits to age 70 (affecting anyone born in 1967) and
indexing it for longevity would reduce spending by 0.8 percent.

·
Raising the Medicare eligibility age to 67 would
reduce spending by 0.2 percent of GDP in 2050. Increasing it to age 70
(consistent with the increase in eligibility age for Social Security describe
above) would reduce spending by 0.9 percent of GDP in 2050.

In today’s climate, none of those changes would be easy to
enact into law. They do illustrate that
there are policy choices that would help put the budget onto a sustainable path
over the long term. Although baby
boomers have a reputation for not acting their age, there is no denying the
fiscal impact of their continued aging.

Fiscal Insecurity

Balancing the budget is not an end in and of itself, but a
means to an end. A balanced budget
provides evidence of sustainable fiscal policy and responsible governance. Deficits accumulated over the last four years
total nearly $1.3 trillion—approximately $4,300 for every man, woman and child
living in the United States today. Explanations for those deficits abound
(recession, terrorism, war, natural disasters, etc.). More than half of the deterioration in the
budget outlook since January 2001 (when CBO projected $5.6 trillion in budget
surpluses for 2002-2011) results from enacted legislation, which policy makers
do control.

Over
the next 10 years there will be two presidential elections and five
congressional elections. Without a firm
commitment to fiscal discipline backed up by budget enforcement rules, deficits
are more likely to increase than decrease.
Budget process tools, such as statutory limits on discretionary spending
and a pay-as-you-go (PAYGO) requirement for entitlement program and tax law
changes, helped policy makers achieve a balanced budget in 1998. The need for such rules is even more acute
now.

It isAt a minimum, elected
officials should agree not to make problems any worse. That means, for a start, returning to
enforceable budget discipline—spending limits for discretionary programs and
pay-as-you-go (PAYGO) requirements for entitlement and tax law changes. t True,
thate
Congress ispassed
working on part of a budget reconciliation
package that includes spending reductions of $99 billion over the 2006-2015
period. HoweverIf enacted,
those savings would amount to a little more than 50 cents out of every $100 in
spending for entitlements and other mandatory programs on over that 10-year
period. Even that marginal progress
would be offset by the proposed extensions of the 2001 and 2003 tax cuts, which
would cost 16 times the amount of pending spending cuts.

What is striking about the
current budget debate is the obvious lack of any consensus within the Congress
about priorities and the goals of fiscal policy. The controversy over the 2006 reconciliation
agreement is as much about balance as it is about the incidence of the spending
cuts. Whereas successive deficit
reduction legislation in the 1980s and 1990s focused on revenue increases,
as well as spending restraint, the current, exclusive emphasis on spending cuts
threatens to undermine serious efforts to address fiscal imbalance.

Pressures are mounting throughout the economy—on private
firms as they attempt to address problems with their global competitiveness
including the cost of health care and retirement benefits for their employees;
on baby boomers, many of whom are balancing the need to support children as
well as aging parents; and on state and local governments that are struggling
with their own fiscal gaps. The ability
of the federal government to be the “insurer of last resort” and to be in a
position to address emerging national needs is compromised by the policy
makers’ inability to confront the budget’s shortcomings. That injects uncertainty and instability into
the economy, when what is required is decisive leadership. The result is fiscal insecurity for both
current and future generations.

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