Still Crazy After All These Years: Understanding the Budget Outlook

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

©2007 Alan J. Auerbach, Jason Furman, and William G. Gale. Reprinted with Permission.

Abstract

The United States has gone undergone major fiscal changes in recent years. Despite the tax cuts enacted early in the decade and the increased spending enacted since then, the Congressional Budget Office (CBO, 2007b) currently projects a baseline surplus of $586 billion in the unified budget over the next 10 years. Under the baseline, the deficit will decline over the next few years, and turn to a surplus by 2012 that will continue to grow through 2017. This paper evaluates recent fiscal outcomes and assesses future fiscal prospects. First, we review recent changes in the budget outlook. There has been a sizable net deterioration in the budget outlook since 2001. For example, in January 2001, the CBO baseline projected a unified budget surplus of $573 billion in 2007. CBO's baseline now projects a deficit of $177 billion for 2007—a deterioration of $750 billion or about 5.5 percent of GDP. This deterioration is due almost entirely to changes in policy. For example, more than 90 percent of the deterioration in the 2007 outlook since 2001 is attributable, according to CBO estimates, to policy changes—tax cuts and increases in spending. The changes in the deficit since 2001 reflect differing trends in policy choices and in economic factors. Beginning in 2001 the deficit rose due to a series of policy changes, including tax cuts, a new Medicare entitlement, and increased spending on defense and homeland security. These policy changes have increased the deficit with each passing year. At the same time, the economy and technical factors that caused revenues to decline in the early 2000s have recovered strongly in recent years. In short, the economic and technical factors that elevated the deficit from 2002–05 have almost entirely reversed themselves, while the effects of policy changes continue to accumulate. As a result, almost all of the net change in fiscal projections since 2001 is due to deficit-increasing changes in policy.

Still Crazy After All These Years: Understanding the Budget Outlook

The U.S. has undergone major fiscal changes in recent years. Despite the tax cuts enacted early in the decade and the increased spending enacted since then, the Congressional Budget Office (2007b) currently projects a baseline surplus of $586 billion in the unified budget over the next 10 years. Under the baseline, the deficit will decline over the next few years and turn to a surplus by 2012 that will continue to grow through 2017.1 This article evaluates recent fiscal outcomes and assesses future fiscal prospects.

We first review recent changes in the budget outlook. There has been a sizable net deterioration in the budget outlook since 2001. For example, in January 2001 the CBO baseline projected a unified budget surplus of $573 billion in 2007. The CBO’s baseline now projects a deficit of $177 billion for 2007—a deterioration of $750 billion, or about 5.5 percent of GDP. More than 90 percent of the deterioration in the 2007 outlook since 2001 is attributable, according to CBO estimates, to policy changes— tax cuts and increases in spending. The changes in the deficit since 2001 reflect differing trends in policy choices and in economic factors. Beginning in 2001 the deficit rose due to a series of policy changes, including tax cuts, a new Medicare entitlement, and increased spending on defense and homeland security. Those policy changes have increased the deficit with each passing year. At the same time, the economy and technical factors that caused revenues to decline in the early 2000s have recovered strongly in recent years. In short, the economic and technical factors that elevated the deficit from 2002 to 2005 have almost entirely reversed themselves, while the effects of policy changes continue to accumulate. As a result, almost all of the net change in fiscal projections since 2001 is due to deficit-increasing changes in policy.

We then look forward and provide an alternative assessment of the fiscal outlook. The CBO baseline budget projections dominate public discussions of the fiscal status of the government. But as the CBO itself emphasizes, the baseline is not intended to serve as a prediction of likely budget outcomes. The set of default assumptions about current spending and tax policies used to develop the baseline are defined in part by statutory rules.2 The baseline assumes that almost all expiring tax provisions will be allowed to expire, the alternative minimum tax will be allowed to grow dramatically, no additional funding requests will be necessary to conduct the wars in Iraq and Afghanistan, and discretionary spending (including defense) will be held constant in real terms. If Congress abides by the ‘‘pay as you go’’ rules it recently adopted, the CBO’s assumptions would be broadly realistic because any changes to, say, limit the spread of the AMT would have to be fully paid for without increasing the deficit. If, however, the practices of recent years are continued and tax cuts and AMT relief are extended without offsets, the fiscal outlook would be considerably worse than the CBO’s baseline forecast. Regardless of the assumption about future policy, an additional problem with the CBO’s featured estimates is that the unified budget figures include large cash flow annual surpluses accruing in trust funds for Social Security, Medicare, and government pensions over the next 10 years. In the longer term, however, Social Security and Medicare face significant deficits.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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