BEYOND THE NUMBERS
New CBO Budget Projections Are Cause for Concern — Not Alarm
New Congressional Budget Office (CBO) projections show that the budget outlook has deteriorated significantly, but that doesn’t justify unwise spending cuts or an economically damaging balanced budget amendment to the U.S. Constitution.
CBO now projects that the deficit will top $1 trillion in 2020 — two years earlier than it projected last June — and continue growing. The debt, now 77 percent of gross domestic product (GDP), will nearly equal the size of the economy by 2028.
CBO confirms that the recent tax cuts have not paid for themselves but, instead, have added significantly to deficits and debt, as the Joint Committee on Taxation concluded earlier. CBO estimates that the tax cuts have increased projected deficits by $1.9 trillion from 2018 through 2028, even after accounting for the law’s effect on economic growth.
CBO also notes that about a third of the added economic growth from the tax bill will benefit foreigners, not U.S. residents. That’s because foreign investment in the United States will go up, as will the return that foreign investors will earn on their U.S. investment.
This fiscal picture is cause for concern. Generally, the debt-to-GDP ratio should rise during periods of economic weakness or major emergencies and fall during good times. Tax revenues and spending on programs like unemployment insurance rise and fall naturally with economic conditions and, appropriately, policymakers allocate additional resources to fight recessions and address emergencies. Allowing the debt ratio to rise when the economy is strong, as in the new projections, may make policymakers too cautious to provide needed stimulus in the form of tax cuts or spending increases when the economy weakens. Also, a perpetually rising debt ratio makes it likelier that interest rates and the value of the dollar will rise, which would discourage investment and net exports. Moreover, a rising debt ratio is ultimately unsustainable when interest payments rise faster than GDP.
But the budget outlook is no reason for alarm. Researchers find no clear threshold above which debt significantly compromises economic growth. Moreover, today’s low real interest rates justify a higher debt-to-GDP ratio than was appropriate when the government faced much higher borrowing costs, because the costs of making the interest payments on our debt are lower than they’d otherwise be.
Stabilizing or reducing the debt-to-GDP ratio doesn’t require balancing the budget; it merely requires that the economy grow faster than the debt rises. For example, the nation ran balanced budgets or surpluses in only eight years from 1946 through 1979, yet the debt fell from 106 percent of GDP to 25 percent because the economy grew faster than the debt.
Adopting a balanced budget amendment to the Constitution, which the House will consider later this week, would be particularly damaging. As we’ve explained, it would raise serious risks of tipping weak economies into recession, make recessions longer and deeper, and harm Social Security and other trust funds.
Proposals to rescind billions of dollars in non-defense funding from the government funding bill that Congress passed last month — as President Trump may propose in the coming weeks — are also misguided. This category of spending has borne the brunt of deficit reduction in recent years and — even after the increases that the recent bipartisan budget agreement provided — will remain well below historical levels. CBO projects that non-defense discretionary spending in 2019 will equal 3.3 percent of GDP, which is still below its post-1962 average of 3.8 percent.
CBO’s new projections show that the aging of the population, rising health care costs, and other factors are significantly driving up the cost of, in particular, Social Security, Medicare, and Medicaid. As a result, even with further efforts to slow health care cost growth and find other efficiencies, total federal spending and revenues will need to be larger in relation to the size of the economy in coming years than they have been in the past.
Unfortunately, the tax bill moved the budget in exactly the wrong direction. CBO reports that federal revenues will drop to 16.5 percent of GDP in 2019 — well below their 40-year average of 17.4 percent. Restoring the federal revenue base should therefore be the major goal of fiscal policy in the next few years.