Federal Fiscal Policy Chartbook: What’s the Baseline?
|A Tough Operating Framework for Fiscal Policy
In the coming months, Congress and the administration will continue to work through a lengthy list of legislative items, including lifting the debt ceiling, funding the government, tackling a repeal and possible replacement for the Affordable Care Act (ACA) and attempting to pass major tax legislation. While the details and political likelihood of these proposals have yet to fully develop, one of the biggest challenges facing policymakers is the fiscal outlook under current law. This year's Budget and Economic Outlook published by the Congressional Budget Office (CBO) shows rising deficits and higher debt levels over the next 10 years.1 As the fiscal policy debate continues to unfold, it is an open question whether more conservative members of Congress will agree to even greater deficit spending and debt if proposed budgetary offsets prove to be politically unpalatable. In our fiscal policy outlook, we review the current law baseline for federal spending and revenues to provide some context for the coming fiscal policy debates. In addition, we compare the assumptions employed by the CBO with our own economic forecast.
Over the next 10 years, if current law remains unchanged, CBO expects federal revenues and outlays to average 18.1 percent of GDP and 22.0 percent of GDP, respectively. The result is a large and growing budget gap that climbs from 2.9 percent of GDP in federal fiscal year (FY) 2017 to 5.0 percent of GDP by FY 2027. The stock of debt, measured by the debt-to-GDP ratio, would climb roughly 12 percentage points from today's level to 88.9 percent of GDP in FY 2027.
The growth in annual deficits and by extension federal debt stems primarily from growing outlays for the major health care programs, Social Security and net interest expenses. These three components of the budget comprised about 56 percent of total federal spending in FY 2016 and, under CBO's baseline, would account for roughly 67 cents of every dollar spent by the federal government in FY 2027. Against this backdrop, Congress and the administration will face significant challenges fitting their policy ideas within the long-term fiscal outlook.
We Expect Greater Deficits Relative to the Baseline
The current law baseline from the CBO serves as a key yardstick by which future policy actions will be measured. With large and growing budget deficits under current law, enacting policy changes that do not make the fiscal outlook significantly worse remains the biggest challenge for policymakers.
Amid all of the debates over tax reform, ACA repeal, deregulation, immigration, trade and a slew of other policy areas, the discussion regarding the unsustainability of many entitlement programs and their adverse effect on the budget outlook has been drowned out. For example, the latest Trustees report on the state of the Social Security program shows that, without congressional intervention, the trust fund will be exhausted in 2034, resulting in an automatic 21 percent reduction in benefits.2 Critically, the key drivers of federal debt growth in the years ahead are either programs the Trump administration has signaled some unwillingness to alter (such as Social Security and Medicare) or spending that policymakers can do little to change (net interest). Thus, financing these programs over the long-run translates into higher taxes, dramatically reduced spending on discretionary programs or greater deficit spending through debt issuance. The current baseline projections for the federal budget are a key hurdle as policy makers attempt to implement their policy wish list.
In our February Monthly Economic Outlook, we established a set of assumptions about the future path of federal fiscal policy. Among these assumptions were an increase in defense spending, the repeal and partial replacement of the Affordable Care Act and related taxes, individual income tax cuts and corporate tax cuts. At this time, we do not see a path for additional infrastructure spending, although some tax breaks for infrastructure projects are expected. With these assumptions, we see the federal budget deficit for the current 2017 fiscal year climbing to $650 billion or 3.4 percent of GDP compared to the CBO's estimate of $559 billion or 2.9 percent of GDP. For fiscal year 2018, we expect a federal budget deficit of $950 billion or 4.7 percent of GDP compared to the CBO's current law baseline of $487 billion or 2.4 percent of GDP.3 In our outlook, we do not assume that the additional fiscal stimulus, mostly in the form of tax cuts, will be paid for through offsetting reforms, such as the border adjustment tax. Thus, our outlook entails much higher budget deficits relative to the CBO's outlook. The bottom line is that even under current law, the fiscal outlook remains on an unsustainable course, a path that will look much worse should fiscal policy actions result in even larger deficits in the years ahead.
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