A Look Into Our Fiscal Future
Last week, the Congressional Budget Office (CBO) released its first ten-year budget forecast since the COVID-19 pandemic upended the global economy. It’s a sobering assessment. The nation was facing a daunting fiscal challenge over the coming decades even before the crisis erupted; the surge in near-term borrowing has exacerbated the problem in dramatic fashion. The right political response is not immediate austerity but adoption of a long-term plan to align multi-generational spending commitments with achievable levels of tax collection.
According to CBO’s projection, the federal government will run a budget deficit in 2020 of $3.3 trillion, or 16 percent of GDP. The 2020 shortfall has ballooned from collapsing revenue and $2.3 trillion in emergency fiscal support. As a percentage of the national economy, the 2020 deficit is matched only by the wartime borrowing of 1943 to 1945. By next year, cumulative federal debt will exceed annual GDP; by 2030, it will reach 109 percent of GDP. Not so long ago — 2008— it was under 40 percent of GDP.
After 2020, CBO expects the economy to gradually recover — a not unreasonable assumption given that the public health emergency will pass at some point. Unemployment is forecast to fall to an average of 5.9 percent in 2023 and 2024. Historically low inflation and interest rates will dampen growth of the government’s net interest payments and slow the indexing of Social Security and other programs. The forecast shows an average annual budget deficit of 4.5 percent of GDP over the period 2026 to 2030, less than the 4.6 percent of GDP deficit recorded in 2019 when the economy was relatively strong.
While the CBO projection is daunting, policymakers should expect reality to be worse. CBO builds its forecast on current law and policy, which means it has excluded the cost of a possible additional round of COVID response legislation. A more likely scenario is eventual agreement on a compromise bill, with a cost of $1.5 to $2 trillion. Most of the new borrowing would occur in 2021.
CBO also projects increases in federal revenue from expiring tax cuts. While this is one possible scenario, a safer bet is that Congress will protect the middle-class from paying anything above what is required in current law (as Vice President Biden has proposed). That means some tax cuts enacted in 2017 might be extended, and perhaps permanently. Doing so could add another 1.0 percent of GDP annually to the deficit after 2025.
Another source of fiscal exposure is discretionary appropriations. CBO assumes spending for defense and non-defense accounts will average 5.9 percent of GDP from 2026 to 2030. That would represent an 8 percent cut relative to what was spent annually over the period 2014 to 2019. In the aftermath of the COVID-19 pandemic, it is more likely that Congress will boost funding for several critical agencies and program categories, including into health research, public health surveillance and response efforts, and emergency preparedness. Finding offsetting cuts is always a challenge in the appropriations process, so the default expectation should be wider deficits when pressure builds to put resources into sensitive accounts.
CBO has not yet updated its long-term budget forecast, which it last released in January. At that time, the agency expected federal debt wouldn’t reach 100 percent of GDP until 2031, after which it would soar. By 2050, cumulative federal borrowing was expected to reach 180 percent of GDP, and annual interest payments alone would cost 7.2 percent of GDP, up from 1.8 percent in 2019.
The pandemic will leave the country in an even weaker position to manage the costs of an aging population. It is possible, and maybe likely, that CBO’s next look at the long-term will show debt exceeding 200 percent of GDP within three decades. To believe the country could borrow at such a rate without severe negative economic and geopolitical consequences is naïve and reckless.
Congress should respond to this deteriorating fiscal landscape by focusing on restoring long-term stability to the nation’s finances. It is not necessary to balance the budget in the near term, or ever. What is required are gradual adjustments that moderate long-term spending on the major programs — Social Security, Medicare, and Medicaid. Tax hikes are necessary too, but they cannot be implausible relative to the levels tolerated by the public historically.
Elected leaders find it difficult to focus on challenges that do not present immediate difficulties for their constituents. But the nation’s fiscal imbalance is not amenable to rapid change and therefore requires long-term planning. Modifications to program rules need to be gradual, to minimize disruption for current beneficiaries.
The Social Security reforms enacted in 1983 provide a model. At that time, Congress approved an increase in the program’s normal retirement age (NRA), from 65 to 67. The change applied only to new retirees, and only after a long delay. The first affected cohort did not turn 65 until 2003, twenty years after the law was approved. And only retirees turning 65 in 2027 and later will have their benefits adjusted based on the full age 67 standard.
At the time the increase in the NRA was debated, it was controversial. However, once enacted, it faded from public discourse. Both parties supported the final bill, which made it difficult for either side to gain a partisan advantage from attacking its provisions.
Closing the long-term fiscal gap will require many NRA-like adjustments, so bipartisan compromise will be essential, both to get them enacted and to insulate them from later political attacks.
The nation’s leaders have squandered multiple opportunities over the past thirty years to bring spending and revenue into closer alignment over the long-term. Those failures have left the country vulnerable to a fiscal crisis. There is still time for a course correction, but CBO’s new report makes it clear that it is short, and the required correction has now widened considerably.
James C. Capretta is a Contributor at RealClearPolicy and holds the Milton Friedman Chair at the American Enterprise Institute.