CBO Issues Interesting Budget & Spending Projections

February 2012

On the last day of January 2012, the Congressional Budget Office (CBO) issued its budget and spending projections for the federal government covering the next ten years. The 167-page report is full of economic and spending charts and statistics that a firm like Fulcrum finds entirely fascinating. Recognizing that the level of detail contained in the full report may not be quite as fascinating for you, we provide here a summary of the CBO’s most important conclusions.

The Economy & Unemployment Will Stay Weak or will Deteriorate

The CBO estimates that the unemployment rate for 2012 will average 8.9%, and will deteriorate to 9.2 % for 2013. In another table, the unemployment rate for both years is 0.1% less, meaning 8.8% and 9.1% for 2012 and 2013, respectively.

These unemployment rates are higher than what has been recently reported. The recent unemployment rate has been favorably impacted by discouraged unemployed workers who are taken out of the calculations. The CBO believes that these shorter-term unemployment reductions are not indicative of the weakness in the labor market.

Much has recently been written by others about structural unemployment; that is, the effect of the unemployment rate by potential workers who do not have the correct skills. The CBO indicates that little of the unemployment is caused by this, and instead attributes the unemployment to a lack of consumer demand. In this regard, the CBO see no significant increase in economic activity, and in fact has a lower forecast that was released in August 2011. According to the CBO,

“The economy remains in a severe slump. The Congressional Budget Office (CBO) expects that, under current laws governing federal taxes and spending, economic activity will continue to grow slowly over the next two years.”

The Deficit May Decrease … Or Not

The CBO creates two projections. The first is based on expiration of the so-called Bush tax cuts that are scheduled to expire at the end of 2012, as well as certain changes that would not be politically popular. However, if changes are made to extend certain items, then an entirely different situation occurs. The CBO describes its baseline and alternative forecasts as follows:

“CBO’s baseline projections are heavily influenced by changes in tax and spending policies that are embodied in current law—changes that in some cases represent a significant departure from recent policies. As a result, those projections show much higher revenues and lower outlays than would occur if the lower tax rates now in effect were extended and if provisions constraining future spending were not implemented. To illustrate the budgetary consequences of maintaining some tax and spending policies that have recently been in effect, CBO developed projections under an “alternative fiscal scenario.” That scenario incorporates the following assumptions:

• Expiring tax provisions (other than the payroll tax reduction) are extended;

• The AMT is indexed for inflation after 2011;

• Medicare’s payment rates for physicians’ services are held constant at their current level (rather than dropping by 27 percent in March 2012 and more thereafter, as scheduled under current law); and

• The automatic spending reductions required by the Budget Control Act in the absence of legislation reported by the Joint Select Committee on Deficit Reduction do not take effect (thereby leaving in place the discretionary caps established by the act, which would otherwise be subject to those reductions).”

Under the baseline or existing-law scenario, taxes increase and the deficit declines. The overall situation under the existing-law alternative is described as follows:

“Much of the projected decline in the deficit occurs because, under current law, revenues will rise considerably as a share of GDP—from 16.3 percent in 2012 to 20.0 percent in 2014 and 21.0 percent in 2022. In particular, between 2012 and 2014, revenues in CBO’s baseline shoot up by more than 30 percent, mostly because of the recent or scheduled expirations of tax provisions, such as those that lower income tax rates and limit the reach of the alternative minimum tax (AMT), and the imposition of new taxes, fees, and penalties that are scheduled to go into effect.”

Under the “alternative fiscal scenario”, budget deficits and public debt increase to unworkable amounts. Under this alternative, other changes in spending would clearly be required. The economy would suffer. The CBO’s bottom line under the alternative is:

“Real GDP under that scenario would fall increasingly below the level in CBO’s baseline projections because the larger budget deficits would reduce private investment in productive capital.”

Entitlements Must Change

Under both forecast alternatives, demographic factors play a significant role. The CBO describes this as follows:

“During the coming decade and over the longer term, the aging of the population and rising costs for health care will continue to exert significant pressure on the federal budget. The number of people age 65 or older will increase by about one-third between 2012 and 2022— from 14 percent of the population to 17 percent— substantially raising the cost of Social Security, Medicare, and Medicaid. In addition, the Affordable Care Act, enacted in 2010, will significantly increase the number of nonelderly people receiving assistance through federal health care programs. …

Because of the aging of the population and rising costs for health care, the set of budget policies that were in effect in the past cannot be maintained in the future. In CBO’s projections for 2022 under the alternative fiscal scenario, gross outlays for all federal programs apart from Social Security, the major health care programs, and net interest are projected to be 7.8 percent of GDP, lower than in any year during the past 40 years and well below the 11.4 percent of GDP that such outlays have averaged over that period. Yet the budget deficit in 2022 under that scenario is projected to be 6.1 percent of GDP. Therefore, to keep deficits and debt from causing substantial harm to the economy, policymakers will need to allow federal revenues to increase to a much higher percentage of GDP than the average over the past 40 years, make major changes to Social Security and federal health care programs, or pursue some combination of the two approaches.”

The level of entitlement spending is unworkable under any forecast alternative. The CBO describes this as follows:

“At $1.6 trillion in 2012, federal outlays for Social Security, Medicare, Medicaid, and other health care programs will make up more than 70 percent of mandatory spending (or 10.4 percent of GDP). Spending for those programs will rise by $1.5 trillion from 2012 to 2022— accounting for nearly all of the growth in mandatory spending over that period. By 2022, spending for those programs will represent more than 80 percent of mandatory spending and 12.8 percent of GDP.

Programs that are designed to provide income security—such as unemployment compensation, the Supplemental Nutrition Assistance Program (SNAP, formerly known as Food Stamps), and certain refundable tax credits—will account for about 17 percent of mandatory spending in 2012. …

Spending for the program [Medicaid] will climb again in 2013 and will shoot up rapidly in 2014, 2015, and 2016 as a result of provisions in the Affordable Care Act. By 2022, under current law, federal outlays for Medicaid are expected to total $605 billion, more than twice the 2012 amount; spending will equal about 2.5 percent of GDP, compared with 1.7 percent this year. …The Affordable Care Act establishes new exchanges for the purchase of health insurance and authorizes government subsidies for such purchases for individuals and families who meet income and other eligibility criteria. The subsidies for health insurance premiums are structured as refundable tax credits; the portions of such credits that exceed taxpayers’ liabilities are classified as outlays, while the portions that reduce tax payments appear in the budget as reductions in revenues. CBO estimates that about 8 million people will receive exchange subsidies in 2014 and roughly 20 million will receive them by 2022. Outlays for providing those subsidies, operating the exchanges, and running related programs will total $104 billion by 2022, according to CBO’s estimates.”

Subsidized “Tax Expenditures” are Huge

The CBO describes this topic as follows:

“A number of exclusions, deductions, exemptions, and credits in the individual and corporate income systems cause revenues to be much lower than they would be otherwise. Some of those tax provisions are termed “tax expenditures” because they resemble government spending by providing financial assistance to specific activities, entities, or groups of people. Tax expenditures are more like entitlement programs than like discretionary spending programs: They are not subject to annual appropriations, and any person or entity that meets the requirements for them can receive the benefits. Because of their budgetary treatment, however, tax expenditures are much less transparent than spending on entitlement programs.”

The amounts involved are staggering, and so are worthy of a debate regarding whether the activities being subsidized reflect our national priorities. The CBO estimates the overall size of these subsidies as follows:

“Tax expenditures have a major impact on the federal budget. On the basis of estimates prepared by JCT and extrapolated by CBO through the 10-year budget window, CBO estimates that certain major tax expenditures in the individual income tax code (described below) will total nearly $12 trillion over the 2013–2022 period—or 5.8 percent of GDP … In 2012, those major tax expenditures total more than $800 billion—or 5.3 percent of GDP, equal to about one-third of the federal revenues projected for 2012 and greater than projected spending on Social Security, on defense, or on Medicare.”

The following table lists the four largest tax expenditures, the area that is being encouraged by the existence of the subsidy, and their size as a percentage of the Gross Domestic Product (GDP)

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