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Congressional Budget Office
Presentation to the
National Association for Business Economics
Fiscal Policy ChoicesMarch 8, 2010
Douglas W. Elmendorf
Director
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Fiscal Policy Choices
Review the estimates done by the Congressional Budget Office (CBO) and the staff of the Joint Committee on Taxation (JCT).
Discuss a number of challenges to those estimates.
Nothing I’m going to say is new: Everything is drawn from the letters that CBO has released. But probably you have not been following everything we’ve written as closely as I have, so some or all of this may be new to you.
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Forecast for a Slow Recovery
Severe economic downturns often sow the seeds of robust recoveries:– During a slump in economic activity, consumers defer
purchases, and businesses postpone capital spending.– Once demand picks up, spending and employment can
accelerate rapidly.
The current recovery will be dampened by several factors:– Continuing fragility of some financial markets and institutions.– Restrained increase in household spending.– Declining support from monetary and fiscal policy.
4
Real Federal Funds Rate
Percent
Note: The real federal funds rate is defined as the nominal rate less the year-over-year change in the core PCE price index.
5
Estimated Budgetary Effects of ARRA
Billions of Dollars
2009 2010 2011 2012 2013 2014 2015
-50
0
50
100
150
200
250
300
350
400
450
Revenues
DiscretionaryOutlays
Mandatory Outlays
Total Effect on the Deficit
6
Effect of ARRA on the Output Gap
Gap Between Actual and Potential GDP as Percentage of Potential GDP
Without Stimulus
Legislation
7
The Budget Deficit or Surplus
Percentage of GDP
1970 1980 1990 2000 2010 2020
-12
-10
-8
-6
-4
-2
0
2
4
-12
-10
-8
-6
-4
-2
0
2
4Actual Baseline
Projection
8
Unemployment Rate
Percent
9
With Tax Cuts Extended and AMT Indexed
Budget Deficit or Surplus
Percentage of GDP
10
CBO’s Estimate of the President’s Budget, 2011-2020
Trillions of Dollars
Deficit under current law baseline 6.0
Extension of most of 2001 and 2003 tax cuts and indexing of AMT (approximate, including debt service)
3.7
Other proposals (approximate, including debt service) *
Deficit under the President’s budget 9.8
Note: * = Less than $0.05 trillion.
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Rising Debt Burden
Percentage of GDP
1970 1980 1990 2000 2010 2020
0
10
20
30
40
50
60
70
80
90
100
0
10
20
30
40
50
60
70
80
90
100
Tax CutsExtended andAMT Indexed
Actual Projected
Baseline
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Why Does Rising Federal Debt Matter?
Tax revenues are used to pay interest rather than finance current programs.
Crowding out of saving and investment lowers future output and income relative to what would otherwise occur.
The ability of the government to respond to future needs is reduced.
The risk of a sharp jump in interest rates (perhaps related to flight from U.S. Treasuries or U.S. assets more generally) is heightened.
13
Debt Burden Across Countries in 2007
Percentage of GDP
Source: OECD.
LuxembourgAustraliaNorwayIreland
New ZealandMexicoIceland
SwitzerlandCanada
Czech RepublicDenmark
Slovak RepublicKoreaSpain
FinlandUNITED STATES
SwedenNetherlands
GermanyTurkeyPoland
United KingdomFranceAustria
HungaryPortugalBelgium
ItalyGreeceJ apan
0 20 40 60 80 100 120 140 160 180
2020 CBOBaseline
With Tax CutsExtended andAMT Indexed
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The Path of Fiscal Policy
The problem with the federal budget deficit is not its level today when the economy is weak. The problem is its future path.
Forecasts of budget and economic outcomes are highly uncertain. We believe that our projection balances the risks.
The outlook for the budget under “current policy” is bleak. The key choices are not whether to change course on the federal budget, but how quickly and in what way.
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Effective Federal Tax Rates
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006
0
5
10
15
20
25
30
35
40
Lowest Quintile
Middle Quintile
Highest Quintile
Top 1%
Percent
16
Federal Revenues, 1970 to 2020
Percentage of GDP
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
0
14
15
16
17
18
19
20
21
22
With Tax CutsExtended andAMT Indexed
Baseline
AverageRevenues,
1970 to 2020
Actual Projected
Note: Extending certain tax provisions enacted in 2001 and 2003 would also increase outlays for refundable tax credits. However, the outlay effect is shown here in the revenue line.
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Components of the Federal Budget
1970 2007 2020 March Baseline
Percentage of GDP
Revenues 19.0 18.5 20.3
Outlays 19.3 19.6 23.3
Social Security, Medicare, and Medicaid 3.8 8.2 11.1
Defense 8.1 3.9 3.6
Other mandatory spending and nondefense discretionary spending
6.0 5.8 5.3
Net interest 1.4 1.7 3.2
Deficit 0.3 1.2 3.0Note: Figures are shown net of offsetting receipts where relevant.
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Outlays for Some Key Federal Programs Will Exceed Total Federal Revenues Under “Current Policy”
Percentage of GDP
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
0
14
16
18
20
Revenues, with Tax Cuts Extended andAMT Indexed
Outlays for Medicare, Medicaid,Social Security, Defense, and Net Interest
Actual Projected
Note: Extending certain tax provisions enacted in 2001 and 2003 would also increase outlays for refundable tax credits. However, the outlay effect is shown here in the revenue line.
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If the Goal is to Balance the Budget in 2020
The Scale of The Problem The Scale of Possible Solutions
$0.7 trillion Baseline deficit $2.5 trillion Social Security, Medicare, and Medicaid
$1.4 trillion Deficit if 2001 and 2003 tax rate cuts are extended and AMT is indexed
$1.2 trillion Other mandatory spending and nondefense discretionary spending
$0.8 trillion Defense
$2.4 trillion Individual income tax
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Conclusion
The problem posed by the federal budget deficit is not its current level, but its trajectory—especially if policymakers make changes to current law to maintain what many people view as current policy.
In the past several decades, the country paid for increases in Social Security, Medicare, and Medicaid spending through cuts in defense spending relative to the size of the economy. That approach is not feasible in the future. Instead, significant changes will be needed in taxes or spending directly visible to many Americans.