Transcript: Testimony of Doug Elmendorf on CBO’s budget and economic outlook for 2012-2022

Testimony of Doug Elmendorf, Director of the Congressional Budget Office, on the Budget and Economic Outlook for 2012 – 2022 before the House Budget Committee on Feb. 1, 2012:

“Thank you, Mr. Chairman, Congressman Van Hollen. Thank you for your kind words about CBO. I am privileged to be leading a group of extraordinarily talented and dedicated public servants. And we all appreciate very much the support that you, Mr. Chairman, and you, Congressman Van Hollen, have shown for our work. We will continue to do our very best for this committee and for the Congress as a whole.

“I’ll be referring, as I talk, to some charts that I’m told are in your notebooks. It’s about a half dozen slides. They’re mostly out of the outlook but they’re collected in this little handout to make it easier for you to follow what I say.

“Let me begin by noting our baseline economic and budgetary projections are conditioned on current law – not because we expect that there will be no changes in law but because this approach provides a benchmark against which potential changes can be measured. 

CBO Director Doug Elmendorf. SOURCE:

“What we are presenting is a benchmark not a forecast. That distinction has a large impact on the budget and economic projections.

“What is our assessment of the economic outlook?

“As you know, the pace of the recovery has been slow since the recession ended two-and-a-half years ago. And we project that it will continue to be slow for the next two years, reflecting both the lingering effects of the crisis and the financial markets and the recession and the fiscal restraint that will arise under current law.

“Specifically, the current law fiscal policy will reduce the growth of output slightly in 2012 and significantly in 2013 through a combination of large tax increases and spending cuts.

“Our projections incorporate: the upcoming expiration of the payroll tax cut and emergency unemployment benefits; the expiration of the tax cuts enacted in 2001, 2003, and 2009 as well as other expiring tax provisions; the constraints on spending imposed by last year’s Budget Control Act; and the winding down of the budgetary effects of the 2009 Recovery Act.

“Taken together, those policies will generate a sharp fiscal contraction. In addition, the excess number of houses, loss of wealth, run-up in debt, and other legacies of the economic downturn are continuing to weigh on household and business spending.

“If you look at the first slide in the packet, we project that real GDP will grow by only 2% this year and only about 1% next year. We expect economic activity to quicken after 2013 but real GDP to remain below the economy’s potential through 2017.

“According to our projections, the economy is only about halfway through the cumulative shortfall in output that will result from the recession and its aftermath.

“The costs associated with that persistent output gap are immense and they fall disproportionately on people who lose their jobs, who are displaced from their homes, or who own businesses that fail.

“In particular, the labor market still has a great deal of slack mainly as a consequence of continued weakness in demands for goods and services.

“In CBO’s forecast, unemployment rate remains above 8% both this year and next. As economic growth picks up after 2013, unemployment rate will gradually decline. But in our projection, it remains above 7% until 2015 before dropping to 5.25% by the end of the coming decade.

“While the economy continues to be weak during the next few years, inflation and interest rates will remain low.

“Let me turn now to our budget projections.

“Under current law, we expect that this year’s deficit to be about $1.1 trillion. At 7% of GDP that is nearly 2% less than the deficit recorded last year but still larger than any deficit between 1947 and 2008.

“Over the next few years, projected deficits in CBO’s baseline narrow sharply, averaging 1.5% of GDP and totaling about $3 trillion between 2013 and 2022. With deficits small relative to the size of the economy, debt held by the public drops a little as a share of GDP but remains quite high.

“Much of the projected decline in the deficit occurs because under current law, revenues will rise considerably. In particular, between 2012 and 2014, revenues in our baseline shoot up by more than 30% because of the recent or scheduled expiration of various tax provisions and new taxes or other collections that are scheduled to go into effect.

“Federal spending in the baseline declines modestly relative to GDP in the next few years as the economy expands and the statutory caps constrain discretionary appropriations.

“Later in the decade, spending turns up again relative to GDP because of increasing expenses generated by the aging of the population and rising cost for health care and because of the accumulation of debt and rising interest rates will cause a surge in the government’s interest costs.

“Of course, these baseline projections are heavily influenced by the changes in tax and spending policies that are embodied in current law. Changes that in some cases represent a significant departure from recent policies.

“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 scenarios. Like the baseline, this is not a prediction by us about policy or a recommendation about policy. It’s simply meant to show to you the consequences of some fiscal action that are regularly discussed in the Congress.

“This alternative scenario incorporates the following assumptions. First, that all expiring tax provisions – other than the payroll tax reduction – are extended. Second, that the Alternative Minimum Tax (AMT) is indexed for inflation after 2011. Third, that Medicare’s payment rates for physician services are held constant at their current level rather than dropping by 27% in March and more thereafter as scheduled under current law. And fourth, that 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, although in this scenario the original cap under the discretionary appropriations would remain in place.

“Under that alternative scenario, deficits over the 2013-2022 period would be far higher than the baseline, averaging 5.5% of GDP rather than 1.5% and totaling $11 trillion rather than roughly $3 trillion. Debt held by the public would climb on an unsustainable path reaching 94% of GDP in 2022 – the highest figure since just after World War II.

“Under that scenario, the economy would be noticeably stronger in the next few years than under current law but noticeably weaker later in the decade. The report presents estimates of those effects using ranges of number to reflect the uncertainty involved. The midpoint of the ranges through the end of 2013 show GNP that is 2% higher and unemployment rate that is 1% lower than would be the case under current law. However, the midpoint of the range for 2022 shows GNP that is almost 2.5% lower than under current law because of the crowding out of investment that will be caused by the escalating debt.

“It bears emphasis that projecting economic outcomes for any path of fiscal policy and the budget outcome that would result from them is very difficult. Many things could turn out to cause the economy and the budget be worse or better than we project. However, there is no plausible economic outcome under which the policies of the alternative scenario I’ve outlined would lead to a sustainable budget outcome.

“The fundamental fiscal challenge during this decade and beyond remains the aging of the population and the rising cost for health care. The number of people aged 65 or older will increase by one-third in the coming decade, substantially raising the cost of Social Security, Medicare, and Medicaid. In addition, the Affordable Care Act will significantly increase the number of non-elderly people receiving assistance through federal health care programs. Furthermore, CBO predicts that the cost per enrollee for Social Security and the major health care programs will continue to rise.

“Because of these forces, the set of budget policies that were in effect in the past cannot be maintained in the future.

“Here’s one way to think about the problem using CBO’s projection under the alternative fiscal scenario, which is as I’ve said represents a combination of many recent and current policies.

“Under the scenario, outlays for Social Security and the health care programs would be much higher by the end of this coming decade than in the past – more than 5% GDP higher than the net 40-year average. However, outlays for all other federal programs are projected to be much lower than in the past, averaging in the past 40 years about 11% of GDP. Now projections in this scenario, they will be about 8% of GDP in 2022. That would be lower than any year in the past 40 years. And despite the constraint in those programs, the rising costs for Social Security and the federal health care programs mean that the budget deficit under this scenario is projected to be 6.1% of GDP.

“To keep debt from rising relative to GDP, the deficit would need to be about $900 billion smaller in 2022 – in that year alone – would be the case under the scenario.

“Therefore to put the federal budget on sustainable path, policymakers will need to allow federal revenues to increase to a much higher percentage of GDP than we’ve seen in the past 40 years. Or make very large changes to Social Security and federal health care programs. Or pursue some combination of those two approaches.

“Let me close by highlighting the consequential choices that policymakers face this year.

“On one hand, if policymakers leave current laws unchanged, the federal debt will probably recede slowly relative to the size of the economy. That will occur because of a large increase in revenues and a sharp restraint in federal spending apart from the largest programs I’ve mentioned.

“However, both of those budgetary changes from historical patterns will have significant economic and social effects. Moreover, the sharp fiscal restraint will markedly slow the economic recovery.

“On the other hand, changing current law to allow current policies to continue would boost the economy and allow people to pay less in taxes and benefit more from government programs in the next few years but would put the nation on a quickly unsustainable fiscal course.

“If policymakers want to achieve both a short-term economic boost and medium-term and long-term fiscal sustainability, they would need to enact policies that lead deficits significantly wider than in our current law baseline in the next few years but significantly narrower that would occur under this continuation of current policies that we’ve described in the alternative fiscal scenario.

“In conclusion, how much and how quickly the budget deficit declines over the coming decade will depend in part on how well the economy does. Probably more critical, though, will be the choices you make as you face the substantial changes to tax and spending policies that are slated to take effect within this year.”



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