Transcript: Remarks by CBO Director Douglas Elmendorf on the 2013 long-term U.S. budget outlook

Partial transcript of remarks by Douglas Elmendorf, Director of the Congressional Budget Office, on the 2013 long-term U.S. budget outlook. The press conference was held on Sept. 17, 2013:

…Today’s report differs from the report we published last year by incorporating the effects of the significant tax legislation that Congress enacted in January, by including a wide range of recent data and by having some significant methodological improvements.

But the bottom line remains the same as it was last year. The federal budget is on a course that cannot be sustained indefinitely.

In our extended baseline, which largely follows current law, we project that federal debt held by the public would rise from 73% of GDP today – already high by historical standards – to 100% of GDP 25 years from now, even before incorporating the harmful economics of the rising debt.

To be sure, the deficit has shrunk dramatically during the past few years, from nearly 10% of GDP in 2009 to about 4% this year.

And we expect under current law the deficit would decline further to about 2% of GDP.

After that, however, we project that deficits would start growing again.

Federal spending would be pushed up by rising interest payments on the federal debt and by the growing costs for Social Security and the major health care programs – Medicare, Medicaid, and subsidies to be provided through insurance exchanges.

Interest payments on the debt would rise as interest rates rebounded from their current unusually low levels and, in particular with debt so large, the increase in interest rates that we and others expect will have a very large effect on interest payments.

Projected spending for Social Security increases relative to GDP in our extended baseline because of the retirement of the baby boom generation which would increase the number of people eligible for the program by more than one-third in just 10 years.

Spending for the health care programs would increase for three reasons. First, the retirement of the baby boomers. Second, rising costs of health care per person. And third, the expansion of federal support for health insurance for low-income people.

Meanwhile, projected federal spending for all other programs taken together decline sharply relative to GDP in our extended baseline. Such spending has average roughly 11% of GDP during the past 40 years and is currently about 10% of GDP, although below its average, and would fall to 7.5% of GDP in 2023 and 7% in 2038.

By 2020 under current law, total federal spending – apart from Social Security, the major health care programs, and interests on the debt – would be a smaller percentage of GDP than at any time since the 1930s.

Thus, the upward pressure on federal spending relative to the size of the economy comes not from a general growth in the size of the government but from growth in just a handful of the largest programs – Social Security, Medicare, and Medicaid along with the rising costs of servicing the government’s debt.

Federal revenues will also increase over time under current law but more gradually than federal spending.

Federal revenues have averaged 17.5% of GDP during the past 40 years. They’re now a little lower but rise to 18.5% by 2023 and nearly 20% in 2038 in our extended baseline.

The gap between federal spendings and revenues would widen steadily after 2015.

By 2038 under our extended baseline, the deficit would be 6.5% of GDP and federal debt held by the public would be 100% of GDP even before we account for the economic effects of that increase in debt. That would be more than any year except 1945 and 1946.

With such large deficits, federal debt would be growing relative to GDP a path that could not be followed indefinitely.

In our report, we separately project how the economic consequences of the policies that underlie the extended baseline would affect the long-term budget outlook.

The growth in debt would reduce the nation’s output and raise interest rates relative to what would happen if the debts were more stable. That in turn would lead to wider budget deficits.

With those effects included, debt under the extended baseline would rise to 108% of GDP in 2038.

Debt that is so large relative to our annual output would in the long-term reduce output and income, compared to what they would be if debt were closer to its historical average percentage of GDP.

Debt that is so large would also require higher interest payments, reduce lawmaker’s ability to use fiscal policy to respond to unexpected developments and increase the risk of a fiscal crisis.

In our report this morning, we also show the effects of some alternative sets of fiscal policies – some that would produce larger deficits than current law and some that would produce smaller deficits.

For example, if certain tax and spending policies that might be difficult to maintain were modified – what we call the alternative fiscal scenario – federal debt would be much greater than 108% of GDP by 2038.

In addition, we devoted a chapter of the report to the uncertainty of long-term budget projects. We discussed a number of sources of uncertainty and present budget projections based on different outcomes per activity, interest rates, and federal spendings for health care.

Of course, any projections this far into the future are very uncertain. Nevertheless, our analysis shows under a wide range of possible assumptions about some key factors the budget is on an unsustainable path.

As lawmakers consider change in policies that would put the budget on a more sustainable path, they will face choices about the magnitude of deficit reduction, the policies that will be used to reduce deficits, and the timing of deficit reduction.

Economic theory does not say what the optimal amount of federal debt is nor what the right amounts of federal spending and revenues are.

But a significant reduction in debt from its current percentage of GDP would require substantial changes in tax policies, spending policies or both.

As an illustration, if lawmakers wanted to bring debt to 31% of GDP in 2038 – a little below its 40-year average – using policies that phase in over the next decade, they would need to enact a combination of increases in revenues and cuts in spending that would total about $4 trillion during the decade.

In deciding how quickly to reduce deficits, lawmakers face difficult trade-offs. Waiting to cut federal spending or [raise] taxes would lead to a greater accumulation of debt and would increase the size of the policy adjustments needed to achieve any chosen debt target.

However, implementing spending cuts or tax increases quickly would weaken the economic expansion and give people little time to plan for and adjust to the policy changes.

The negative short-term effects of deficit reduction on output and employment would be especially large now because output is so far below its potential or maximum sustainable level that the Federal Reserve is keeping short-term interest rates near zero and could not lower them further to offset the impact of changes in spending and tax policies.

Thank you.

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