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Taxes and the Budget: What is the long-term budget scenario?

The Office of Management and Budget (OMB), the Congressional Budget Office (CBO), the Government Accountability Office (GAO), and a variety of private groups compile long-run federal budget scenarios. Those scenarios differ one from another because the economic and policy assumptions underlying them differ, but all conclude with the same sad tale: current budget policy is not sustainable.

  • Social Security, Medicare, and Medicaid are all affected by the aging of the population as the baby-boom generation reaches retirement age and life expectancy continues to increase. Medicare and Medicaid are also afflicted by soaring health costs as their expenditures per capita grow much faster than income per capita. Consequently, expenditures on these three programs will grow much faster than the economy. The budget pressures from these sources are made worse by an additional fact: low birth rates since the 1960s imply that the labor force and hence the number of taxpayers will grow at a slowing rate.
  • CBO and GAO each produce two long-run budget paths, one more optimistic than the other, which they call "scenarios" rather than projections because they are not intended as forecasts but simply illustrate the likely implications of current policy. The huge deficits that emerge in all of their long-run paths could not possibly be financed domestically or internationally; this means that current policy is unsustainable. This analysis focuses on the less optimistic scenarios because their policy assumptions seem more reasonable.
  • CBO’s more pessimistic scenario (see figure) assumes that Congress makes permanent the Bush tax cuts of 2001 and 2003 and extends all other temporary tax cuts. This scenario assumes that taxes claim 18.9 percent of GDP in 2030, compared with 18.8 percent in 2007 and an average (and relatively constant) tax burden over the past forty years of 18.3 percent. Spending for Social Security, Medicare, and Medicaid is meanwhile projected to grow from 8.4 percent of GDP in 2007 to 14.5 percent in 2030; the total federal tax burden would have to rise by about one-third to finance that increase entirely with higher taxes. Other noninterest spending is assumed to remain roughly constant relative to GDP, but because this budget scenario implies a rapidly growing public debt, the government’s interest bill rises from 1.7 percent to 4.8 percent of GDP. The problem feeds on itself as larger deficits impose higher interest bills, which in turn cause still larger deficits. The public debt eventually explodes, climbing from 37 percent of GDP at the end of fiscal 2007 to more than 100 percent in 2030.
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  • GAO assumes a slightly lower tax burden than CBO and slightly more rapid growth in Social Security, Medicare, and Medicaid. As a result, the debt exceeds GDP in 2027-three years earlier than in the CBO scenario.
  • OMB has developed only one projection but uses sensitivity analysis to show the implications of alternative assumptions. The projection assumes that Congress adopts the president’s recommendations for reducing Medicare reimbursements and other savings, so that Medicare costs grow much more slowly than in the CBO and GAO scenarios. Consequently, the debt does not exceed GDP until well after 2040.
  • All these long-run budget projections assume that the growth of health spending eventually slows, because it is implausible that such spending will be allowed to absorb an ever-growing share of GDP and eventually squeeze out non-health-related consumption. But all of the projections may be too optimistic about the timing and the extent of the slowdown. Any squeeze on non-health-related consumption can be postponed for a very long time if foreigners continue to finance our budget deficits, and even if they do not, it may be investment rather than consumption that is squeezed out. If projections of health costs prove too optimistic, a budget crisis will arrive sooner than the scenarios anticipate.
 
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   Entry 2 of 8