What must lawmakers do to prevent deficits and debt from exploding over the next 25 years? The surprising answer is… nothing! If policymakers simply follow current law for taxes and spending, federal debt will likely edge down as a share of the economy in the middle of this decade and begin only a gradual rise thereafter.
New projections by the Center on Budget and Policy Priorities and the Committee for a Responsible Federal Budget show that recent legislation and other factors have substantially improved the long-term budget outlook. CBPP, for instance, now projects that debt will rise to 99 percent of gross domestic product in 2040. That's a far cry from the economically and financially dangerous levels of 200 to 300 percent of GDP and rising explosively that budget analysts were projecting just a few years ago.
To be sure, policymakers still must find ways to keep debt from growing faster than the economy. But they should ignore calls for radical policy changes based on outdated scenarios of exploding debt.
The chart below shows how much things have changed since the Congressional Budget Office issued its last long-term budget report in June 2012. It compares the three illustrative projections of debt as a percent of GDP in the new CBPP report (of June 27) with the two projections in last year's CBO report, neither of which reflects current budget realities.
CBO's "extended baseline" projection assumed – consistent with existing laws for taxes and spending – that policymakers would let the tax and spending changes that were scheduled to take place at the end of 2012 (the famous "fiscal cliff") take effect. Its "alternative fiscal scenario" assumed they would not and would, in fact, continue to enact tax cuts in order to keep revenues from rising above 18.5 percent of GDP, would change Medicare law substantially to undo Obamacare cost-control measures and would reverse the budget cuts enacted since 2010.
CBPP's projections lie above CBO's extended baseline scenario largely because they account for the lower revenues resulting from the American Taxpayer Relief Act that policymakers enacted in January to replace the so-called "fiscal cliff." They lie below CBO's alternative fiscal scenario because they assume policymakers will follow current laws and policies (which include the expiration of some tax cuts under ATRA) without making changes that constrain deficits further or, on the other hand, cutting taxes or expanding programs without offsetting the costs.
As a result, revenues rise gradually as a share of GDP. CBPP's "optimistic" and "pessimistic" cases vary the assumptions about a few key policies and about how fast health care costs will grow. CBPP's analysis also highlights a fact that policymakers should always keep in mind: our long-term budget challenges are rooted in demographic changes and economy-wide health-care costs. We do not have an "out-of-control-spending crisis" and we do not have an "entitlement crisis."
Under current laws and policies, Social Security spending will rise slowly but steadily in the next two decades but then stabilize. CBPP projects that if lawmakers stick with current laws and policies, spending as a percent of GDP for all other programs besides Social Security and the major health programs will be half its 2010 level by 2040.
The wild card is health care costs, both public and private, which historically have grown faster than GDP for various reasons, including technological advances and more utilization. CBPP projects, based on projections by the Social Security and Medicare Trustees and CBO, that the Obamacare cost-controls plus other developments in health care delivery will slow but not erase the "excess cost growth" in U.S. health spending. Different assumptions about health care cost growth are one key feature distinguishing CBPP's optimistic and pessimistic projections from its base case.
As the CBPP report makes clear, policymakers must do more to put the long-term budget on a sustainable path. But policies to lower the debt must be balanced against other desirable policy goals:
All else being equal, a lower debt-to-GDP ratio is preferred because of the additional flexibility it provides policymakers facing economic or financial crises. But, all else is never equal. Lowering the debt ratio comes at a cost, requiring larger spending cuts, higher revenues, or both. That is why we have emphasized the importance of not only the quantity but also the quality of deficit reduction, which should not hinder the economic recovery or cut spending in areas that can boost future productivity or harm vulnerable members of society.
Chad Stone is chief economist at the Center on Budget and Policy Priorities.