Four Observations about the Federal Budget

By Elmendorf, Douglas W. | Business Economics, July 2011 | Go to article overview

Four Observations about the Federal Budget


Elmendorf, Douglas W., Business Economics


Four observations on the current and future federal budget are presented and discussed. These are (I) resumption of healthy economic growth will not he enough to close the gap between expenditures and revenues, (2) closing the gap will require significant changes in expenditures and/or revenues, (3) the pace of closing the gap involves difficult trade-offs, and (4) there is no shortage of feasible proposals for putting fiscal policy on a sustainable path.

Business Economics (2011) 46, 139-143.

doi:10.1057/be.2011.19

Keywords: federal budget, fiscal policy, federal revenues, federal expenditures, federal deficits

In my comments today, I would like to offer four observations about the federal budget:

* First, if current policies are continued, the gap between spending and revenues will remain very large, even after we return to normal economic conditions.

* Second, fiscal policy cannot be put on a sustainable path just by eliminating waste and inefficiency; the policy changes that are needed will significantly affect popular programs or people's tax payments or both.

* Third, policymakers face difficult tradeoffs in deciding how quickly to implement policy changes that would reduce future budget deficits.

* Fourth, there is more focus in Washington on federal budget problems today than there has been since the late 1990s, and that focus has led to a range of proposals for tackling the problems.

Let me discuss each of these observations in turn.

1. Current Policies Imply Large Fiscal Deficits, Even with a Return to Normal Economic Conditions

The Congressional Budget Office (CBO) estimates that, if current laws remain unchanged, the budget deficit this year will be SI.4 trillion, or 9.3 percent of gross domestic product (GDP). That would follow deficits of 10.0 percent and 8.9 percent of GDP, representing the three largest deficits since 1945. As a result, debt held by the public will jump from 40 percent of GDP at the end of fiscal year 2008 to nearly 70 percent at the end of this fiscal year.

Over the next few years--assuming that current laws are unchanged, as we do in our baseline projections--budget deficits as a share of GDP would drop markedly. Deficits would average almost 3(1/2) percent of GDP from 2012 through 2021, totaling $6.7 trillion over the decade. As a result, debt held by the public would reach 76 percent of GDP in 2021.

However, that projection understates the budget deficits that would occur if many policies currently in place were continued, rather than allowed to expire as scheduled under current law. For example, suppose instead that three major aspects of current policy were continued during the coming decade:

* First, the higher 2011 exemption amount for the alternative minimum tax was extended and, along with the alternative minimum tax brackets, was indexed for inflation;

* Second, that the other major provisions in December's tax legislation that affected individual income taxes and estate and gift taxes were extended, rather than allowed to expire in January 2013; and

* Third, that Medicare's payment rates for physicians' services were held constant, rather than dropping sharply as scheduled under current law.

Figure 1 shows that if those policies were extended permanently, deficits from 2012 through 2021 would average nearly 6 percent of GDP and would cumulate to nearly $12 trillion. Figure 2 shows that debt held by the public in 2021 would rise to almost 100 percent of GDP, the highest level since 1946.

It bears emphasis that under current policies federal fiscal policy is heading into territory that is unfamiliar to us and to other developed countries as well. Figure 3 shows that if we continue on the path to debt held by the public becoming nearly as large as GDP, our debt-to-GDP ratio will exceed that of most developed countries during the past several decades. …

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