LTBO #1

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Over the next month, I am going to have a series of blogs that take you through the Congressional Budget Office’s (CBO) “Long-Term Budget Outlook (LTBO).”  This was released on June 30^th and will help us to understand the issues.  If you want to read it yourself, here’s the link.


This series on the LTBO will not be successive.  In other words, it will be interrupted by other issues.  For example, once I find out if an op-ed piece that I wrote last week is going to be published, I will print it here.  I also have a piece that I will publish about the similarities and differences between the US and England (once the article is published that I was interviewed for).


Now, on to LTBO issue 1…


The CBO has examined the budget under two different scenarios.  The extended baseline scenario assumes that current laws won’t change.  Most significantly, this means that the Bush tax cuts of 2001 and 2003 will expire.  When these tax cuts were passed, they lowered tax rates for ten years.  These were not permanent cuts.


The alternative fiscal scenario assumes that laws will change.  In this scenario, the CBO has tried to use their best estimate of what will actually happen.  For example, they assume that the Bush tax cuts will be continued.  Of course, President Obama wants to continue the tax cuts for everyone who makes under $250,000.


So, here are some key differences in assumptions.  With the extended baseline scenario:

1. Bush tax cuts lapse (and tax rates increase).




2. The Alternative Minimum Tax continues and will reach a huge number of taxpayers (increasing the CBO’s assumption of tax revenue).




3. By 2035, tax revenue would be 23% of GDP.  This is significantly higher than the past 65 years (in which tax revenue has averaged 18% of GDP…see Monday’s blog from last week where I discussed this).




4. All non-mandatory spending (mandatory spending includes Social Security and Medicare / Medicaid) would shrink as a percentage of GDP to their smallest levels since World War II.




5. As a result of the increases in revenue and reductions in spending, debt-to-GDP is only expected to increase from 62% to 80% (by 2035).




6. Interest payments would increase from 1% of GDP to 4% of GDP.  In other words, even in this positive scenario, interest payments are expected to be 1/6 of total tax revenue (and this is inflated tax revenue).

Under the alternative fiscal scenario, the CBO made the following assumptions:

1. Medicare’s payment rates for physicians will gradually increase (this doesn’t happen under current law).




2. Several policies that would restrain health care spending (enacted in the recent healthcare legislation) would end by 2020.




3. Spending on programs other than healthcare, Social Security and interest would drop to lower levels (relative to GDP) than their historical average, but not as low as the extended baseline assumptions.




4. The Bush tax cuts of 2001 and 2003 would be extended.




5. The Alternative Minimum Tax would be restrained so that it didn’t reach huge numbers of people.




6. Tax revenue would be approximately 19% of GDP (slightly higher than our 18.1% average over the past 65 years).




7. With lower revenues and higher outflows, debt-to-GDP will reach 87% by 2020.




8. After 2020, higher payments for Medicare, Social Security and interest will result in debt reaching 185% of GDP by 2035.

Here’s what it looks like graphically:

Here are a few things to think about…

1. The Alternative Fiscal Scenario is more realistic (and may even be too conservative).  If high unemployment persists, debt-to-GDP will hit 87% much sooner than 2020.




2. When we get to 185% debt-to-GDP, if you assume a 5% interest rate (which may be very conservative under these conditions), interest expense (on the debt) would be more than 9% of GDP.  THIS MEANS THAT HALF OF OUR TAX REVENUE WOULD SIMPLY BE SERVICING OUR DEBT.  At this point (and probably before), everything blows up.

Have a cheery week…

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