The Congressional Budget Office (CBO) issued a dire warning this week about the long-term federal debt levels: unless policymakers make significant changes in government policies on taxes and spending (particularly for Medicare, Social Security, and healthcare), the federal debt will reach unsustainable levels, with potentially unpredictable results.
CBO warns that not only would unrestrained high debt levels limit the government’s options on how to deal with domestic and foreign policy problems, such debt levels could have significant negative impacts on the economy, such as higher interest rates, more foreign borrowing, and constrained domestic investment that could increase the chances of financial crises.
In its annual long-term budget update released this month, CBO presents it analysis primarily in terms of the federal debt’s share of the Gross Domestic Product (GDP). In 2008, the federal debt accounted for 40 percent of GDP, at about the 40-year average. Since then, that share as skyrocketed. CBO projects that by this year’s end the federal debt will be more than 70 percent of GDP, the highest since World War II. The future growth in that share depends, according to CBO, on what policy decisions the administration and the Congress make about taxes and spending, particularly for Medicare, Social Security, and healthcare.
CBO analyzes the long-term budget outlook under two scenarios, which highlight the difficult choices facing policymakers.
Under CBO's Extended Baseline Scenario, current laws would remain unchanged. This means long-term revenues would increase significantly because the so-called Bush tax cuts would be allowed to expire at the end of the year, the reach of the alternative minimum tax would expand unchecked, and the tax provisions of the new health care law (Affordable Care Act) would go into effect. On the spending side, this scenario assumes that spending for mandatory and discretionary programs under current law would rise at a much lower pace and would, according to CBO, “decline to the lowest percentage of GDP since before World War II." In addition, interest costs would fall. As a result, the percentage of debt to GDP would decline to 61 percent by 2022 and to 53 percent by 2037.
The outlook under CBO’s Extended Alternative Fiscal Scenario is quite different. Under this scenario, many policies that have been in place for a number of years would not be changed. The expiring Bush tax cuts, ATM relief, and other expiring tax cuts (except for the payroll tax cut) would continue to be extended through 2022, significantly restraining revenue increases, which taken together would retard revenue growth. On the spending side, this scenario assumes that Congress will not permit spending restraints, such as for Medicare cost growth and health insurance subsidies, to go into effect. It also assumes that the automatic spending cuts called for in the Budget Control Act of 2011 will not happen and interest costs would increase. As a result, the federal debt would continue to grow, reaching 90 percent of GDP by 2022, 109 percent by 2026, and could approach 200 percent by 2037.