A Grim Budget Outlook

by Donald Marron

Thursday, June 25, 2009 at 06:44 PM EDT

As President Obama has said, the budget really is something to lose sleep over.

Current deficits are enormous due to the weak economy, fiscal stimulus, and the costs of fighting the financial crisis. But the long-run outlook is even scarier, with Medicare, Medicaid, and Social Security pushing spending up much faster than tax revenues. The result is a tsunami of debt.

How much debt?

Well, the folks at the Congressional Budget Office have just released their latest projections of the long-run budget situation. Here is the key graph:

If current trends continue, CBO projects that the level of debt, relative to the size of our economy, will grow to unprecedented levels — and keep going. Within a few decades, the ratio of debt-to-GDP could surpass the peak of World War II.

That level of debt is not sustainable. As CBO notes:

Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States. Over time, the accumulation of debt would seriously harm the economy. Alternatively, if spending grew as projected and taxes were raised in tandem, tax rates would have to reach levels never seen in the United States. High tax rates would slow the growth of the economy, making the spending burden harder to bear.

What’s the solution? Well, CBO can’t be overly specific — its job is to present the facts, not draw policy conclusions — but here’s the advice:

Policymakers could mitigate the economic damage from rapidly rising debt by putting the nation of a sustainable fiscal course, which would require some combination of lower spending and higher revenues than the amounts now projected. Making such changes sooner rather than later would lessen the risks that current fiscal policy poses to the economy.

In short, we need to address this problem as soon as possible. Waiting only lets the problem fester, increasing the risk to our economy.

Note: CBO considers two long-run scenarios. In the “extended-baseline scenario,” CBO takes the current law as given, even if there’s reason to believe that Congress will make changes. In the “alternative fiscal scenario,” CBO tries to capture what today’s underlying fiscal policy actually is; this combines current law with assumptions about changes to the law are likely. The second scenario leads to faster-growing debt because policymakers are assumed to do things that worsen the deficit: e.g., extend tax provisions that expire at the end of 2010 and prevent dramatic cuts to physician payment rates in Medicare.