The President's Budget in the Long Term

Apr 24, 2013 | Budgets & Projections

Continuing our analysis of the President's FY 2014 budget proposal, we turn to how the President's budget would affect long-term revenues and spending. As we said last Monday after looking at the GAO's long-term projections of debt and deficits, our debt problem looks much more daunting when projecting beyond the standard ten-year window. With that in mind, it is useful to look at OMB's 75-year projections of the President's Budget.

OMB publishes these long-term projections for the President's budget in the "Supplemental Materials" section, showing the outlook for spending, revenue, deficits, and debt under many different assumptions, including future policy actions, health care cost growth, and economic and demographic trends.

OMB produces two main long-term outlooks, an optimistic "base case" and a pessimistic "alternative scenario," to illustrate a possible range of what debt, deficits, revenue and spending could be under the President's budget. A big difference between the two scenarios is how they treat the growth of revenues over the long term. Under the base case scenario, revenues would rise gradually from 20 percent of GDP by 2023 to 23 percent of GDP by 2075. Under the alternative projection, revenues would actually fall briefly to 19.8 percent for a number of years before gradually rising to a 20.6 percent by 2075. Revenues rise much more slowly under this scenario because OMB assumes that policymakers will continually adjust tax brackets to ensure that real income growth doesn't push taxpayers into higher tax brackets (so-called "bracket creep").

Another primary difference between the two projections is how they treat the growth of discretionary spending. Under the baseline projection, discretionary spending grows at inflation plus population growth over the long term, resulting in its constant decline as a share of GDP, while the alternative projection grows this category at the rate of GDP growth. The base case assumption has a significant effect, as total outlays under the baseline projection fall from 21.7 percent of GDP in 2023 to 18.1 percent by 2075. While the U.S. in the past has had times with such low levels of spending, health care and Social Security spending is projected to keep increasing under the President's budget. The dramatic fall off is in other mandatory and discretionary spending, from 11.6 percent of GDP in 2012 to 8 percent of GDP in 2023, and continuing downward to 4.6 percent in 2075. Under the alternative projection, outlays rise after 2023 from 21.7 percent of GDP to 25.5 percent by 2075, with discretionary spending holding steady as a percent of GDP after 2023.

[chart:8552]

Source: OMB

While the actual debt path under the President's budget would likely lie in between these two projections, the alternative projection appears to be the more realistic of the two. Under the base case projection of the President's budget, debt would remain above 70 percent of GDP until 2049, when it would begin to fall rapidly. The debt would be completely paid off by 2075. Under the alternative projection, debt would fall from a high of 78.2 percent of GDP in 2015 to 72.5 percent in 2025 before resuming an upward path to greater than 120 percent by 2075.

[chart:8551]

Source: OMB

Of course, there is another major debate related to budget projections that we have touched on before: how fast health care spending will grow over the long term. Recent health care cost growth rates have been low, but many authorities including CBO assume growth rates will return to historical trends (in CBO's case, the trend of the previous 20 years). Furthermore, a recent study indicates that more than three-quarters of the slowdown is due to cyclical economic factors which we would expect to go away at some point. In short, there are reasons to think that health care spending growth will pick up at least somewhat from its lower rate in the past few years.

OMB produces projections from Medicare and Medicaid under different health care cost growth assumptions than CBO, using a health care cost growth rate of GDP plus one percent before curtailing it to be GDP growth after 2030 or so. However, projections using the CRFB Realistic baseline's growth rate for health care are greater than even OMB's pessimistic case. If CRFB Realistic projections turn out to be more accurate, the result would be much higher health care spending and, consequently, higher debt levels.

[chart:8557]

Source: OMB, CRFB Calculations

Long-term projections are subject to a large degree of uncertainty, but given the size and importance of the long-term problem, it is useful to look at these estimates as a rough benchmark of where we are heading. Under many assumptions, the President's budget will likely have to do more to put debt on a downward path as a share of the economy over the long term. Even with the uncertainty in these forecasts, it is better to err on the side of caution. It is politically much easier to adjust if deficit reduction proves to be "too much" compared with deficit reduction not going far enough.