Congressional Budget Office
Director's Blog

Recently, the federal government has been recording the largest budget deficits, as a share of the economy, since the end of World War II. As a result of those deficits, the amount of federal debt held by the public has surged. At the end of 2008, that debt equaled 40 percent of the nation’s annual economic output (as measured by gross domestic product, or GDP), a little above the 40-year average of 36 percent. Since then, large budget deficits have caused debt held by the public to shoot upward; CBO projects that federal debt will reach 62 percent of GDP by the end of this year—the highest percentage since shortly after World War II. The sharp rise in debt stems partly from lower tax revenues and higher federal spending related to the recent severe recession and turmoil in financial markets. However, the growing debt also reflects an imbalance between spending and revenues that predated those economic developments.

This morning CBO released the latest in its series of reports on the long-term budget outlook. (Addendum: I presented the key findings of the report to the National Commission on Fiscal Responsibility and Reform.) The report examines the pressures on the federal budget by presenting our  projections of federal spending and revenues over the coming decades. Under current laws and policies, an aging population and rapidly rising health care costs will boost outlays for Social Security benefits and sharply increase federal spending for health care programs. Unless revenues increase at a similar pace, such spending will cause federal debt to grow to unsustainable levels. If policymakers are to put the nation on a sustainable budgetary path, they will need to let revenues increase substantially as a percentage of gross domestic product, decrease spending significantly from projected levels, or adopt some combination of those two approaches.

The Outlook for Major Health Care Programs and Social Security

Growth in spending on health care programs remains the central fiscal challenge facing the nation. CBO projects that if current laws do not change, federal spending on major mandatory health care programs will grow from roughly 5 percent of GDP today to about 10 percent in 2035 and will continue to increase thereafter. (Mandatory programs are those that do not require annual appropriations; the major mandatory health care programs include Medicare, Medicaid, the Children’s Health Insurance Program, and the subsidies that will be provided through the insurance exchanges that will be established as a result of the new health care legislation.)

That estimate includes all of the effects of the recently enacted health care legislation. Although, CBO expects the legislation to reduce federal budget deficits over the first 10 years and in subsequent decades (through its effects on both revenues and spending), it is expected to increase federal spending in the next 10 years and for most of the following decade; by 2030, however, that legislation will slightly reduce federal spending for health care if all of its provisions are fully implemented, CBO projects. (The estimates for the health care legislation that are used in this report are unchanged from the ones that CBO and the staff of the Joint Committee on Taxation published in March, when the legislation was being considered.)

Under current law, spending on Social Security is also projected to rise over time as a share of GDP, albeit much less dramatically—from 5 percent to 6 percent of GDP. (Later this week, CBO will release a report on a number of different policy options for changing Social Security.)

All told, CBO projects, the aging of the population and the rising cost of health care will cause spending on the major mandatory health care programs and Social Security to grow from roughly 10 percent of GDP today to about 16 percent of GDP 25 years from now if current laws are not changed. (By comparison, spending on all of the federal government’s programs and activities, excluding interest payments on debt, has averaged 18.5 percent of GDP over the past 40 years.)

Budget Outcomes Under Two Long-Term Scenarios

In the report, CBO presents the long-term budget picture under two scenarios that embody different assumptions about future policies governing federal revenues and spending. Budget projections grow increasingly uncertain as they extend farther into the future, so this report focuses largely on the next 25 years.

One scenario, the extended-baseline scenario, adheres closely to current law. That set of policies would result in steadily higher average tax rates because they incorporate the assumptions that most of the tax cuts enacted in 2001 and 2003 expire and that the alternative minimum tax applies to more and more people each year—and because the combination of economic growth and the structure of the tax system generates additional tax revenues as a percentage of income. Those rising rates, combined with the tax provisions of the recent health care legislation, would push total revenues to 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and to larger percentages thereafter. At the same time, government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II. Despite those substantial revenue increases and constrained spending for a portion of the budget, the rising costs of health care programs and Social Security would lead to continued budget deficits, and federal debt held by the public would grow from an estimated 62 percent of GDP this year to about 80 percent by 2035.

The budget outlook is much bleaker under the alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. In this scenario, CBO assumed that Medicare’s payment rates for physicians would gradually increase (which would not happen under current law) and that several policies enacted in the recent health care legislation that would restrain growth in health care spending would not continue in effect after 2020. In addition, under the alternative scenario, spending on activities other than the major mandatory health care programs, Social Security, and interest would fall below the average level of the past 40 years relative to GDP, though not as low as under the extended-baseline scenario.

More important, CBO assumed for this scenario that most of the provisions of the 2001 and 2003 tax cuts would be extended, that the reach of the alternative minimum tax would be kept close to its historical extent, and that over the longer run, tax law would evolve further so that revenues would remain at about 19 percent of GDP, near their historical average.

Under that combination of policy assumptions, federal debt would grow much more rapidly than under the extended-baseline scenario. With significantly lower revenues and higher outlays, debt would reach 87 percent of GDP by 2020, CBO projects. After that, the growing imbalance between revenues and noninterest spending, combined with spiraling interest payments, would swiftly push debt to unsustainable levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2025 and would reach 185 percent in 2035.

Neither of those scenarios represents a prediction by CBO of what policies will be in effect during the next several decades—but these projections, encompassing two very different sets of policy assumptions, provide a clear indication of the serious nature of the fiscal challenge facing the nation.

The Impact of Growing Deficits and Debt

In fact, CBO’s projections understate the severity of the long-term budget problem because they do not incorporate the significant negative effects that accumulating substantial amounts of additional federal debt would have on the economy:

• Large budget deficits would reduce national saving, leading to higher interest rates, more borrowing from abroad, and less domestic investment—which in turn would lower income growth in the United States.
• Growing debt would also reduce lawmakers’ ability to respond to economic downturns and other challenges.
• Over time, higher debt would increase the probability of a fiscal crisis in which investors would lose confidence in the government’s ability to manage its budget, and the government would be forced to pay much more to borrow money.

Keeping deficits and debt from growing to unsustainable levels would require raising revenues as a percentage of GDP significantly above past levels, reducing outlays sharply relative to CBO’s projections, or some combination of those approaches. Making such changes while economic activity and employment remain well below their potential levels would probably slow the economic recovery. However, the sooner that long-term changes to spending and revenues are agreed on, and the sooner they are carried out once the economic weakness ends, the smaller will be the damage to the economy from growing federal debt. Earlier action would require more sacrifices by earlier generations to benefit future generations, but it would also permit smaller or more gradual changes and would give people more time to adjust to them.

Yesterday CBO released estimates of average federal tax rates—households’ federal tax liability divided by their income—in 2007 for households with various amounts of income.  For each income category, the report also presents estimates of average before-tax and after-tax household income; the number of households; and that category’s share of taxes and income. A page on our website, Average Federal Taxes by Income Group, includes CBO’s estimates of average federal tax rates going back to 1979, as well as other information and publications on household income and taxes. 

CBO’s most recent analysis indicates that:

• On average, in 2007 households paid federal taxes, either directly or indirectly, totaling about 20 percent of their income. (That percentage includes corporate income taxes and employers’ share of payroll taxes, which are passed on to households in various ways.) Individual income taxes, the largest component, were 9.3 percent of household income. Payroll taxes for social insurance programs were the next largest source, with an average tax rate of 7.4 percent. Corporate income taxes and excise taxes were smaller, with average tax rates of 3.0 percent and 0.6 percent.
• The overall federal tax system is progressive—that is, average tax rates generally rise with income. Households in the bottom quintile (fifth) of the income distribution paid 4 percent of their income in federal taxes, while the middle quintile paid 14 percent, and the highest quintile paid 25 percent. Average rates continued to rise within the top quintile, with the top 1 percent facing an average rate of close to 30 percent.
• Higher-income groups earn a disproportionate share of pretax income and pay a disproportionate share of federal taxes.  In 2007, the highest quintile earned 56 percent of pretax income and paid 69 percent of federal taxes, while the top 1 percent of households earned 19 percent of income and paid 28 percent of taxes. In all other quintiles, the share of federal taxes was less than the income share. The bottom quintile earned 4 percent of income and paid less than 1 percent of taxes, while the middle quintile earned 13 percent of income and paid 9 percent of taxes.
• Average tax rates in 2007 changed only slightly compared with their levels in 2006. There were no significant changes in the tax law between those years, and changes in the distribution of incomes were not enough to cause large movements in average rates.

This publication was prepared by Ed Harris of CBO’s Tax Analysis Division.

Earlier this week, CBO’s Acting Assistant Director for National Security, Matthew Goldberg, spoke to the National Commission on Fiscal Responsibility and Reform on the topic of discretionary defense spending. Last month, representatives of CBO spoke to the commission on three different occasions to provide information on tax policy, discretionary spending, and mandatory spending.

Discretionary defense spending makes up half of all discretionary spending (that is, spending that is subject to the annual appropriation process) in the federal budget. The Department of Defense (DoD) requested and the Congress provided about $530 billion in appropriations for fiscal year 2010. But current plans would require greater funding in future years. In a report released in January, CBO estimated that to implement the programs, plans, and policies in the Administration’s 2010 budget would require appropriations averaging about $570 billion (in constant 2010 dollars) over the period extending through 2028, excluding any potential costs for overseas contingency operations. DoD’s 10-year budget plan for the period starting in 2011 would require about $50 billion per year more over the next decade than CBO projected in January, mostly to fund overseas contingency operations (including, but not necessarily limited to, the ongoing operations in Afghanistan and Iraq).

An important factor contributing to the projected increases in defense funding needed to implement current plans is that many weapon systems being acquired today are much more expensive than their predecessors. For example, the Air Force has been spending nearly as much annually to purchase relatively small numbers of F-22 fighter jets and Joint Strike Fighters (JSFs) as it did to purchase much larger numbers of F-15s and F-16s during the 1980s.

Another factor contributing to increases in the defense budget has been increases in pay and other benefits for military personnel. Several enhancements to the pay and medical benefits of retired military personnel have been enacted over the past decade, most prominently for the TRICARE for Life program (which supplements Medicare for retirees who are eligible for both programs). In addition, in each of the past six years the military pay raise has exceeded the percentage increase in the Employment Cost Index (a measure of average wages and salaries in the private sector). In contrast, certain charges that military retirees pay under TRICARE Prime (the military system’s health management organization), such as the $460 annual family enrollment fee and the $12 copayment for a civilian outpatient visit, have not been increased in over 10 years.

Recent CBO studies have identified some particular areas where added spending may be needed to meet DoD’s current objectives. The JSF program has thus far experienced a cumulative delay of four years, which will adversely affect the Navy and Marine Corps as well as the Air Force and could necessitate additional spending over the next five years or more to maintain fighter inventories until the JSFs become available in large quantities. As discussed in a CBO study, F/A-18 Hornets in the Navy’s and Marine Corps’ fleets are rapidly approaching the maximum number of hours for which they are certified to fly, at which point (absent further action) they will have to be retired. To maintain fighter inventories at or close to their goals, those two services may have to invest in extending the service lives of their Hornets or purchase additional F/A-18E/F Super Hornets in order to bridge the gap until the JSFs are delivered.

The costs of the Navy’s shipbuilding program may also result in additional pressures on the defense budget. Another CBO study analyzed the Navy’s most recent shipbuilding plan, which covers the 30 years starting in 2011. The Navy’s plan calls for the purchase of 276 ships over that period, but CBO’s analysis indicates that those purchases would not be adequate to meet the Navy’s goal of having a total inventory of 322 ships for most of that period. Further, CBO estimates that purchasing the 276 ships and conducting related activities such as refueling nuclear-powered aircraft carriers would cost an average of $21 billion per year (in 2010 dollars)—considerably more than the $15 billion per year the Congress has appropriated for those purposes on average over the past 30 years, or the $13 billion per year the Congress has provided during the past five years.

CBO’s greatest asset is its staff, committed not only to its important work supporting the Congress, but also to significant causes outside the office.

For a fifth consecutive year, members of CBO’s staff formed a Susan G. Komen Race for the Cure team to support the fight against breast cancer. Captained by CBO Webmaster and breast cancer survivor Simone Thomas, this year’s 18-member team raised $4,754, far exceeding its goal of $3,000. That sum put the CBO team in second place for fundraising in the Congressional category.

The team was active in fundraising, holding a two-day bake sale and soliciting additional donations from friends, family, and other staff members. The team’s fundraising effort lasted for about a month, culminating in a 5K run/walk along the National Mall with 40,000 others on June 5.  Thanks to Simone’s leadership, and the time and generosity of many other staff members, we were able to make an impact in the effort to cure breast cancer. That’s something of which we can all be proud.
 

The federal budget deficit was $941 billion during the first eight months of fiscal year 2010, CBO estimates in its latest monthly budget review, $51 billion less than the shortfall recorded over the same period last year. Both revenues and outlays were lower than the corresponding amounts during the same period last year, by 2 percent and 3 percent, respectively.

Outlays through May were $80 billion (or 3 percent) lower than in the first eight months of fiscal year 2009, CBO estimates. The net reduction in spending reflects sharply lower outlays for the costs of the Troubled Asset Relief Program, for Treasury’s payments to Fannie Mae and Freddie Mac, and for the net costs of federal deposit insurance; altogether, outlays for those activities declined by $336 billion relative to outlays in the first eight months of 2009.

Apart from outlays for those financial programs, spending through May was $257 billion (or 12 percent) higher than in the same period last year, CBO estimates. More than one-third of that increase stemmed from provisions in the American Recovery and Reinvestment Act (ARRA). Most of the growth in ARRA-related spending was for grants to states made by the Department of Education, additional unemployment benefits, refundable tax credits, and the federal share of Medicaid assistance.

Excluding amounts provided by ARRA, Medicaid outlays rose by 5.5 percent through May, exceeding the 4.7 percent increase in Medicare spending.  Social Security outlays grew more slowly through May than in fiscal year 2009 as a whole (up 6 percent compared to close to 9 percent last year), primarily because of there was no cost-of-living adjustment in 2010. Outlays for net interest on the public debt were 22 percent higher through May than in the same period last year. Much of that growth reflects the cost of inflation adjustments for indexed securities.

Receipts in the first eight months of this fiscal year were about $29 billion lower than those in the same period last year. A decline of about $71 billion (or 6 percent) in individual income and payroll taxes accounts for the overall reduction in receipts. Although withheld receipts have declined for the eight months as a whole, they have increased over the previous year’s amounts in recent months, as employment has started to grow. Increases of about $13 billion (or 18 percent) in net corporate receipts (primarily from larger-than-expected payments of 2009 taxes made during the current fiscal year) and about $30 billion in receipts from the Federal Reserve offset some of the drop-off in receipts from individuals’ taxes.

The monthly budget review was prepared by Elizabeth Cove Delisle, Barbara Edwards, Kathleen Gramp, and Joshua Shakin.
 

Lenny Skutnik is a household name belonging to an unassuming Congressional Budget Office employee who insists he “wasn’t a hero” when one winter day in 1982 he jumped from the shore into the icy Potomac River to save a drowning woman after an Air Florida flight crashed on takeoff.  “I was just someone who helped another human being,” Lenny said later. While his rescue of Priscilla Tirado that day was extraordinary, Lenny has been helping the employees at CBO for more than 30 years.

Martin Leonard “Lenny” Skutnik came to work here in 1980 after a stint at the Social Security Administration. A hard-working employee, Lenny was hired to support the staff of the relatively new (1975) office created by the Congress to produce budget and economic analysis. Lenny did whatever needed doing, mostly handling the mail and supplies needed to support the staff and, later, conducting the agency’s printing and providing IT support.

Lenny had been at CBO less than two years when he happened upon the Air Florida crash on his way home from work one night. He said his actions were amplified because they were captured on film and transmitted around the world. Public reaction was huge, and President Ronald Reagan, in his State of the Union address two weeks later, singled Lenny out in the House gallery, giving birth to the tradition of presidents using the annual speech to recognize ordinary people who have accomplished extraordinary things. The Presidential gallery in the House now is sometimes referred to as “The Heroes’ Gallery.” Search on the internet, and you’ll find much written about our Lenny. He’s been called   “the Potomac rescue guy” and “The Icy Swimming Rescue Dude.” Folks have written about talking to their children about heroism, using Lenny as their role model.

One woman wrote, “I was seated at the dinner table last night with my 12- and 13-year-olds and friend’s 8- and 10-year-olds, and they asked us about heroism. I mentioned Lenny Skutnik and what he did, and my friend and I started crying, thinking about that footage we still had in our heads all these years later. The kids were mesmerized. Thank you, Lenny Skutnik. We still remember.” “Lenny Skutnik is in my Top 5 Unforgettable People,” wrote another.

Lenny received many honors for his heroic act, including the United States Coast Guard’s Gold Lifesaving Medal and the Carnegie Hero’s Fund Medal, as well as public tributes that include two “Lenny Skutnik Days” in Mississippi a month after the crash in 1982.  The General Assembly of the Commonwealth of Virginia unanimously passed a resolution in praise of Skutnik’s “unselfish act of bravery.”

There are still many at CBO who are unaware there is a hero among us. Lenny continued to work, conscientiously doing his job as if nothing unusual had happened, personally producing thousands of copies of hundreds of CBO reports during his 30 years of service to the U.S. Congress. “I’ve learned a lot here. I’m not a Ph.D. type,” he said, referring to the many highly educated analysts on CBO’s staff. “It’s been very rewarding for me to work for this institution that has some clout. I’m real proud to have been part of it.”

We’re proud to have had you as part of CBO, Lenny. We hope you enjoy your retirement. You’ve earned it!
 

A short time ago, I received an interesting letter from a young man in Michigan asking about federal budget deficits. I thought that perhaps other students would be interested in the kinds of questions he asked and how I answered him, so I’ve decided to share my letter to him with all of you. Here’s what I wrote:

1. What are the primary causes of the current federal budget deficits?

The current large deficits are the result of a combination of factors. These include an imbalance between tax revenues and the government’s spending that began before the recent economic recession and turmoil in the financial markets, sharply lower revenues and higher spending related to current economic conditions, and the budgetary costs of policies put in place by the government to respond to those conditions.

2. How will budget deficits affect people under the age of 18?

The government runs a budget deficit when it spends more on its programs and activities than it collects in taxes and other revenues. The government needs to borrow to make up the difference. When the federal government borrows large amounts of money, it pushes interest rates higher, and people and businesses generally need to pay more to borrow money for themselves. As a result, they invest less in factories, office buildings, and equipment, and people in the future—including your generation—will have less income than they otherwise would.

Also, the government needs to pay interest on the money it borrows, which means there will be less money available for other things that the government will spend money on in the future. Squeezing other spending affects different people in different ways, depending on their individual situations. For example, many young people benefit from government programs that provide money to families in need of food or medical care or to people who have lost their job, or from the financial support the federal government provides to local schools, or from the grants or loans the government offers to help pay for college education.

3. How is the U.S. government working to reduce budget deficits?

The President created a National Commission on Fiscal Responsibility and Reform to draw up plans to address the deficit problem. Most of the people on the commission are Members of Congress.

The commission will consider ways to reduce the budget deficit by 2015 as well as ways to improve the long-term budget outlook. Under current government policies, the gap between the government’s spending and revenues in coming years will be large. Therefore, balancing the budget would require significant changes in spending, taxes, or both. On CBO’s Web site, you can find information about the budget outlook during the next 10 years and over the long term.

More information about the commission can be found on its Web site: http://www.fiscalcommission.gov.

Congress also has enacted a new law (called “Pay-As-You-Go”) that typically requires legislation that increases spending or lowers tax revenues to include other measures to offset the costs of those changes.

4. What can people, and especially school-aged children, do to help curb budget deficits?

The most important thing that school-aged children can do to help reduce future deficits is to study hard and acquire the best possible education. This will help you and your classmates get better jobs when you grow up, which will help the economy grow. In turn, a stronger economy will produce higher tax receipts for the government, which will lower the deficit.

When young people get jobs, they should be sure to save some of the money they earn. Through a fun and important bit of math called compounding, savings of small amounts can grow over time into significant amounts. For the economy as a whole, the more people save, the more money is available for businesses to invest in factories, office buildings, and equipment. For individuals and families, more savings provide a financial cushion in times of economic difficulty. In particular, more savings can help people pay large medical expenses or save their home in case they lose their job or become ill, thus helping them avoid needing government assistance.

People of all ages can also help to reduce the deficit by learning how the government spends money and from whom the government collects money. Understanding the current budget is essential for choosing intelligently among different ways to change programs and policies in order to reduce deficits.

5. If I am to convey one key message to my school regarding the federal budget deficit, what would it be?

The prospect of budget deficits for many years in the future is a serious problem for our country. Ultimately, people in the United States will have to bring into balance the amount of services they expect the government to provide, particularly in the form of benefits for older Americans, and the amount of taxes they are willing to send to the government to finance those services. Because it takes a long time to implement major policy changes, deciding what those changes will be is an urgent task for our citizens and for our policymakers.

Thank you for taking the time to write to us about these difficult issues.

Best wishes,

Doug Elmendorf