Chapter
1The Congressional Budget Office (CBO) projects that if current laws and policies remained unchanged, the federal budget would show a deficit of $219 billion for 2008 (see Table 1-1). That deficit would amount to 1.5 percent of gross domestic product (GDP), slightly larger than the shortfall of 1.2 percent of GDP ($163 billion) posted in 2007.
Projected Deficits and Surpluses in CBO’s Baseline
Total, Total, Actual 2009- 2009- 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2013 2018 On-Budget Deficit -344 -414 -396 -450 -343 -151 -184 -154 -136 -160 -102 -27 -1,525 -2,104 Off-Budget Surplusa 181 195 198 210 226 238 244 251 254 254 253 249 1,117 2,378 Total Deficit (-) or Surplus -163 -219 -198 -241 -117 87 61 96 117 95 151 223 -408 274 Memorandum: Social Security Surplus 187 197 199 210 226 238 244 250 253 254 253 249 1,118 2,378 Postal Service Outlays 5 2 2 1 * * * * * * * * 2 * Total Deficit (-) or Surplus as a Percentage of GDP -1.2 -1.5 -1.3 -1.5 -0.7 0.5 0.3 0.5 0.6 0.5 0.7 1.0 -0.5 0.1 Debt Held by the Public as a Percentage of GDPb 36.8 36.8 36.7 36.5 35.4 33.3 31.6 29.8 28.0 26.4 24.6 22.6 n.a. n.a. Probability of a Budget Deficit (Percent) n.a. 97 83 79 62 42 45 c c c c c n.a. n.a.Source: Congressional Budget Office.
Note: GDP = gross domestic product; n.a. = not applicable; * = between -$500 million and zero.
b. Debt held at the end of the year.
That increase in the deficit in 2008 would come after three consecutive years of declining deficits. Without changes in law, revenues would increase by only 3.4 percent, but outlays would grow by 5.2 percent. Those estimates—along with the other projections that make up the agency’s budget baseline—reflect an assumption that no further legislation affecting the budget will be enacted. Accordingly, the current deficit projection excludes the effects of potential policy changes to spending or revenues, including any steps lawmakers may take to bolster a weakening economy through fiscal stimulus.1
In addition, so far this year funding has been provided for only a portion of the anticipated costs for operations in Iraq and Afghanistan and the war on terrorism.2 Supplemental appropriations for such purposes could increase outlays by about $30 billion this year.
Beyond 2008, deficits under baseline projections continue each year until 2012, when they yield to modest surpluses through 2018. Under the assumptions that govern those projections, the deficit falls from $219 billion in 2008 (1.5 percent of GDP) to $198 billion in 2009 (1.3 percent of GDP) and $117 billion (0.7 percent of GDP) in 2011 and then changes to small surpluses in 2012 and later years (see Figure 1-1). By 2018, the surplus reaches 1.0 percent of GDP.
The Total Deficit or Surplus as a Share of Gross Domestic Product, 1968 to 2018
Sources: Congressional Budget Office.
CBO’s budget baseline, however, is not intended as a forecast of future outcomes, but rather as a benchmark that encompasses current laws and policies. It is predicated on two key projections that stem from long-standing statutory procedures, one affecting revenues and one affecting discretionary outlays.
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Under current law, revenues will increase from 18.7 percent of GDP in 2008 to almost 20 percent of GDP in 2012 and remain near that historically high level through 2018. Much of that increase results from two factors: the growing impact of the alternative minimum tax (AMT) and, even more significant, the scheduled expiration in December 2010 of provisions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).
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Discretionary outlays, measured relative to the economy, will decline from 7.6 percent in 2007 to 6.1 percent by 2018, a ratio lower than any recorded in the past 40 years. That projection results primarily from the assumption that discretionary funding grows at the rate of inflation, a pace slower than the estimated rate of growth of GDP.
It is likely that appropriations will differ from those assumed in the baseline and that lawmakers will enact changes in spending and tax policies. Although CBO’s baseline projections do not incorporate such potential changes in policy, this chapter shows the implications that some alternative policy assumptions would have for the budget over the next 10 years. For example, CBO has constructed two possible scenarios for future spending related to military operations in Iraq and Afghanistan and other activities associated with the war on terrorism. Those scenarios incorporate different assumptions about how rapidly troop levels might be reduced over the next several years—and have different effects on the path of spending projections.
Alternative assumptions about tax policy also would change CBO’s projections. If all of the tax provisions that are set to expire over the next 10 years were extended and the AMT was indexed for inflation, the budget outlook for 2018 would change from a surplus of $223 billion to a deficit of $617 billion. In addition, debt held by the public at the end of 2018 would nearly double from 22.6 percent of GDP to 44.4 percent, and the 10-year, or cumulative, bottom line would change from a surplus of $0.3 trillion to a deficit of $4.6 trillion.
Over the long term, the nation faces substantial fiscal difficulties, which are already becoming apparent in CBO’s baseline. Throughout the coming decade, spending for the government’s health care programs and spending on the nation’s elderly population will increasingly strain the federal budget. In CBO’s projections, outlays for Medicare grow at an average rate of almost 7 percent per year between 2010 and 2018. Projected federal spending for Medicaid increases even more rapidly. Also, beginning this year, the first baby boomers become eligible for Social Security retirement benefits, and increasing numbers of beneficiaries will help boost the annual rate of growth of spending for Social Security from about 5.1 percent this year to 6.4 percent in 2018.
Beyond 2018, those trends will accelerate. Health care costs are likely to continue growing faster than GDP—as they have for the past 40 years. Indeed, the rate at which health care costs grow relative to national income will be the most important determinant of future federal spending. In addition, as the percentage of the population age 65 or older continues to increase, spending for Medicare, Medicaid, and Social Security will, under current law, exert such pressure on the federal budget as to make the current path of fiscal policy unsustainable.3 Substantial changes in federal spending and tax policies will be necessary to maintain fiscal stability.
The budget deficit fell in 2007 for the third year in a row, dropping from $318 billion in 2005 to $248 billion in 2006 and to $163 billion in 2007. As a percentage of GDP, the deficit declinefrom 2.6 percent in 2005 to 1.2 percent in 2007.
Revenues in 2007 totaled $2.6 trillion (or 18.8 percent of GDP), an increase of 6.7 percent from the amount the previous year. They were buoyed by a rise of 11.5 percent ($120 billion) in individual income tax receipts (see Table 1-2). In contrast, such tax receipts grew by 4.7 percent annually from 1997 to 2006. Revenues from other sources grew more slowly than they have in recent years.
Average Annual Growth Rates of Revenues and Outlays Since 1997 and in CBO’s Baseline
Actual Estimated Projecteda 1997-2006 2007 2008 2009 2010-2018 Revenues Individual Income Taxes 4.7 11.5 4.1 10.6 6.9 Corporate Income Taxes 7.5 4.6 -1.7 -2.2 1.0 Social Insurance Taxes 5.1 3.8 4.6 4.1 4.5 Otherb 4.0 -4.2 3.1 3.0 6.6 Total Revenues 5.2 6.7 3.4 6.1 5.5 Outlays Mandatory 6.0 2.7 6.9 6.7 5.6 Discretionary 6.7 2.6 4.5 2.9 2.2 Net Interest -0.6 5.0 -1.6 3.1 0.8 Total Outlays 5.5 2.9 5.2 4.9 4.1 Memorandum: Consumer Price Index 2.6 2.3 3.2 2.3 2.2 Nominal GDP 5.4 4.6 3.9 4.3 4.7Source: Congressional Budget Office.
Note: The growth rates in this table do not account for shifts in the timing of certain payments or receipts.
a. CBO’s baseline budget projections. CBO uses the employment cost index for wages and salaries to inflate discretionary spending related to federal personnel and the gross domestic product price index to adjust other discretionary spending when constructing its baseline.
b. Includes excise, estate, and gift taxes as well as customs duties.
Corporate income tax receipts grew by 4.6 percent ($16 billion) last year, compared with 7.5 percent annually over the preceding decade (which included a particularly rapid average annual growth rate of nearly 40 percent between 2003 and 2006). Social insurance tax revenues (including payroll tax receipts for Social Security and Medicare) grew by 3.8 percent ($32 billion) in 2007, lower than the 5.1 percent average annual growth over the 1997–2006 period.
Revenues from all other sources, including excise, estate, and gift taxes as well as customs duties, dropped by 4.2 percent ($7 billion) in 2007, in part as a result of the abolition of certain telephone tax payments and the refund of some previous payments of those taxes. Those revenues had increased at an average rate of 4 percent per year in the previous 10 years.
Outlays totaled $2.7 trillion in 2007, or 20.0 percent of GDP. Federal spending grew modestly last year, by 2.9 percent (if adjusted for shifts in the timing of certain payments, the rate of increase was slightly less—2.6 percent). In recent years, the growth of spending was much higher, averaging 5.5 percent from 1997 to 2006. Both mandatory and discretionary spending grew more slowly in 2007 than they did over the past 10 years.
Mandatory spending rose by 2.7 percent (to $1.45 trillion) in 2007, compared with 6.0 percent average annual growth from 1997 to 2006.4 Growth in Medicare spending, which rose by 16.7 percent in 2007, was well above the average annual rate for that program of 6.9 percent over the previous 10 years. That percentage difference from 2006 outlays, however, overstates the growth in Medicare spending because it reflects shifts in the timing of certain payments. After adjusting for payments that were shifted from 2006 to 2007, CBO estimates that outlays for Medicare grew by 12.8 percent in 2007 and by 7.1 percent, on average, from 1997 to 2006. That substantial increase in 2007 occurred in part because 2007 was the first full fiscal year in which the new prescription drug program (Part D of Medicare) was in effect and because of rapid growth in the Medicare Advantage component of the program (under which beneficiaries may enroll in private health insurance plans).
Outlays for Social Security grew at a faster pace than in recent history—6.9 percent in 2007 versus 4.6 percent, on average, over the past decade. (Outlays for Social Security were held down in 2006 because the Treasury adjusted both Social Security outlays and revenues down by $6.2 billion to correct for previous accounting errors related to taxes withheld from Social Security benefits. With that accounting change excluded, the growth rate was 6.0 percent in 2007, and the adjusted rate over the 1997–2006 period was 4.7 percent.) Growth in Medicaid was below average, with outlays 5.5 percent above the 2006 level, compared with average annual growth of about 7 percent over the preceding decade. (See Chapter 3 for a more detailed discussion of these and other spending programs.)
All other mandatory spending experienced a sharp drop in growth compared with that in the past 10 years, returning to more typical levels. In recent years, this component of mandatory spending (with Medicare, Medicaid, and Social Security excluded) had increased markedly because of a variety of factors, including increases in the amounts and refundable portions of the earned income tax credit (EITC) and child tax credit, higher spending on agricultural subsidies, and large outlays for flood insurance payments following Hurricane Katrina.
Discretionary spending also grew more slowly than it had in the past—by 2.6 percent in 2007 (reaching $1.0 trillion), compared with 6.7 percent, on average, over the previous 10 years. That slower growth happened in part because, in 2007, many federal agencies were operating under a continuing resolution, which stipulated funding levels at or below the amounts they received in 2006. Within the category of discretionary spending, outlays for defense increased by 5.5 percent, whereas nondefense spending contracted slightly, dropping by 0.6 percent in 2007.5 In contrast, from 1997 through 2006, defense spending grew by 6.9 percent annually, and nondefense spending increased by 6.4 percent.
Funding for U.S. operations in Iraq and Afghanistan and other activities in the war on terrorism expanded significantly in 2007. Budget authority for those purposes totaled $171 billion in that year, compared with $120 billion in 2006. (Funding for those operations and activities is discussed in greater detail in Box 1-1.) CBO estimates that outlays for those purposes totaled about $120 billion in 2007.
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Box 1-1. Funding for Activities in Iraq and Afghanistan and for the War on Terrorism
Since September 2001, the Congress and the President have provided a total of $691 billion in budget authority for military and diplomatic operations in Iraq, Afghanistan, and other regions in support of the war on terrorism and for related veterans’ benefits and services (see the table). Appropriations specifically designated for those activities, which averaged about $93 billion a year from 2003 through 2005, rose to $120 billion in 2006 and $171 billion in 2007. The Administration has requested $193 billion for war-related purposes in 2008, of which $88 billion has been appropriated thus far.
Estimated Appropriations Provided for Activities in
Iraq and Afghanistan and for the War on Terrorism, 2001 to 2008(Billions of dollars)
2001 2002 2003 2004 2005 2006 2007 2008 Total,
2001-2008Military Operations and Other Defense Activities Iraqa 0 0 46 68 53 89 113 71 440 Otherb 14 18 34 21 18 22 39 13 178 Subtotal 14 18 80 88 70 111 152 84 618 Indigenous Security Forcesc Iraq 0 0 0 5 6 3 6 2 21 Afghanistan 0 0 0 0 1 2 7 1 12 Subtotal 0 0 0 5 7 5 13 3 33 Diplomatic Operations and Foreign Aid Iraq 0 0 3 15 1 3 3 1 26 Other * 2 5 2 2 1 2 1 15 Subtotal * 2 8 17 3 4 5 1 40 Veterans' Benefits and Servicesd Iraq 0 0 0 0 0 0 1 0 1 Other 0 0 0 0 0 0 * 0 * Subtotal 0 0 0 0 0 0 1 0 1 Totale 14 19 88 111 81 120 171 88 691
Source: Congressional Budget Office.
Note: * = between zero and $500 million.
a. CBO estimated how much money has been provided for Operation Iraqi Freedom by allocating funds on the basis of obligations reported by the Department of Defense (DoD). For more information about funding for that operation, see Congressional Budget Office, Estimated Costs of U.S. Operations in Iraq Under Two Specified Scenarios (July 13, 2006).
b. Includes Operation Enduring Freedom (in and around Afghanistan), Operation Noble Eagle (homeland security missions, such as combat air patrols, in the United States), the restructuring of Army and Marine Corps units, classified activities other than those funded by appropriations for the Iraq Freedom Fund, and other operations. (For 2005 through 2008, funding for Operation Noble Eagle has been intermingled with regular appropriations for the Department of Defense. That funding is not included in this table because it cannot be separately identified.)
c. Funding for indigenous security forces—which went to accounts for diplomatic operations and foreign aid (budget function 150) in 2004 and, since 2005, has gone to defense accounts (budget function 050)—is used to train and equip local military and police units in Iraq and Afghanistan.
d. Excludes almost $2 billion in spending for medical care, disability compensation, and survivors’ benefits for veterans of operations in Iraq and Afghanistan and the war on terrorism. Those amounts are based on CBO’s estimates of spending from regular appropriations for the Department of Veterans Affairs and were not explicitly appropriated for war-related expenses.
e. At the current rate of military operations, the funding provided to date for 2008 will not be sufficient to pay for all of the costs that will be incurred this year.
Funding to date for military operations and other defense activities related to the war totals $618 billion, most of which has gone to the Department of Defense (DoD). Lawmakers also provided $33 billion to train and equip indigenous security forces in Iraq and Afghanistan.1 A total of $651 billion has thus been appropriated since September 2001 for defense operations in Iraq and Afghanistan and for the war on terrorism.
In addition, $40 billion has been provided for diplomatic operations and foreign aid to Iraq, Afghanistan, and other countries that are assisting the United States in the war on terrorism. Of that amount, $16 billion was appropriated for the Iraq Relief and Reconstruction Fund.
DoD reports that it obligated an average of about $11 billion per month in 2007 for operations in Iraq and Afghanistan and for other activities related to the war on terrorism—an increase of about $3 billion compared with average monthly obligations in 2006. Operation Iraqi Freedom accounted for approximately 85 percent of all reported obligations; Operation Enduring Freedom (which refers mainly to operations in and around Afghanistan) accounted for another 15 percent. Additional security missions that have taken place in the United States since the terrorist attacks of September 11, 2001—such as combat air patrols over Washington, D.C., and New York City (known as Operation Noble Eagle)—accounted for less than 1 percent.
Because most appropriations for operations in Iraq and Afghanistan and for other activities related to the war on terrorism appear in the same budget accounts that record appropriations for DoD’s other functions, determining how much has actually been spent for those activities is difficult. However, CBO estimates that appropriations for defense operations in Iraq and Afghanistan and for the war on terrorism resulted in outlays of about $430 billion through fiscal year 2007 (with about $115 billion occurring in 2007). Of the funds appropriated for international affairs related to the war, about $30 billion was spent through 2007, CBO estimates. In total, by the agency’s estimate, outlays for operations in Iraq and Afghanistan amounted to about $120 billion last year. The President has requested another $105 billion for the war in 2008, in addition to the $88 billion that has been appropriated for that year. If that amount is provided, outlays in 2008 (which also include outlays from prior years’ appropriations) would total about $145 billion, CBO estimates.
1. The $33 billion includes $5 billion provided for Iraqi security forces in 2004 in an appropriation for the Department of State’s Iraq Relief and Reconstruction Fund.Outlays for net interest rose by 5.0 percent in 2007 after a decade in which they declined, on average, by 0.6 percent per year. That increase in net interest payments reflects an uptick in short-term interest rates and a larger amount of federal debt. In 2007, short-term interest rates were nearly 30 basis points higher than in 2006, and the debt increased by about $200 billion.6
The Concept Behind CBO’s Baseline Projections
The projections that make up CBO’s baseline are not intended to be predictions of future budgetary outcomes—rather, they represent CBO’s best judgment of how the economy and other factors would affect federal spending and revenues if current laws and policies remained in place. CBO constructs its baseline in accordance with provisions set forth in the Balanced Budget and Emergency Deficit Control Act of 1985 and the Congressional Budget and Impoundment Control Act of 1974. (Although the relevant provisions in the Deficit Control Act expired at the end of September 2006, CBO continues to follow that law’s specifications in preparing its projections.) In general, those provisions spell out how the agency should project federal spending and revenues under current laws and policies. The resulting baseline can then be used as a benchmark against which to measure the effects of proposed changes in spending and tax laws and policies.
For discretionary spending, the Deficit Control Act specified that the baseline should be derived by assuming that the most recent year’s budget authority, including any supplemental appropriations, is provided in each future year, with adjustments to reflect projected inflation (as measured in specified indexes) and certain other factors (such as the annual cost-of-living adjustments to federal benefits).
For revenues and mandatory spending, the Deficit Control Act required that baseline projections assume that present laws continue unchanged.7 In many cases, the laws that govern revenues and mandatory spending are permanent. Thus, CBO’s baseline projections for those programs reflect anticipated changes in the economy, demographics, and other relevant factors that affect the implementation of those laws.
CBO’s Baseline Projections for 2008 to 2018
Under CBO’s assumptions for its baseline, the federal budget will show a deficit in 2008 of around 1.5 percent of GDP—though that figure could be higher if economic stimulus is provided or if additional appropriations are made for operations in Iraq and Afghanistan. In the baseline, deficits of about the same magnitude remain through 2011, at which point they give way to surpluses as a result of the rise in projected revenues when certain tax provisions expire. By 2018, the surplus equals about 1.0 percent of GDP (see Table 1-3).
CBO’s Baseline Budget Projections
Total, Total, Actual 2009- 2009- 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2013 2018 In Billions of Dollars Revenues Individual income taxes 1,163 1,211 1,340 1,399 1,611 1,753 1,863 1,962 2,070 2,184 2,307 2,438 7,966 18,928 Corporate income taxes 370 364 356 334 333 357 327 342 350 361 374 388 1,707 3,522 Social insurance taxes 870 910 947 997 1,049 1,101 1,149 1,199 1,249 1,301 1,355 1,411 5,244 11,758 Other 164 169 174 177 188 231 245 260 272 285 298 311 1,016 2,441 Total 2,568 2,654 2,817 2,907 3,182 3,442 3,585 3,763 3,941 4,131 4,334 4,548 15,933 36,649 On-budget 1,933 1,990 2,123 2,177 2,414 2,636 2,743 2,883 3,024 3,175 3,337 3,509 12,093 28,020 Off-budget 635 665 694 730 768 806 842 880 918 957 997 1,039 3,839 8,629 Outlays Mandatory spending 1,450 1,550 1,654 1,737 1,846 1,884 2,022 2,138 2,270 2,451 2,578 2,706 9,142 21,285 Discretionary spending 1,042 1,089 1,121 1,145 1,170 1,186 1,216 1,243 1,272 1,307 1,335 1,360 5,838 12,356 Net interest 238 234 241 266 283 286 285 285 282 278 271 259 1,360 2,735 Total 2,731 2,873 3,015 3,148 3,299 3,355 3,524 3,666 3,824 4,037 4,183 4,325 16,341 36,376 On-budget 2,277 2,404 2,519 2,628 2,757 2,788 2,926 3,037 3,160 3,334 3,439 3,536 13,618 30,124 Off-budget 454 469 496 520 541 568 597 629 664 702 744 789 2,723 6,251 Deficit (-) or Surplus -163 -219 -198 -241 -117 87 61 96 117 95 151 223 -408 274 On-budget -344 -414 -396 -450 -343 -151 -184 -154 -136 -160 -102 -27 -1,525 -2,104 Off-budget 181 195 198 210 226 238 244 251 254 254 253 249 1,117 2,378 Debt Held by the Public 5,035 5,232 5,443 5,698 5,827 5,751 5,701 5,613 5,503 5,414 5,269 5,050 n.a. n.a. Memorandum: Gross Domestic Product 13,670 14,201 14,812 15,600 16,445 17,256 18,043 18,856 19,685 20,540 21,426 22,355 82,156 185,018 As a Percentage of Gross Domestic Product Revenues Individual income taxes 8.5 8.5 9.0 9.0 9.8 10.2 10.3 10.4 10.5 10.6 10.8 10.9 9.7 10.2 Corporate income taxes 2.7 2.6 2.4 2.1 2.0 2.1 1.8 1.8 1.8 1.8 1.7 1.7 2.1 1.9 Social insurance taxes 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.3 6.3 6.3 6.3 6.4 6.4 Other 1.2 1.2 1.2 1.1 1.1 1.3 1.4 1.4 1.4 1.4 1.4 1.4 1.2 1.3 Total 18.8 18.7 19.0 18.6 19.3 19.9 19.9 20.0 20.0 20.1 20.2 20.3 19.4 19.8 On-budget 14.1 14.0 14.3 14.0 14.7 15.3 15.2 15.3 15.4 15.5 15.6 15.7 14.7 15.1 Off-budget 4.6 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.6 4.7 4.7 Outlays Mandatory spending 10.6 10.9 11.2 11.1 11.2 10.9 11.2 11.3 11.5 11.9 12.0 12.1 11.1 11.5 Discretionary spending 7.6 7.7 7.6 7.3 7.1 6.9 6.7 6.6 6.5 6.4 6.2 6.1 7.1 6.7 Net interest 1.7 1.6 1.6 1.7 1.7 1.7 1.6 1.5 1.4 1.4 1.3 1.2 1.7 1.5 Total 20.0 20.2 20.4 20.2 20.1 19.4 19.5 19.4 19.4 19.7 19.5 19.3 19.9 19.7 On-budget 16.7 16.9 17.0 16.8 16.8 16.2 16.2 16.1 16.1 16.2 16.1 15.8 16.6 16.3 Off-budget 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.4 3.4 3.5 3.5 3.3 3.4 Deficit (-) or Surplus -1.2 -1.5 -1.3 -1.5 -0.7 0.5 0.3 0.5 0.6 0.5 0.7 1.0 -0.5 0.1 On-budget -2.5 -2.9 -2.7 -2.9 -2.1 -0.9 -1.0 -0.8 -0.7 -0.8 -0.5 -0.1 -1.9 -1.1 Off-budget 1.3 1.4 1.3 1.3 1.4 1.4 1.4 1.3 1.3 1.2 1.2 1.1 1.4 1.3 Debt Held by the Public 36.8 36.8 36.7 36.5 35.4 33.3 31.6 29.8 28.0 26.4 24.6 22.6 n.a. n.a.Source: Congressional Budget Office.
Note: n.a. = not applicable.
Even without additional legislation that might increase outlays, federal spending is expected to pick up in 2008. Spending will rise by 5.2 percent from 2007 levels, CBO estimates, reaching nearly $2.9 trillion this year (or 20.2 percent of GDP, compared with 20.0 percentof GDP for 2007). In CBO’s baseline, spending relative to GDP falls slightly over the coming years—to 19.3 percent by 2018. Baseline projections of trends for mandatory and discretionary spending move in opposite directions relative to GDP: Growth in mandatory spending outstrips growth in the economy, while projected discretionary spending loses ground relative to GDP.
Mandatory spending, which currently constitutes over half of all federal spending, is projected to grow at rates approaching 7 percent per year in 2008 and 2009. In later years, the growth of mandatory spending slows somewhat, averaging around 5.6 percent from 2010 to 2018. CBO estimates that under current laws and policies, outlays for such spending will reach 12.1 percent of GDP by 2018, 1.5 percentage points above their level in 2007.
In contrast, discretionary spending is assumed simply to keep pace with inflation and is therefore estimated to grow at a rate of 2.2 percent per year after 2009—less than half as fast as the projected rate of growth of nominal GDP (4.7 percent). Projected growth in discretionary spending is also less than one-third the rate of increase in such spending over the past 10 years: From 1997 to 2006, discretionary spending grew by about 6.7 percent annually.
Revenues in the baseline average less than 19 percent of GDP until 2011, when they start to rise; in 2012 and years thereafter, revenues continue to grow relative to the size economy and reach 20.3 percent of GDP by 2018. That increase in revenues follows the baseline’s underlying assumptions regarding laws that affect individual income taxes. In particular, the projections assume the expiration of various tax provisions originally enacted in EGTRRA and JGTRRA.
The baseline also does not assume any further legislation to provide relief from the alternative minimum tax. Such legislation has been in effect to varying degrees since 2001 but expired on December 31, 2007. As a result, the number of taxpayers who pay the AMT in the baseline projection jumps markedly in tax year 2008, and revenues jump most significantly a year later, in 2009. The share of total revenues attributable to the AMT is projected to rise through 2010.8 Consequently, the impact on revenues and on the budget from modifying the tax so that it does not apply to a broad array of taxpayers (which was not the intent when it was originally enacted) becomes greater over time. The Joint Committee on Taxation estimates that the relief provided for the 2007 tax year (in Public Law 110-166) will reduce revenues by a total of slightly more than $50 billion; similar changes in subsequent years would have a bigger effect.
In CBO’s baseline, accumulated federal debt held by the public (mainly in the form of Treasury securities sold directly in the capital markets) equals 36.8 percent of GDP at the end of 2008—the same level as in 2007. Under baseline projections, debt held by the public as a percentage of GDP falls each year of the 2009–2018 period as deficits decline and surpluses emerge, thus diminishing the government’s anticipated borrowing needs. In the projections, in 2018, public debt drops to 22.6 percent of GDP (see Figure 1-2). Alternative assumptions about spending and tax policies, however, could produce a substantially different debt-to-GDP ratio in that year.
Debt Held by the Public as a Share of Gross Domestic Product, 1940 to 2018
Source: Congressional Budget Office.
Changes in CBO’s Baseline Since August 2007
CBO’s estimate of the deficit for 2008 is higher than the one that it published in its previous Budget and Economic Outlook, in August 2007, primarily because revenuesare expected to be lower than previously estimated.9 In December, the Congress and the President enacted the Tax Increase Prevention Act of 2007 (P.L. 110-166), which provided some relief from the AMT for the tax year that ended on December 31, 2007. That law, along with other legislation with much smaller effects, boosted the projected deficit for 2008 by $59 billion (see Table 1-4). Changes due to economic and other factors increased the projected deficit for 2008 by another $5 billion.
Changes in CBO’s Baseline Projections of the Deficit Since August 2007
Total, Total, 2008- 2008- 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017 Total Deficit as Projected in August 2007 -155 -215 -255 -134 62 36 65 85 58 109 -696 -343 Changes Legislative Revenues -69 20 * 1 3 -1 1 1 * * -46 -44 Outlaysa -10 -29 -45 -54 -56 -58 -66 -71 -77 -81 -194 -546 Subtotal, legislative -59 49 45 54 59 57 67 71 77 81 148 502 Economic Revenues -33 -60 -63 -55 -45 -44 -44 -45 -45 -45 -256 -479 Outlaysa -16 -14 -5 -2 * 3 8 10 11 13 -37 8 Subtotal, economic -17 -46 -58 -52 -45 -47 -52 -55 -56 -58 -218 -486 Technical Revenues -14 2 19 10 7 10 7 4 2 1 25 51 Outlaysa -26 -12 -7 -4 -4 -5 -9 -11 -13 -17 -53 -108 Subtotal, technical 12 15 26 15 11 15 16 16 16 18 79 159 Total Effect on the Deficitb -64 17 14 17 25 25 32 32 36 42 8 175 Total Deficit (-) or Surplus as Projected in January 2008 -219 -198 -241 -117 87 61 96 117 95 151 -688 -168Source: Congressional Budget Office.
Notes: * = between -$500 million and $500 million.
See Appendix A for more details on changes in CBO’s projections since August 2007.
a. Includes net interest payments.
b. Negative numbers represent an increase in the deficit.
For the years after 2008, CBO’s baseline projections show slightly lower deficits and higher surpluses than they did in August. (Changes to the baseline projections are discussed in detail in Appendix A.) Much of the improvement in the baseline’s bottom line is related to the timing of appropriations for operations in Iraq and Afghanistan and other activities related to the war on terrorism, rather than to changes in the underlying budgetary and economic environment.
Because baseline projections are derived from the most recent appropriations, CBO based its August projections on appropriations for 2007, which included about $170 billion in funding for military and diplomatic operations in Iraq and Afghanistan and other activities in the war on terrorism.
In contrast, the basis for CBO’s most recent baseline is the level of funding enacted for 2008, which includes only partial-year funding for those purposes.10 To date, $88 billion has been provided in 2008 for operations in Iraq and Afghanistan and other activities related to the war on terrorism. The effect of extending that smaller amount of enacted appropriations throughout the projection period is partially offset by increases in spending in other areas, resulting in a net reduction of $546 billion in outlays between 2008 and 2017.
Other changes, in the aggregate, worsen the projected budget outlook by a total of $371 billion over the 2008–2017 period. Most of that difference results from a deteriorating economic outlook. CBO’s projections incorporate a slowdown in economic growth in the final quarter of 2007 and in 2008 and a slight reduction in the economy’s potential rate of growth during the next 10 years. (Chapter 2 discusses the details of CBO’s economic projections.) Over the entire 10-year projection period, the net result of changes in the economic outlook is a reduction of $479 billion in revenues, most of which stems from lower projections of corporate income tax receipts. Economic changes affecting projections of outlays offset $8 billion of that reduction.
The remaining revisions to CBO’s baseline result from technical factors—those not directly related to changes in legislation or the economic outlook. Such revisions since August have generally raised projections of revenues and lowered estimates of outlays from 2008 to 2017, thereby reducing this year’s estimated deficit by $12 billion and the 10-year cumulative deficit by $159 billion.
Uncertainty and Budget Projections
Actual budgetary outcomes are almost certain to differ from CBO’s baseline projections because of future legislative actions, unanticipated changes in conditions affecting the economy, and many other factors that affect federal spending and revenues.
Uncertainty of Future Legislative Actions
To illustrate how different fiscal policies might affect the baseline, CBO estimated the budgetary impact of some alternative policy actions (see Table 1-5). The discussion below focuses on their direct effects on revenues and outlays. Such changes would also affect projected debt-service costs (shown separately in Table 1-5).
The Budgetary Effects of Selected Policy Alternatives Not Included in CBO’s Baseline
Total, Total, 2009- 2009- 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2013 2018 Policy Alternatives That Affect Discretionary Spending Reduce the Number of Troops Deployed for Military Operations in Iraq and Afghanistan and Other ActivitiesRelated to the War on Terrorism to30,000 by 2010a Effect on the deficit or surplusb -30 -43 -14 22 45 55 60 63 65 68 70 65 390 Debt service * -2 -4 -4 -2 0 3 6 9 13 17 -12 35 Reduce the Number of Troops Deployed for Military Operations in Iraq and Afghanistan and Other Activities Related to the War on Terrorism to 75,000 by 2013c Effect on the deficit or surplusb -30 -58 -59 -51 -29 -13 4 17 21 24 25 -210 -120 Debt service * -2 -5 -9 -11 -13 -13 -14 -13 -13 -12 -40 -106 Increase Regular Discretionary Appropriations at the Rate of Growth of Nominal GDPd Effect on the deficit or surplusb 0 -9 -33 -64 -95 -125 -154 -184 -214 -246 -280 -324 -1,403 Debt service 0 * -1 -4 -8 -13 -21 -30 -41 -55 -70 -26 -243 Freeze Total Discretionary Appropriations at the Level Provided for 2008 Effect on the deficit or surplusb 0 17 38 62 87 114 142 171 202 232 263 316 1,326 Debt service 0 * 2 4 8 13 20 29 39 52 67 28 235 Policy Alternatives That Affect the Tax Codee Extend EGTRRA and JGTRRAf Effect on the deficit or surplusb * -3 -6 -147 -254 -281 -292 -304 -316 -329 -344 -692 -2,277 Debt service * * * -4 -14 -28 -43 -60 -78 -98 -119 -46 -444 Extend Other Expiring Tax Provisions Effect on the deficit or surplusb -6 -14 -22 -31 -38 -44 -49 -53 -58 -63 -67 -149 -438 Debt service 0 -1 -1 -3 -5 -7 -10 -12 -16 -20 -24 -16 -97 Index the AMT for Inflationg Effect on the deficit or surplusb -6 -75 -76 -71 -42 -49 -58 -68 -80 -94 -110 -313 -724 Debt service 0 -2 -5 -9 -13 -16 -19 -23 -28 -34 -40 -45 -189 Memorandum: Interactive Effect of Extending EGTRRA and JGTRRA and Indexing the AMTe Effect on the deficit or surplusb 0 0 0 -18 -61 -69 -76 -83 -90 -97 -105 -148 -598 Debt service 0 0 0 * -2 -6 -9 -14 -19 -24 -30 -9 -105 Total Discretionary Outlays in CBO's Baseline 1,089 1,121 1,145 1,170 1,186 1,216 1,243 1,272 1,307 1,335 1,360 5,838 12,356 Total Outlays for Operations in Iraq and Afghanistan in CBO's Baseline 115 103 96 93 93 95 97 98 100 102 104 480 981 Total Deficit (-) or Surplus in CBO's Baseline -219 -198 -241 -117 87 61 96 117 95 151 223 -408 274Sources: Congressional Budget Office; Joint Committee on Taxation.
Notes: GDP = gross domestic product; EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax; * = between -$500 million and $500 million.
a. This alternative does not extrapolate the $88 billion in funding for military operations and associated costs in Iraq and Afghanistan provided for 2008. However, it incorporates the assumption that an additional $105 billion in budget authority will be provided in 2008 to carry out operations in those countries. Future funding for operations in Iraq, Afghanistan, or elsewhere would total $118 billion in 2009, $50 billion in 2010, and then about $34 billion a year from 2011 on—for a total of $440 billion over the 2009–2018 period.
c. This alternative does not extrapolate the $88 billion in funding for military operations and associated costs in Iraq and Afghanistan provided for 2008. However, it incorporates the assumption that an additional $105 billion in budget authority will be provided in 2008 to carry out operations in those countries. Future funding for operations in Iraq, Afghanistan, or elsewhere would total $161 billion in 2009, $147 billion in 2010, $128 billion in 2011, $101 billion in 2012, $79 billion in 2013, and then about $77 billion a year from 2014 on—for a total of $1 trillion over the 2009–2018 period.
d. Under this alternative, appropriations for 2008 for operations in Iraq and Afghanistan (as well as other emergency appropriations) are extrapolated according to rules for the baseline.
f. These estimates do not include the effects of extending the increased exemption amount or the treatment of personal credits for the AMT that expired at the end of 2007. The effects of that alternative are shown separately.
g. This alternative incorporates the assumption that the exemption amount for the AMT (which was increased through 2007 in the Tax Increase Prevention Act of 2007) is extended at its higher level and, together with the AMT tax brackets, is indexed for inflation after 2007. In addition, the treatment of personal credits against the AMT (which was also extended through the end of 2007 in that act) is assumed to be continued. If this alternative was enacted jointly with the extension of the expiring tax provisions, an interactive effect after 2010 would make the combined revenue loss over the 2011–2018 period greater than the sum of the two separate estimates (see the memorandum).
Activities Related to Iraq and Afghanistan and the War on Terrorism. CBO’s baseline includes outlays that arise from the $88 billion in appropriations already provided for 2008 for operations in Iraq and Afghanistan and for other activities related to the war on terrorism and from the resulting $979 billion in budget authority for those purposes that is projected over the 2009–2018 period (as well as outlays from funding provided in 2007 and prior years). However, the funding for 2008 represents only a portion of what will be needed for those operations throughout this year.
In subsequent years, the annual funding required for military operations in Iraq and Afghanistan or in other locations may eventually be less than the amounts in the baseline if the number of troops and pace of operations diminish over time. Because of considerable uncertainty about those future operations, CBO has formulated two scenarios. Under both, the number of active-duty, Reserve, and National Guard personnel would average 205,000 in fiscal year 2008, after which those force levels would decline at different rates and to different sustained levels. Many other budgetary outcomes—some costing more, some less—are also possible for the operations described in these scenarios.
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Under the first scenario, troop levels would be rapidly reduced, with deployed forces declining until 30,000 military personnel were stationed overseas in support of the war on terrorism at the beginning of 2010 and in each year over the 2011–2018 period, although not necessarily in Iraq and Afghanistan. Under such a scenario, discretionary outlays for 2008 would be about $30 billion higher than the amount in the baseline, but annual outlays would be lower beginning in 2011. In total, over the 2008–2018 period, discretionary outlays would be close to $360 billion less than the amount in the current baseline.
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Under the second scenario, the number of troops would decline more gradually, dropping to about 175,000 in 2009 and continuing to fall steadily in subsequent years, until 75,000 remained overseas in 2013 and each year thereafter. Under such a scenario, discretionary outlays for 2008 would increase by about $30 billion compared with the amount in the current baseline, but annual outlays would be less than the projection beginning in 2014. During the 2008–2018 period, total outlays for military activities related to Iraq, Afghanistan, and the war on terrorism would be greater than the amount in the baseline by about $150 billion.
Other Discretionary Spending. Many alternative assumptions about the future growth of discretionary spending are possible. For example, if appropriations (other than those for activities in Iraq and Afghanistan and other funding declared as an emergency requirement) were assumed to grow through 2018 at the same rate as nominal GDP instead of at the rate of inflation, total projected discretionary spending would be $1.4 trillion higher than the amount in the current baseline. In contrast, if lawmakers did not increase appropriations after 2008 to account for inflation, cumulative discretionary outlays would be $1.3 trillion lower. Under that latter scenario (sometimes referred to as a freeze in appropriations), total discretionary spending would fall from 7.6 percent of GDP in 2007 to 4.9 percent in 2018.
Revenues. The baseline assumes that major provisions of EGTRRA and JGTRRA—such as the introduction of the 10 percent tax bracket, increases in the child tax credit, repeal of the estate tax, and lower rates for capital gains and dividends—will expire as scheduled at the end of 2010. On balance, the tax provisions that are set to expire during the 2009–2018 period reduce revenues; thus, under a scenario in which they all were extended, projected revenues would be lower than the amount in the current baseline. For example, if all expiring tax provisions (except those related to the exemption amount for the AMT) were extended, total revenues over the 2009–2018 period would be about $2.7 trillion lower than the current baseline projection.11 That estimate reflects the fact that the effect of lowering the amount of taxpayers’ liabilities would be partially offset by an increase in the number of taxpayers subject to the AMT.
Another change in policy that could affect revenues involves the modification of the AMT, which many observers believe cannot be maintained in its current form. Because the AMT’s exemption amount and brackets are not adjusted for inflation, the impact of the tax will grow in coming years as more taxpayers become subject to it. If the AMT was indexed for inflation after 2007 and no other changes were made to the tax code, federal revenues over the next 10 years would be $724 billion lower than the amount in the baseline, according to CBO and the Joint Committee on Taxation’s estimate.
Because the number of taxpayers who are subject to the AMT will depend on whether the tax provisions originally enacted in EGTRRA and JGTRRA are still in effect, the combination of indexing the AMT for inflation and extending the expiring provisions would reduce revenues by more than indexing alone. The effect of that interaction would lower revenues by an additional $598 billion between 2011 and 2018.
In addition to being affected by future legislative actions, the federal budget is sensitive to economic and technical factors that are difficult to forecast. In constructing its baseline, CBO must make assumptions about such economic variables as interest rates, inflation, and the growth of GDP. (CBO’s economic assumptions are explained in detail in Chapter 2.) Discrepancies between those assumptions and actual economic conditions can significantly affect the extent to which budgetary outcomes differ from baseline projections. For instance, CBO’s baseline reflects an assumption that real GDP grows by 1.7 percent in calendar year 2008, by 2.8 percent in 2009, and by an average of 2.7 percent annually from 2010 to 2018. If the actual rate was 0.1 percentage point higher or lower each year, the effect on the projection of the cumulative surplus for the 2009–2018 period would be about $300 billion. (For further discussion of the effect of economic assumptions on budget projections, see Appendix C.)
Uncertainty also surrounds technical factors that affect CBO’s baseline budget projections. For example, the rate of spending per enrollee for Medicare and Medicaid, which has generally grown faster than GDP, is difficult to forecast, but it will have a large impact on the costs of those programs in coming years. CBO’s projections of spending for those programs also depend on assumptions about the growth of their enrollment and, indirectly, general inflation. For example, if per capita costs or enrollment in the next 10 years grew 1 percentage point faster or slower than CBO has projected, the impact on Medicare and Medicaid outlays would be $625 billion over that period.
Other projections also are vulnerable to technical uncertainty. For example, CBO must estimate prices for various agricultural commodities as well as crop yields, all of which are volatile and strongly affect how much the government will pay farmers under price- and income-support programs. Assumptions about revenues are particularly sensitive to technical uncertainty. Although CBO uses its economic projections to estimate overall income from current production, it must make technical assumptions about the amount of revenues to expect from a given amount of such income. Differences between the expectations and actual revenues can lead to significant deviations from CBO’s baseline projections.
To help illustrate the uncertainty surrounding CBO’s baseline projections, Figure 1-3 displays the range of possible outcomes for the total deficit or surplus under current law (that is, excluding the possible impact of future legislation). The current baseline projection of the deficit falls in the middle of the highest-probability area, as shown in the darkest part of the figure. The probabilities of other projections are based in part on the differences between CBO’s past baselines and actual budgetary results. The other paths in that dark portion of the figure have nearly the same probability of occurring as CBO’s current projections. Projections that are increasingly different from the baseline are shown in the lighter areas, but they have a significant likelihood of coming to pass. For example, CBO projects a baseline deficit of 1.3 percent of GDP for 2009, but even with no changes in policy, there is a roughly 25 percent chance that the deficit that year will be higher by 1.0 percent of GDP and a roughly 20 percent chance that the budget in that year will be in balance.
Uncertainty of CBO’s Projections of the Budget Deficit or Surplus Under Current Policies
Source: Congressional Budget Office.
Notes: This figure, calculated on the basis of CBO’s track record in forecasting, shows the estimated likelihood of alternative projections of the budget deficit or surplus under current policies. The baseline projections described in this chapter fall in the middle of the darkest area of the figure. Under the assumption that tax and spending policies do not change, the probability is 10 percent that actual deficits or surpluses will fall in the darkest area and 90 percent that they will fall within the whole shaded area.
Actual deficits or surpluses will be affected by legislation enacted in future years, including decisions about discretionary spending. The effects of future legislation are not reflected in this figure.
For an explanation of how CBO calculates the probability distribution underlying this figure, see Congressional Budget Office, The Uncertainty of Budget Projections: A Discussion of Data and Methods (March 2007). An updated version of that publication is forthcoming.
The uncertainty surrounding CBO’s baseline compounds over time. By 2013, when CBO projects a baseline surplus of about 0.3 percent of GDP, there is a 25 percent likelihood that the federal government will post a deficit in that year of about 1.8 percent of GDP. However, there is also a 25 percent chance that the surplus will be higher by about 2 percent of GDP (under an assumption that current laws and policies do not change).
Federal Debt Held by the Public
Debt held by the public comprises debt that the Department of the Treasury issues to raise cash to fund the operations and pay off the maturing liabilities of the federal government. (Other measures of debt are discussed in Appendix B.) When the federal government runs a deficit, the Treasury borrows money from the public by selling securities in the capital markets. That debt is purchased by various domestic buyers, such as mutual funds, state and local governments, Federal Reserve banks, commercial banks, insurance companies, and individuals, as well as by private foreign entities and central banks. Of the $5.0 trillion in outstanding public debt at the end of 2007, domestic investors owned 55 percent ($2.8 trillion) and foreign investors held 45 percent ($2.2 trillion).
Among investors from other nations, those in Japan, China, and the United Kingdom have the biggest holdings of Treasury securities.12 The central banks and private entities in those countries hold about $1.2 trillion of such debt—roughly 25 percent of the total. In 2007, foreign investors added about $220 billion in Treasury securities—or about $15 billion more than the amount of money that the Treasury borrowed from the public last year. In the past five years, investors from abroad have added more than $1 trillion in securities, or roughly 70 percent of the total increase in public debt duringthat time. Investors in China have increased their holdings by $292 billion of such debt in the past five years, and investors in Japan and the United Kingdom have added $208 billion and $189 billion, respectively, totheir holdings.
Among domestic investors, Federal Reserve banks, state and local governments, and mutual funds are the largest investors in Treasury securities, holding around $775 billion, $511 billion, and $266 billion, respectively, of debt sold to the public.13
Debt held by the public fluctuates according to changes in the government’s borrowing needs. In 1993, it equaled nearly 50 percent of GDP, but by 2001, it measured 33 percent (see Figure 1-2). Since then, debt held by the public has risen to 37 percent of GDP. Under assumptions in the baseline (in particular, that discretionary spending grows at the rate of inflation and that tax provisions expire as scheduled), debt held by the public remains at 37 percent of GDP until 2010 and then falls to 35 percent in 2011 (the average debt-to-GDP ratio during the past 40 years). After 2011, it falls more rapidly, dropping to 23 percent of GDP by 2018 (see Table 1-6). At that time, debt held by the public totals $5.0 trillion in CBO’s baseline, or roughly the same amount that it is currently.
CBO’s Baseline Projections of Federal Debt
Actual 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Debt Held by the Public at the Beginning of the Year 4,829 5,035 5,232 5,443 5,698 5,827 5,751 5,701 5,613 5,503 5,414 5,269 Changes to Debt Held by the Public Deficit or surplus (-) 163 219 198 241 117 -87 -61 -96 -117 -95 -151 -223 Other means of financing 43 -22 13 14 12 11 10 9 7 6 5 4 Total 206 197 211 255 129 -76 -51 -87 -111 -88 -146 -219 Debt Held by the Public at the End of the Year 5,035 5,232 5,443 5,698 5,827 5,751 5,701 5,613 5,503 5,414 5,269 5,050 Memorandum: Debt Held by the Public at the End of the Year as a Percentage of GDP 36.8 36.8 36.7 36.5 35.4 33.3 31.6 29.8 28.0 26.4 24.6 22.6Source: Congressional Budget Office.
Changes in policy, however (such as those shown in Table 1-5), would lead to a different amount of public debt. For example, if the number of troops involved in military operations in Iraq, Afghanistan, and elsewhere in support of the war on terrorism declined to 30,000 by the beginning of 2010 and all other policies were consistent with those assumed in the baseline, debt held by the public in 2018 would fall by $426 billion relative to the amount in the baseline, bringing the total to $4.6 trillion, or 20.7 percent of GDP. By contrast, if the provisions in EGTRRA and JGTRRA set to expire in 2010 were extended through 2018, debt held by the public in 2018 would rise by $2.7 trillion relative to the baseline amount, bringing the total to $7.8 trillion, or 34.8 percent of GDP.
The Composition of Debt Held by the Public. About 88 percent of publicly held debt consists of marketable securities—Treasury bills, notes, bonds, and inflation-indexed issues (called TIPS). The remaining 12 percent comprises nonmarketable securities, such as savings bonds and securities in the state and local government series, which are nonnegotiable, nontransferable debt instruments issued to specific investors.14
The Treasury sells marketable securities to brokers in regularly scheduled auctions, whose size varies with changes in the government’s cash flow. (Periodically, the Treasury also sells cash-management bills to cover shortfalls in cash balances.) In May 2007, the Treasury stopped issuing three-year notes. CBO projects that, under the assumptions incorporated in its baseline, the elimination of those issues will cause a modest decline in the amount of notes outstanding as a percentage of total marketable debt. That percentage is projected to fall from 55 percent at the end of 2007 to 49 percent by 2011. In contrast, the share of marketable debt accounted for by bills and inflation-protected securities is expected to expand over the next five years: The share for bills is projected to grow from 22 percent to 27 percent and for inflation-protected securities from 10 percent to 12 percent of the total. Finally, bonds are expected to drop from their current level of 13 percent to 12 percent of total marketable debt.
Why Changes in Debt Held by the Public Do Not Equal Surpluses and Deficits. In most years, the amount of debt that the Treasury borrows or redeems roughly equals the annual budget deficit or surplus. However, a number of factors—which are broadly labeled "other means of financing"—also affect the government’s need to borrow money from the public. For 2008, CBO’s projection of debt held by the public shows borrowing to be $22 billion less than the amount of the deficit because CBO estimates that the Treasury will reduce its cash balance from its level at the end of 2007. Debt held by the public will grow by more than the cumulative deficit over the 2009–2018 period, CBO projects, because changes in other means of financing will increase the Treasury’s borrowing needs.
Among such means of financing, the capitalization of financing accounts used for federal credit programs usually has the biggest effect on the government’s borrowing. Direct student loans, rural housing programs, loans made by the Small Business Administration, and other credit programs require the government to disburse money up front in anticipation of repayment at a later date. Those initial disbursements are not counted in the budget, which reflects only the programs’ estimated costs for subsidies, defaults, and other items. Each year from 2009 to 2018, the amount of loans disbursed will typically be larger than the amount of repayments and interest collected. Thus, the government’s annual borrowing needs will, on average, be $9 billion greater than the annual budget deficit or surplus might indicate.
Although the baseline projections show budget surpluses in the later years of the 10-year projection period, the nation faces substantial fiscal challenges over the long term. Growth in spending—particularly for Medicare and Medicaid—is likely to exceed growth in federal revenues as well as in the economy. Attaining fiscal stability in the coming decades almost certainly will require some combination of reductions in the growth of spending and increases in taxes as a share of the economy.
The future rates of growth for the government’s major health care programs—Medicare and Medicaid—will be the primary determinant of the nation’s long-term fiscal balance. Over the past four decades, per-beneficiary costs in the programs have increased about 2.5 percentage points faster per year than has per capita GDP. If current laws and policies remained in place, federal spending on those two programs alone would rise from 4.6 percent of GDP in 2007 to about 12 percent by 2050 and 19 percent by 2082.15 That percentage represents about the same share of the economy that the entire federal budget does today (see Figure 1-4).
Projected Federal Spending Over the Long Term
(Percentage of gross domestic product)
Source: Congressional Budget Office.
The aging of the nation’s population also will affect the federal budget over time. CBO projects that under current law, Social Security spending will rise from its current level of 4.3 percent of GDP in 2007 to around 6 percent in 25 years (and roughly stabilize at that rate), in part because of that demographic shift.
If tax revenues as a share of GDP remain at current levels (roughly 19 percent of GDP), additional spending for Medicare, Medicaid, and Social Security will eventually cause future budget deficits to become unsustainable. Even if revenues follow the path projected under current law and rise to about 24 percent of GDP by 2050, budgetary pressures will increase significantly. As a result, substantial reductions in the projected growth of spending, a sizable increase in taxes as a percentage of the economy, or some combination of changes in policies for spending and revenues is likely to be necessary to achieve fiscal stability. Such policy changes would certainly have some effect on the economy, but those effects would probably be less than the costs of allowing deficits to grow to unsustainable levels.
See Congressional Budget Office, Options for Responding to Short-Term Economic Weakness (January 2008).
In addition to the $88 billion in funding already provided this year, the Administration has requested $105 billion for military operations in Iraq and Afghanistan and other activities associated with the war on terrorism.
See Congressional Budget Office, The Long-Term Budget Outlook (December 2007).
After adjusting for shifts in the timing of some payments, CBO estimates that mandatory spending grew by 2.0 percent in 2007 and that growth from 1997 to 2006 averaged 6.1 percent.
After adjusting for the effects of shifts in the timing of payments, defense spending in 2007 grew by 6.0 percent.
A basis point is one one-hundredth of a percentage point.
The Deficit Control Act provided some exceptions. For example, it directed that spending programs whose authorizations are set to expire be assumed to continue if they have outlays of more than $50 million in the current year and were established on or before the enactment of the Balanced Budget Act of 1997. Programs established after that law was enacted are not automatically assumed to continue. The Deficit Control Act also required CBO to assume that expiring excise taxes dedicated to trust funds will be extended at their current rates. The law did not provide for the extension of other expiring tax provisions, even if they had been extended routinely in the past.
Like the rate structure of the regular income tax, the AMT extracts a greater proportion of overall income as real income rises. But unlike the regular income tax, the AMT is not indexed for inflation. So as income rises each year with the overall level of prices, a larger number of taxpayers find themselves subject to the AMT. Chapter 4 discusses the increased role of the tax in CBO’s projections.
See Congressional Budget Office, The Budget and Economic Outlook: An Update (August 2007).
Appropriations for 2008 were provided in the Department of Defense Appropriations Act, 2008 (P.L. 110-116), in the Consolidated Appropriations Act, 2008 (P.L. 110-161), and in a joint resolution making continuing appropriations for fiscal year 2008 (P.L. 110-92).
That estimate does not include any macroeconomic effects—unlike CBO’s baseline projections, which incorporate the effects that the tax provisions’ expiration would have on the economy as a whole. However, such effects are likely to be small relative to GDP.
See Department of the Treasury, "Major Foreign Holders of Treasury Securities" (December 17, 2007), available at www.ustreas.gov/tic/mfh.txt. That information should be viewed as approximate, because in many cases, it is impossible to accurately determine the home country of foreign holders of U.S. securities, as intermediaries may be involved in the custody, management, purchase, or sale of the securities.
Department of the Treasury, Financial Management Service,Treasury Bulletin (December 2007).
State and local government securities are time deposits that the Treasury sells to the issuers of state and local government tax-exempt debt to help them comply with the provisions of the Internal Revenue Code prohibiting arbitrage.
For more details, see Congressional Budget Office, The Long-Term Budget Outlook (December 2007).