06 21 Long Term Budget Outlook

 

CONGRESS OF THE UNITED STATES CONGRESSIONAL BUDGET OFFICE

CBO CBO’ss 2011 201 1 CBO’ Long-Term Budget Outlook 

Federal Spending and Revenues Percentage of GDP 30

Actual

Projected

Actual

Projected

25 20

Spending

Spending

15

Revenues

Revenues

10 5 0 2000

2005

2010

2015

2020

2025

2030

2035

2000

2005

Extended-Baseline Scenario

2015

2020

2025

2030

2035

Alternative Fiscal Scenario

Federal Debt Held by the Public

Percentage of GDP 200

2010

Actu Ac tual al

Proj Pr ojec ecte ted d

175 150

Alternative Fiscal Scenario

125 100

Extended-Baseline Scenario

75 50 25 0 2000

2005

2010

2015

2020

 JUNE 2011

2025

2030

2035

 

Pub. No. 4277

 

 A 

CBO R E P O R T  

CBO’s 2011 Long-Term Budget Outlook   June 2011

The Congress of the United States  Congressional Budget Office  O

 

Notes Unless otherwise indicated, the years referred to in this report are federal feder al fiscal years (which run from October October 1 to September 30). 30). Numbers in the text and tables may not add up to totals because of rounding. The figure on the cover shows, in the top panel, federal spending and revenues under the Congressional Budget Office’s Office’s extended-baseline scenario and alter alternative native fiscal scenario. In the bottom panel, the cover figure shows federal debt held h eld by the public under those two scenarios. The extended-baseline ex tended-baseline scenario adheres closely clo sely to current law, law, following CBO’s CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fisca fiscall scenario 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 fo r a long period. Supplementary data underlying the long-term budget scenarios are posted along with this report on CBO’s Web site (  www.cbo.gov  www.cbo.gov ))..

CBO

 

Preface

T

his Congressional Budget Office (CBO) report presents the agency’ agency’ss projections of federal spending and revenues over the coming decades. Under current law, an aging population and rapidly rising health care costs will sharply increase federal spending for f or health care programs and Social Security Security.. If revenues remained at their historical average average share of gross domestic product (GDP), such spending growth would cause federal debt to grow to unsustainable levels. If policymakers are to put the federal government on a sustainable budgetary path, they will need to increase revenues substantially as a percentage of GDP, GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches. In keeping with CBO’s mandate to provide objective, impartial analysis, this report makes no recommendations.

This report was prepared under the supervision of Joyce Manchester, Manchester, and many analysts at CBO provided assistance assistance and helpful comments. Noah Meyerson Meyerson wrote Chap Chapte terr 1. Benjamin Benjam in Page Page wrote Chap Chapter ter 2. Lyle Nelson and Julie Topoleski authored Chap Chapte terr 3. Noah Noa h Meyerson Meyerson wrote wrote Chap Chapter ter 4, and he and Sam Papenfuss wrote Chap Chapte terr 5. Joshua Shakin  wrote Chap Chapte terr 6. Noah Meyerson wrote Appendix wrote Appendix A , and Charles Pineles-Mark compiled  Appendix B. James Baumgardner Baumgardner,, T Tom om Bradley, Bradley, Wendy Wendy Edelberg, Peter Fontaine, Fontaine, Holly Harvey, Harvey, Jean Hearne, Kim Kowalewski, Kowalewski, Deborah Lucas, William Randolph, and Frank Sammartino provided useful guidance. Charles Charles Pineles-Mark, Jonat Jonathan han Schwabish, Michael Simpson, and Julie Topoleski Topoleski developed the long-term budget simulations, and  Jonathan Huntley Huntley prepared the macroeconomic macroeconomic simulations. David W Weiner einer coordinated the revenue simulations, which were prepared by Paul Paul Burnham, Grant Driessen, Ed Harris,  Athiphat Muthitacharoen, Muthitacharoen, Larry Ozanne, Kurt Kurt Seibert, and Joshua SShakin. hakin. Sarah Axeen, Stephanie Burns, Jimmy Jin, and Kalyani Parthasarathy provided research assistance. Christine Bogusz, Christian Howlett, Kate Kelly, Leah Mazade, and John Skeen edited the report. Maureen Costantino and Jeanine Rees prepared the report for publication, and Maureen Costantino designed the cover. Monte Ruffin printed the initial copies, and Linda Schimmel handled the print distribution. The report is available at CBO’s Web Web site (  www.cbo.gov  www.cbo.gov ))..

Douglas W. Elmendorf  Director  June 2011

CBO

 

Contents Summary 

ix 

1

 The Long-Term Outlook Outlook for the Federal Budget  Budget 

1

 Alternative Scenarios for the Long-Term Budget Outlook  Outlook  The Long-Term Outlook for Spending  The Long-Term Outlook for Revenues The Size of the Fiscal Imbalance Uncertainty of Long-Term Budget Projections

 2  7  12  13 16 

2

 The Economic Impact Impact of Long-Term Budget Budget Policies

 21

CBO’s Long-Term Economic Benchmark  How Rising Debt and Changing Marginal Tax Rates Would Affect Output Economic Effects of the Fiscal Policies Assumed in CBO’s Extended-Baseline and Alternative Fiscal Scenarios

 22   26   28 

The Effects of Waiting to Resolve the Long-Term Budgetary Imbalance Other Consequences of Rising Federal Debt

 31  33

 The Long-Term Outlook Outlook for Mandatory Spending Spending on Health Care Care

 35 

3

Overview of Major Government Health Care Programs The Historical Growth of Health Care Spending  CBO’s Methodology for Long-Term Projections Long-Term Projections of Mandatory Spending on Health Care

 36  40  42  45 

4

 The Long-Term Outlook Outlook for Social Security  Security 

51

How Social Security Works The Outlook for Social Security Spending and Revenues

51 53

CBO  

VI

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

5

 The Long-Term Outlook Outlook for Other Federal Spending  Spending 

57 

Other Federal Spending Spending Over the Past Four Decades Projections of Other Federal Spending Under CBO’s Long-Term Budget Scenarios

57  59 

 The Long-Term Outlook Outlook for Revenues

61

Revenues Over the Past 40 Years Revenue Projections Under CBO’s Long-Term Budget Scenarios Long-Term Implications for Tax Rates and the Tax Burden

62  64  69 

A

Changes in CBO’s Long-Term Projections Since June 2010

73

B

Long-Term Projections Through 2085

79 

Glossary 

85 

6

CBO  

CONTENTS

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

 T  Tables ables 1-1.. 1-1

Assump Assumptio tions ns Abou Aboutt Spend Spending ing and Revenu Revenues es Unde Underly rlying ing CBO CBO’s ’s Long Long-Te -Term rm Budget Scenarios

4 

1-2.. 1-2

Projec Projected ted Spendi Spending ng and and Reve Revenue nuess Unde Underr CBO’s CBO’s Long-T Long-Term erm Budget Budget Scena Scenario rioss

8 

1-3.. 1-3

The The Feder Federal al Fiscal Fiscal Ga Gap p Unde Underr CBO’ CBO’ss Long Long-Te -Term rm Budget Budget Scenar Scenarios ios

15 

2-1.. 2-1

The The Effect Effect of the the Fiscal Fiscal Polici Policies es Assu Assumed med in CBO’s CBO’s Long-T Long-Term erm Budget Budget Scenarios on Real GNP and GDP in 2025 and 2035

 28 

3-1.

Excess Cost Growth in Spending for Health Care

42 

3-2.. 3-2

Financ Financial ial Meas Measure uress for Medic Medicare are’s ’s Hospi Hospital tal Insu Insuran rance ce Trus Trustt Fund Fund Under Under CBO’ CBO’ss Extended-Baseline Scenario

49 

4-1.. 4-1

Financ Financial ial Meas Measure uress for Soci Social al Secu Securit rityy Under Under CBO’ CBO’ss Long-T Long-Term erm Budge Budgett Sc Scena enario rioss

55 

5-1. 5-1.

CBO’ CBO’ss Base Baseli line ne Pr Proj ojec ecti tion onss of Oth Other er Fed Federa erall Spen Spendi ding  ng 

60 

6-1.. 6-1

Assump Assumptio tions ns Abou Aboutt Reven Revenues ues Underl Underlyin yingg CBO’ CBO’ss LongLong-Ter Term m Budget Budget Scenar Scenarios ios

63

6-2.. 6-2

Source Sourcess of Growth Growth in Tota Totall Revenu Revenues es as as a Shar Sharee of GDP GDP Betw Between een 2011 2011 and and 2035 2035 Under CBO’s Extended-Baseline Scenario

65 

6-3.. 6-3

Estima Estimates tes of of Effecti Effective ve Margi Marginal nal Tax Tax Rates Rates Unde Underr CBO’s CBO’s Exte Extende nded-B d-Base aselin linee Scenar Scenario io

71

6-4.. 6-4

Indivi Individua duall Incom Incomee and and Payro Payroll ll Taxe Taxess as a Shar Sharee of Income Income Under Under CBO’ CBO’ss Extended-Baseline Scenario

72 

S-1.. S-1

Federa Federall Debt Debt Held Held by the the Publ Public ic Under Under CBO’ CBO’ss LongLong-Ter Term m Budget Budget Scena Scenario rioss

 xi 

1-1.. 1-1

Primar Primary y Spen Spendin dingg aand nd Revenu Revenues, es, by Categor Category, y, Under Under CBO’s CBO’s Long-T Long-Term erm Budget Scenarios

1-2.. 1-2

Federa Federall Debt Debt Held Held by the the Publ Public ic Under Under CBO’ CBO’ss LongLong-Ter Term m Budget Budget Scena Scenario rioss

14 

1-3.. 1-3

Reduct Reduction ionss in Primar Primaryy Spen Spendin dingg or Incr Increas eases es in in Reven Revenues ues in in Vario Various us Year Yearss Needed to Close the 25-Year Fiscal Gap Under CBO’s Alternative Fiscal Scenario

16 

One Potential Path for Revenues and Noninterest Spending Sufficient to Close the 25-Year 25-Year Fiscal Fiscal Gap

18 

The Effect Effect of the the Fiscal Fiscal Polici Policies es Assume Assumed d iin n CBO’ CBO’ss L Long ong-Te -Term rm Bud Budget get Scenarios on Real Gross National Product per Person

 30 

Figures

1-4. 2-1.. 2-1

6 

2-2.. 2-2

Federa Federall Debt Debt Held Held by by the the Publi Public, c, With With and Withou Withoutt the the Econom Economic ic Effec Effects ts of the

3-1.

Fiscal Policies Assumed in CBO’s Long-Term Budget Scenarios Distribution of Spending for Health Services and Supplies, 2009

 32   37 

Mandato Mandatory ry Fede Federal ral Spendi Spending ng on on Healt Health h Care Care,, by Categor Category, y, Unde Underr CBO’ CBO’ss Extended-Baseline Scenario

46 

3-2.. 3-2

  VII

CBO  

VIII

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figures (Continued) 3-3.. 3-3

Mandat Mandatory ory Federa Federall Spend Spending ing on Health Health Care Care Unde Underr CBO CBO’s ’s Long Long-Te -Term rm Budget Scenarios

46 

3-4.. 3-4

Mandato Mandatory ry Fede Federal ral Spendi Spending ng on on Healt Health h Care Care Unde Underr CBO’s CBO’s Alte Alterna rnativ tivee Fisca Fiscall

4-1.. 4-1

Scenario and Different Assumptions About Excess Cost Growth After 2021 Spendi Spending ng for for Soci Social al Secu Securit rityy Unde Underr CBO’ CBO’ss L Long ong-Te -Term rm Bud Budget get Scenar Scenarios ios

48  52 

4-2. 4-2.

The The Popu Popula lati tion on Age Age 65 65 or Old Older er as as a Perc Percen enta tage ge of of the the Popu Popula lati tion on Age Agess 20 to 64 64

53

5-1.. 5-1

Ot Other her Federal Federal Spendi Spending ng Under Under CBO’s CBO’s Long-T Long-Term erm Budget Budget Scenar Scenarios ios

58 

5-2. 5-2.

Other ther Fede Federa rall Spe Spend ndin ing, g, by Cate Catego gory ry,, 197 1971 1 to 20 2010 10

59 

6-1.

Total Revenues Under CBO’s Long-Term Budget Scenarios

62 

66-2. 2.

Re Revven enu ues, es, b byy Sou Sourc rce, e, 197 1971 to to 2 201 010 0

64 

6-3.. 6-3

Indivi Individua duall Income Income Tax Revenu Revenues es Under Under CBO’s CBO’s Extend Extendeded-Bas Baselin elinee Scenario and Two Variants

66 

The The Impac Impactt of the Altern Alternati ative ve Minimu Minimum m Tax Tax on on IIndi ndivid vidual ual Income Income Tax Liability Under CBO’s Extended-Baseline Scenario

70 

Comparison of CBO’s 2010 and 2011 2011 Budget Projections Under the Extended-Baseline Scenario

75 

Comparison of CBO’s 2010 and 2011 2011 Projections of Mandatory Federal Spending on Health Care Under the Extended-Baseline Scenario

76 

Comparison of CBO’s 2010 and 2011 2011 Budget Projections Under the  Alternative Fiscal Scenario Scenario

77 

Primar Primaryy Spen Spendin dingg and and Reven Revenues ues,, b byy Cate Categor gory, y, Under Under CBO’s CBO’s Long-T Long-Term erm Budgett Scenarios Budge Scenarios Through Through 2085

80 

Federa Federall Debt Debt Held Held by the the Pub Public lic Under Under CBO’ CBO’ss LongLong-Ter Term m Budget Budget Scenar Scenarios ios Through 2085

81

Compar Compariso ison n of CBO’s CBO’s 2010 2010 and 2011 2011 Budg Budget et Projec Projectio tions ns Under Under the the Extended-Baseline Scenario Through 2085

82 

Compar Compariso ison n of CBO’s CBO’s 2010 2010 and 2011 2011 Budg Budget et Projec Projectio tions ns Under Under the the  Alternative Fiscal Scenario Scenario Through 2085

83

6-4.. 6-4  A-1.  A-2.  A-3. B-1.. B-1 B-2.. B-2 B-3.. B-3 B-4.. B-4

Boxes 1-1.. 1-1

How the Aging Aging of of the the Popu Populat lation ion and Rising Rising Costs Costs for Health Health Care Care

33-1. 1.

 Affect Federal Spending on Major Mandatory Programs Natio tiona nall SSpe pen ndi din ng oon n Hea Heallth Car aree

10  47 

CBO  

Summary 

R

ecently, the federal ecently, feder al government has been recording budget deficits that are the largest as a share of the economy since 1945. Consequently, Consequently, the amount of federal debt held by the public has surged. At the end en d of 2008, that debt equaled 40 percent of the nation’s annual economic output (a little above the 40-year average of 37 percent). Since th then, en, the figure has shot upward: upward: By the end of this year, the Congressional Budget Office

continue to increase thereafter.1 Spending on Social Security is projected to rise much less sharply, from less than 5 percent percent of GDP to today day to about about 6 percent percent in 2030, 2030, and then to stabilize at roughly that level. Altogether, Altogether, the aging of the population and the rising cost of health care  would cause spending on the major mandatory health care programs and Social Security to grow from f rom roughly 10 percent of GDP today to about 15 percent of GDP

(CBO) projects, federal debt will reach roughly 70 percent of gross domestic product (GDP)—the highest percentage since shortly after World War War II. The sharp rise in debt stems partly from f rom lower tax revenues and higher federal spending related to the recent severe recession. However, the growing debt also reflects an imbalance between spending and revenues that predated the recession.

25 years from now now.. (By comparison, spending on all of the federal government’s programs and activities, excluding interest payments on debt, has averaged about  18.5 percent of GDP over over the past 40 years.) years.) That combined increase of roughly 5 percentage points for such spending as a share of the economy is equivalent to about $750 billion today. today. If lawmakers ultimately modified some provisions of current law that might be difficult to sustain for a long period, that increase would be even larger.

 As the economy continues to recover and the the policies adopted to counteract the recession phase out, budget deficits will probably decline markedly in the next few years. But the budget outlook, for both the coming decade and beyond, is daunting. The retirement of the baby-boom generation portends a significant and sustained increase in the share of the population receiving benefits from Social Security, Security, Medicare, and Medicaid. Moreover,, per capita spending for health care is likely to Moreover continue rising faster than spending per person on other o ther goods and services for many years (although the magniWithout significant tude of that gap is very uncertain).  Without changes in government policy, those factors will boost federal outlays sharply relative to GDP in coming decades under any plausible assumptions about future trends in the economy, economy, demographics, and health care costs.  According to CBO’s projections, if current laws laws remained in place, spending on the major mandatory health care programs alone would grow from less than 6 percent of GDP today to about 9 percent in 2035 and would

Long-Term Long-T erm Scenarios In this report, presents that the long-term budget outlook under CBO two scenarios embody different assumptions about future policies governing federal revenues and spending. Neither of those scenarios represents a prediction by CBO of what policies will be in effect during the next several decades, and the policies adopted in coming years will surely differ from those assumed for the scenarios. Moreover Moreover,, even if the assumed policies were adopted, their economic and and budgetary consequences would undoubtedly differ from those 1. Mandatory Mandatory progra programs ms are pr progra ograms ms that do n not ot requ require ire annu annual al appropriations by the Congress; the major mandatory health care programs consist of Medicare, Medicaid, the Children’s Health Insurance Program, and health insurance subsidies that will be provided through the exchanges established by the March 2010 health care legislation.

CBO  

X

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

projected in this report because outcomes also depend on economic conditions, demographic trends, and other factors that are difficult to predict. The report focuses on the next 25 years rather than a longer longer horizon, because b bududget projections grow increasingly uncertain as they extend

 The Alternative Alternative Fisca Fiscall Scenario

farther into the future.2  One long-term budget scenario used in this analysis, the extended-baseline scenario, adheres scenario, adheres closely to current law. law. Under this scenario, the expiration of the tax cuts enacted since 2001 and most recently extended in 2010, the growing reach of the alternative minimum tax, the tax provisions of the recent health care legislation, and the  way in which the tax system interacts with with economic growth would result in steadily higher revenues relative to GDP. GDP. Revenues would reach 23 percent of GDP by 2035—much higher than has typically been seen in recent decades—and would grow to larger percentages thereafter.. At the same time, under this scenario, thereafter s cenario, government spending on everything other than the major majo r mandatory health care programs, Social Social Security, 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  W  World orld War War II.

sustain for a long period. Most important are the assumptions about revenues: that the tax cuts enacted since 2001 and extended most recently in 2010 will be extended; that the reach of the alternative minimum tax will be restrained to stay close to its historical extent; and that over the longer run, tax law will evolve further f urther so that revenues remain near their historical average of 18 percent of GDP. GDP. This scenario also incorporates assumptions that Medicare’s Medicare’s payment rates for physicians will remain at current levels (rather than declining by about a third, as under current law) and that some policies enacted in the March 2010 health care legislation to restrain growth in federal health care spending will not continue in effect after 2021. In addition, the alternative scenario includes an assumption that spending on activities other than the major mandatory health care programs, Social Security, Security, and interest on the debt will not fall quite as low as under the extended-baseline scenario, although it will still fall to its lowest level (relative (relative to GDP) since before W World orld  W  War ar II.

That significant increase in revenues and decrease in the relative magnitude magnitude of other spending would offset much—though not all—of the rise in spending spe nding on health

Under those policies, federal debt would grow much more rapidly than under the extended-baseline scenario.  With significantly lower lower revenues and higher outlays,

care programs and Social Security. Security. As a result, debt would increase slowly from its already high levels relative to GDP, as would the required interest payments on that debt. Federal debt held by the public would grow from an estimated 69 percent of GDP this year to 84 percent by 2035 (see Summary Figure Figure 1). With both debt and interest rates rising over time, interest payments, which absorb federal resources that could otherwise be used to pay for government services, would climb to 4 percent p ercent of GDP (or one-sixth of federal revenues) by 2035, compared with about 1 percent now.

debt held by the public would exceed 100 percent of GDP by 2021. After that, the th e growing imbalance between revenues and spending, combined with spiraling s piraling interest payments, would swiftly push debt to higher and higher levels. Debt as a share of GDP would exceed its historical peak of 109 percent by 2023 2023 and would Summary F Figure igure 1). approach 190 percent in 2035 (see  Summary

 The Extended-Baseli Extended-Baseline ne Scenari Scenario o

2. Because considerable interest exists in the longer-term outlook, figures showing projections through 2085 are presented in Appendix B, and associated data are available on CBO’s Web site v )).. ( www.cbo.go  www.cbo.gov 

The budget outlook is much bleaker under the alternative  fiscal scenario, 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

Many budget analysts believe that the alternative fiscal scenario presents a more realistic picture of the nation’s nation’s underlying fiscal policies than the extended-baseline scenario does. The explosive path of federal debt under the alternative fiscal scenario underscores the need for large and rapid policy changes to put the nation on o n a sustainable fiscal course.

CBO  

SUMMARY

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Summary Figure 1.

Federal Debt Held by the Public Under CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) 200

Actu ctual

200

Proj oje ecte cted

175

175

150

150

Alternative Alternati ve Fiscal Scenario 125

125

100

100

75

75

Extended-Baseline Scenario 50

50

25

25

0 2000

Source Sou rce::

0 2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: The extended-baselin extended-baseline e scenario adheres closely to current current law, law, following following CBO’s 10-year baseline baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table 1-1 on page 4.)

 The Impact of Growing Deficits and Debt  CBO’s projections in most of this report understate the CBO’s severity of the long-term budget problem because they do not incorporate the negative effects that additional federal debt would have on the t he economy, economy, nor do they include the impact of higher tax rates on people’ peo ple’ss incentives to work and save. In particular, large budget deficits and growing debt 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. Taking Taking those effects into account, CBO estimates that under the extendedbaseline scenario, real (inflation-adjusted) gross national product (GNP) would be reduced slightly by 2025 and by as much as 2 percent by 2035, compared with what it would be under the stable economic economic environment that underlies most of the the projections in this report.3  Under the alternative fiscal scenario, real GNP would be 2 percent percent to 6 percent percent lower in in 2025, and and 7 percent percent to 18 percent lower in 2035, than under a stable economic environment.

Rising levels of debt also would have other negative consequences that are not incorporated in those estimated effects on output:  

Higher levels of debt imply higher interest payments on that debt, which would eventually require either higher taxes or a reduction in government benefits and services.

 

Rising debt would increasingly restrict policymakers’  ability to use tax and spending policies pol icies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, the effects of such developments on the economy and people’s people’s well-being could be worse.

3. GNP differ differss from GD GDP P prima primarily rily b byy includ including ing the ccapita apitall income that residents earn from investments abroad and excluding the capital income that nonresident nonresidentss earn from domestic investment. In the context of analyzing the impact of growing deficits and debt, GNP is a better measure because projected budget deficits would be partly financed by inflows of capital from other countries.

 

XI

CBO  

XII

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

 

Growing debt also would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis

significantly from projected levels, or adopt some combination of those two approaches. Making such changes  while economic activity and employment employment remain well below their potential levels would probably slow the economic recovery. recovery. However, However, the sooner that medium-

 would confront policymakers with extremely difficult choices. To To restore investors’ confidence, policymakers  would probably need to enact spending cuts or tax increases more drastic and painful than those that  would have been necessary had the adjustments come sooner.

and long-term changes to tax and spending policies po licies are agreed on, and the sooner they are carried out o ut once the economy recovers, the smaller will be the damage to the economy from growing federal debt. Earlier action would permit smaller or more gradual changes and would give people more time to adjust to them, but it would require more sacrifices sooner from current older workers and retirees for the benefit of younger workers and future generations.

To keep deficits d eficits and debt from climbing to unsustainable levels, policymakers will need to increase revenues substantially as a percentage of GDP, GDP, decrease spending

CBO  

CHAPTER 

1  The Long-Term Long-Term Outlook for the Federal Budget 

T

he federal government has recently been recording the largest budget deficits, relative to the size of the economy,, since 1945. As a result, the amount of federal debt omy held by the public has surged. Debt is expected to equal roughly 70 percent of the economy’s economy’s annual output, or gross domestic product (GDP), at the end of this fiscal

alternative scenario, debt held by the public would equal more than 100 percent of GDP in 2021 rather than about 75 percent.

year, up from 40 percent at the end of 2008. That sharp year, deterioration in the fiscal situation reflects several factors: an imbalance between spending and revenues that t hat predated the 2007–2009 recession and turmoil in financial markets; a decline in tax revenues and an increase in spending on benefit programs caused by that economic downturn; and the costs of federal policies enacted in response to the downturn.

extended-baseline scenario, scenario, reflecting the assumption that current laws do not change, and an alternative fiscal scenario,, which incorporates scenario incorporates several changes changes to current law that are widely expected to occur or that would modify some provisions of law that might might be difficult to sustain for a long period, thus maintaining what some analysts might consider “current policy” as opposed to current law.

If current laws were to remain unchanged, the budget deficit would drop markedly as a percentage of GDP in the next few years, the Congressional Budget Office (CBO) projects, and federal debt held by the public

Looking beyond the next decade, the fiscal outlook o utlook  worsens further. Although Although long-term budget projections are highly uncertain, if current laws remained in effect, the aging of the population and rising r ising costs for health

 would stabilize at about 75 percent of GDP for the next decade—the highest percentage in U.S. history except during a brief period around World World War II.1 However, if some policies that are in effect e ffect now were extended, instead of expiring or changing as specified s pecified in current law,, budget deficits and accumulated debt would be law greater. In particular, particular, if lawmakers extended expiring tax provisions, limited the reach of the alternative minimum tax (AMT), set most annual appropriations to grow in line with GDP, and made certain other changes to current law, law, annual budget deficits def icits would still decline relative to GDP during the next few fe w years but would be increasing steadily by the end of the decade. Under that

care would almost certainly pushcurrent federallaw, spending sharply relative to GDP. Under federalup revenues would also increase—to significantly higher percentages of GDP than have ever been seen in the United States—but spending would grow at a similar pace, CBO projects. Federal debt would rise from about 75 percent of GDP in 2021 to almost 85 percent by 2035 and then remain fairly high.

1. For more details ab about out CB CBO’ O’ss most recent 10-year current-law current-law baseline projections, see Congressional Budget Office,  Office,  An  An Analysis Analysis of the President’s Budgetary Proposals for Fiscal Year 2012  (April  (April

This report presents CBO’s estimates of the long-term budget outlook under both sets of assumptions—an

Under CBO’s CBO’s alternative fiscal scenario, revenues would increase much more slowly than spending, and debt held by the public would balloon to nearly 190 percent of GDP by 2035. As debt grew, so would the burden of paying interest on it; thus, under that alternative scenario, annual federal spending on interest would rise from about 1 percent of GDP today to 9 percent by 2035. Such a path for federal borrowing would clearly be

2011), Table 1-5.

unsustainable.

CBO  

2

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Moreover, those projections of federal debt under the Moreover, long-term scenarios do not include the harmful effects effe cts that rising debt would have on economic growth and interest rates. If those effects eff ects were taken into account, projected debt would increase even faster. Chap Chapte terr 2 

changes to the AMT and to the Medicare program’s program’s payments to physicians—will not be made again.3  Because of the structure of current tax law, law, federal revenues would grow significantly faster than GDP over the long run under this scenario, ultimately rising well

presents estimates of the economic effects effe cts of growing debt and the impact of those economic changes on the trajectory of debt under both scenarios.

above the levels that U.S. taxpayers have seen in the past (for more details, see Chap Chapte terr 6).  

If policymakers are to put the nation on a sustainable budgetary path, they will need to let le t revenues increase substantially as a percentage of GDP, GDP, decrease spending significantly from projected levels, or adopt some combination of those two approaches. With economic activity and employment currently well below the levels that could be achieved if the nation’s labor force and capital stock were fully utilized, raising revenues or curbing spending immediately would probably slow the economic expansion. However However, , the sooner soo that mediumandon— longterm changes to spending andner revenues are agreed and the sooner they are implemented after the period of economic weakness—the smaller will be the damage to the economy from rising federal debt.

 Alternative Scenarios for the Long-Term Long-T erm Budget Outlook  The two sets of long-term budget projections presented in this report are based on the following fo llowing differing assumptions about future policy (see Table 1-1 on page page 4): 4):  

scenario adheres closely to curThe extended-baseline scenario adheres rent law. It follows CBO’s March 2011 baseline budget projections for the next decade d ecade and then extends the baseline concept beyond that 10-year window. window.2  The current-law assumption of the extended-baseline scenario implies that many adjustments that lawmakers have routinely made in the past—such as

2. CBO’s CBO’s baseli baseline ne is a neutral reference reference point for measuring the budgetary effects of proposed changes to federal revenues or spending. It consists of projections of budget authority, outlays, revenues, and the deficit or surplus over 10 years calculated according to rules originally set forth in the Balanced Budget and Emergency Deficit Control Act of 1985. Those projections are not intended to be predictions of future budgetary outcomes; rather, they represent CBO’s best judgment of how economic and other factors  would affect federal federal reven revenues ues and spending if current laws did

The alternative fiscal scenario embodies scenario embodies several changes to current law that would continue certain tax and spending policies that people have grown accustomed to (because the policies are in place now or have been in place recently). Versions Versions of some of the changes assumed in the scenario—such as those related to the tax cuts originally enacted in 2001, the AMT, AMT, certain other tax provisions, and Medicare’s Medicare’s payments to physicians—have regularly been enacted in the past and are widely expected to be made in some form for m over the next few years.  After 2021, the alternative fiscal scenario also incorporates modifications to several provisions of current law that might be difficult to sustain for a long period. Thus, the scenario includes changes to certain restraints on the growth of spending s pending for Medicare and to indexing provisions that would slow the growth of federal subsidies for health insurance coverage. In addition, the scenario includes unspecified changes in tax law that would keep revenues constant as a share of GDP after 2021. Together, the changes incorporated in this scenario represent one interpretation of what it would mean to continue today’s underlying fiscal policy. However, different analysts might perceive the underlying intention of current policy policy differently. differently.4

The projections in much of this report repor t understate the size of the budgetary shortfalls that th at would be likely to result 3. The alternat alternative ive minimum minimum tax is a parall parallel el incom incomee tax syste system m with fewer exemptions, deductions, deductions, and rates than the regular income tax. Households must calculate the amount they owe under both the AMT and the regular income tax and pay the larger of the two amounts. 4. CBO discus discussed sed alt alterna ernative tive p polic olicyy assum assumption ptionss in The Budget and Economic Outlook: Outlook: Fiscal Years Years 2011 to 2021 (January 2021 (January 2011), pp. 21–24. The alternative fiscal scenario presented here combines several of the alternative policy paths presented in that report and

not chan change. ge.

encompasses others as well.

CBO  

CHAPTER ONE

from those policy paths. In order to clearly illuminate long-term budgetary trends, as distinguished from the resulting economic effects, CBO generally assumes stable economic conditions after 2021 (what it labels its economic benchmark ). ). In particular, particular, economic variables such as GDP growth and interest rates are assumed to be the same as if federal f ederal debt remained at 76 percent of GDP, the level it reaches in 2021 in CBO’s baseline pro jections. In actuality, actuality, if debt grew faster than GDP, GDP, economic growth would slow and real (inflation-adjusted) interest rates would rise. The budget projections in most of this report also omit the impact that different effective marginal tax rates would have on people’s incentives to  work and save.5 (Although the projections generally do not incorporate those economic effects, the effects are discussed discu ssed in detail detail in Chap Chapte terr 2.)

 The Extended-Baseli Extended-Baseline ne Scenari Scenario o Under CBO’except CBO’s s current-law primary primar y spending— all spending interestscenario, payments on federal debt—  would drop relative to GDP in the next few years, level out for the rest of the decade, and grow significantly in later decades. The severe recession and financial turmoil, as well as federal policies implemented in response to them, pushed primary outlays to 24 percent of GDP in 2009, the highest level since World War II. Such outlays  were above 22 percent percent of GDP in 2010, and CBO pro jects that they will remain at that level in 2011. However, However, as the economy recovers and the budgetary effects of those recent policies diminish, primary spending is pro jected to decline to 20 percent of GDP and stay stay near that level through 2021. In subsequent years, primary spending would follow a gradual upward path under the extended-baseline scenario, reaching 23 23 percent of GDP in 2035 (see the top panel of Figure Figure 1-1 on page 6).6  (This report focuses on primary spending because growth in debt as a share of GDP is determined mainly by the relationship between revenues and primary outlays.)7 If current law continued, revenues would also rise considerably; by the 2020s, they would reach higher levels relative to the size of the economy than ever recorded in the nation’s history. Under current law, revenues would jump 5. Effective marginal ta taxx rates on labo laborr or capital inco income me represent represent the percentage of the last dollar of such income that is taken by federal taxes. 6. Longer-te Longer-term rm versions versions of som somee of the fig figures ures in this this chapter chapter are

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

from about 15 percent of GDP now to 19 percent in 2013 as the economic recovery increased taxable income, as the tax cuts enacted since 2001 expired in 2012 and 2013 as scheduled, and as the reach of the AMT expanded greatly (because, unlike most of the tax code, the dollar amounts of its parameters do not automatically increase with inflation). In later years, revenues would continue to rise relative to GDP, GDP, for three main reasons. First, ongoing increases in real income would push taxpayers into higher tax rate brackets. Second, ongoing inflation, although it is projected to be modest, mode st, would cause more people to owe tax under the AMT. AMT. And third, the excise tax on certain high-premium health insurance plans, which is scheduled to take effect in 2018, would have a growing impact on revenues. Taken Taken together, those factors would cause marginal tax rates to increase and federal revenues to grow faster f aster than the economy, reaching 23 percent of GDP in 2035. By comparison, federal revenues averaged 18 percent of GDP between 1971 1971 and 2010, peaking at 20.6 percent of GDP in in 2000. Even with revenues rising to those projected levels, however (and with the the economic effects of the increases in marginal tax rates omitted), the federal government  would still experience experience substantial budgetary shortfalls. By By 2035, the deficit (including interest costs) would equal about 4 percent of GDP under the extended-baseline scenario, and federal debt held by the public public would equal 84 percent of GDP. In later years, debt would grow at approximately the same rate as the economy, as both revenues and spending increased relative to GDP; therefore, debt would continue to be a much larger percentage of GDP than has been seen in most of U.S. history.

 The Alternative Alternative Fisca Fiscall Scenario Under CBO’s CBO’s alternative fiscal scenario, primary spending would be 1.1 percentage points higher as a share of GDP in 2021 than under the extended-baseline scenario (see the bottom panel of Figure Figure 1-1 on page 6). That difference would grow in later years. The higher primary spending stems from several assumptions of the alternative scenario: that through 2021 lawmakers will act to 7. Several factors not directly directly included in budget totals also affec affectt the governme government’ nt’ss need to borrow from the public. Those factors include increases or decreases in the government’s cash balance as well as the cash flows refle reflected cted in the financing accounts used for federal credit programs. Changes in those factors were not

 

3

presented in Appendix in Appendix B.

modeled in this analysis.

CBO  

4

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 1-1.

 Assumptions About Spending and Revenues Underlying CBO’s Long-Term Long-T erm Budget Scenarios Extended- Baseline Sc ena rio Medicare

Alternative Fisc al Scenario Assumptions About Spendin Spending g

As sc heduled under current law

As scheduled under c urrent law , ex c ept that payment rates for physicians are maintained at the 2011 levels through 2021 (rather than at the lower rates of the sustainable growth rate mechanism) and that, after 2021, several policies that would restrain spending growth are assumed not to be in effect

a

Medic aid

As sc heduled under current law

As s cheduled under c urrent law

Ex c hange Subsidies

As scheduled under current law

As s cheduled under c urrent law , ex cept that a polic y that would slow the growth of per-participant subsidies for health insurance coverage is assumed not to be in effect and eligibility thresholds are assumed to be modified to maintain the share of the population eligible for subsidies

CH IP IP

As projec tte ed in C B BO O ''ss bas el eline through 2021; r em emaining

As projec te ted in C B BO O ''ss baseline through 2021; remaining

c onstant as a s hare of G D DP P thereafter

constant as a share of G D DP P thereafter

Soc ial Security

As scheduled under current law

As s cheduled under c urrent law

Other Noninterest Noninterest

As projected projected in CBO's baseline baseline through through 2021; 2021; remain remaining ing

As proj projected ected in CBO's baseline baseline through through 2021, except that all

Spendi ending ng

at th the e 202 2021 leve evel as a shar share e of GDP th ther ere eaf aftter, er, exce excep pt

disc scre reti tion ona ary ap appr pro opr priiati ation onss grow grow at th the e sa same me ra rate te as nomi mina nall

that some refundable tax credits, Medicare premiums,

GD P through 2021, and discretionary appropriations are further

and certain payments by states to Medicare are as

adjusted by assuming that the number of troops deployed for

scheduled under c urrent law

certain types of military o op perations is reduc ed to 45, 000 by 2 20 015;

b

thereafter, spending remains at the 2021 level as a share of GDP, except that Medicare premiums and certain payments by states to Medicare are consistent with the projections of Medicare spending in this scenario

Continued

prevent Medicare’s payment rates for physicians from declining; that lawmakers will not allow various restraints on the growth of Medicare costs and health insurance subsidies to have their full effect after the first decade of the projections; and that, as a percentage of GDP, GDP, federal spending for things other than Social Security, Security, major mandatory health programs, and interest payments will be close to the level experienced during much of the past decade (rather than falling below that level over the next decade, as under the extended-baseline scenario). 8  On the revenue side, the alternative fiscal scenario incorporates the assumption that almost all expiring tax

important, CBO assumes for that scenario that the cuts in individual income taxes enacted since 2001 and most recently extended in 2010, which are now scheduled to expire in 2012 or 2013, will be extended through 2021; that relief from the AMT, AMT, which is scheduled to expire at the end of 2011, will continue through 2021; and that the 2012 parameters of the estate tax (adjusted for inflation) will apply through 2021. Thereafter, Thereafter, revenues are 8. Mandatory Mandatory progra programs ms are pr progra ograms ms that do n not ot requ require ire annu annual al appropriations by the Congress; the funding available for them is generally not limited. Most mandatory spending is for entitlement programs, in which the federal governme government nt is required to make payments to any person or entity that meets the eligibility criteria

provisions will be extended through 2021 (the end of CBO’ss 10-year baseline projection period). Most CBO’

set in law. Discretionary spending, by contrast, is controlled by annual appropriation acts.

CBO  

CHAPTER ONE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 1-1.

Continued Conti nued

 Assumptions About Spending and Revenues Underlying CBO’s Long-Term Long-T erm Budget Scenarios Ext ended- B a seline S Sc c ena rio Alterna t ive Fisc a l Sc ena rio Assumptions About Revenues

Individual Income Taxes

As scheduled under current law

All provisions scheduled to expire in the nex t 10 years are extended through 2021, including the income tax reductions and AMT relief temporarily extended in the 2010 tax act; revenues remain constant as a share of GDP thereafter

c

Payroll Taxes

As sc heduled under current law

As scheduled under c urrent law

Corporate Corpora te Income Taxes

As schedule ed d unde underr current law throug through h 2021 2021;;

All provisions provisions scheduled scheduled to expire in the next 10 years are

remai rem aini ning ng consta constant nt as a sha share re of GDP th ther erea eaft fter er

ext exten ende ded d tthro hroug ugh h2 202 021; 1; re reven venue uess rema remain in con consta stant nt as a share of GDP thereafter

Excise Taxes

As scheduled under current law

All prov isions scheduled to expire in the nex t 10 years are extended through 2021; revenues remain constant as a share of GDP thereafter

Estate and G ifift Taxes

As scheduled under c ur urrent law

The 2012 tax rates and ex em emption amount (adjusted for inflation) continue through 2021; revenues remain constant as a share of GDP thereafter

Other Sources Sources of Revenue

As schedule ed d unde underr current law throug through h 2021 2021;;

All provisions provisions scheduled scheduled to expire in the next 10 years are

remai rem aini ning ng consta constant nt as a sha share re of GDP th ther erea eaft fter er

ext exten ende ded d tthro hroug ugh h2 202 021; 1; re reven venue uess rema remain in con consta stant nt as a share of GDP thereafter

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-baseline scenario adheres clos closely ely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain susta in for a long period. period. CHIP = Children’s Health Insurance Pr ogram; GDP = gross domestic product; AMT = alternative minimum tax; 2010 tax act = Tax Relief, Unemployment Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312). a.

These assumptions about about payment rates rates for physicians physicians are identical to those in the fourth fourth policy alternative alternative in Congressional Budge Budgett Office, The Budget and Economic Outlook: Fiscal Yea Years rs 2011 to 202 1  (January 2011), Table 1-7.

b.

These assumptions are are identical to those in the first and second second policy alternatives alternatives in Congressional Budget Office, Office, The Budget and Eco-  nomic Outlook: Fiscal Years 2011 to 2021  (January 2011), Table 1-7.

c.

These assumptions are identical to those in the seventh and and eighth policy alternative alternativess in Congressiona Congressionall Budget Office, Office, The Budget and Economic Outlook: Fiscal Years Years 2011 t o 2021  (January 2011), Table 1-7.

 

5

CBO  

6

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 1-1.

Primary Spending and Revenues, by Category, Category, Under CBO’s CBO’s Long-Term Budget Scenarios (Percentage of gross domestic product) Extended-Baseline Scenario

30

Actua ctuall

25

30

Proj oje ecte cted Total Primary Spending

Revenues

25

20

20

Other Noninterest Spending

15

10

15

10

Medicare, Medicaid, CHIP, and Exchange Subsidies

5

5

Social Security 0 2000

2005

2010

2015

2020

2025

2030

Alternative Fiscal Scenario

30

Actu ctual

30

Proje roject cte ed

Revenues

Total Primary Spending

25

0 2035

25

20

20

15

Other Noninterest Spending

15

10

Medicare, Medicaid, CHIP, and Exchange Subsidies

10

5

5

Social Security 0

0 2000

Source Sou rce::

2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table Table 1-1 on page 4.) CHIP = Children’s Health Insurance Program.

CBO  

CHAPTER ONE

assumed to remain at their 2021 level of 18.4 percent of GDP, just above the average of the past 40 years. That revenue path, combined with the spending policies described above, would produce a deficit equal to 15 percent of GDP in 2035. It would also push federal fede ral debt held by the public to more than 100 percent of GDP by 2021 and soon afterward to levels unprecedented in the United States, reaching almost 190 percent by 2035.

 The Long-Term Outlook Outlook for Spending   With interest payments on debt held by the public excluded, federal outlays have averaged 18.6 percent of GDP over the past 40 years. Such primary spending is now unusually high—and is expected to remain so through 2012—because of the recent recession and policies implemented in response to to it. However, However, in CBO’ss baseline, such outlays are projected to decline CBO’ to 20 perc percent ent of GDP by 2018. 2018. Primary spending would rise again under both of CBO’s CBO’s long-term budget scenarios—to 23 percent of GDP by 2035 under the extended-baseline scenario and to 25 percent under the alternative fiscal scenario (see Table 1-2). 1-2). In both cases, primary outlays would continue to grow steadily in later years.

Mandatory Outlays for Health Care Programs and Social Security Federal spending for mandatory programs has accounted for a sharply rising share of primary p rimary outlays in the past few decades, averaging 55 percent in recent years. Most of that growth h has as been concentrated in the three largest entitlement programs—Social Security Security,, Medicare, and Medicaid. Together, Together, federal outlays for f or those three programs made up 46 percent of primary spending, on average, over the past 10 years, up from 27 percent in 1975. 1975. Under CBO’s CBO’s two scenarios, all of the projected growth in primary spending as a share of GDP over the long term stems from increases in mandatory spending, particularly in outlays for the government’ government’ss major health he alth care programs: Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and insurance subsidies that  will be provided through the exchanges exchanges created by the March 2010 health care legislation.9 Under both scenarios, total outlays for those health care programs would

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

spending, see Chap Chapte terr 3.) Spending on Social Security  would rise much more slowly, slowly, from almost 5 percent of GDP in 2011 to about 6 percent in the 2030s and beyond (see Chap Chapte terr 4). Under both scenarios, the trust funds for Social Security and for Part A of Medicare would be exhausted over  However,, to measure the imbalance between the time.11 However revenues for those programs and the outlays for benefits currently specified in law, CBO assumes that the two programs will continue to pay benefits as now scheduled. (Spending for other parts of Medicare also flows through a trust fund, but automatic infusions of money from the t he Treasury’s general fund effectively ensure that it cannot become insolvent. Medicaid has no underlying trust fund.) Causes of Spending Growth.  Two factors account for the

projected increases in outlays for the government’ government’ss large entitlement programs: aging of the population and rapid growth of health care spending per capita. (For a detailed breakdown of the roles played by those factors, see s ee Box 1-1 on page 10.) 10.) The retirement of the large babyboom generation born between 1946 and 1964 portends a long-lasting shift in the age profile of the U.S. population. That shift will substantially alter the balance between the working-age and retirement-age segments of the population. During During the next next decade alone, the the number of people over the age of 65 is expected to rise by more than a third. third. Over the longer term, the share share of people age 65 or older is projected to grow from about 13 percent now to 20 percent in 2035, whereas the share of people ages 20 to 64 is expected to fall from 60 percent to 55 percent. In later decades, the aging of the population is expected to continue, co ntinue, though at a slower rate, because of further increases in life expectancy. 9. That legislation legislation was the Patient Patient P Protection rotection and Afford Affordable able C Care are  Act (Public (Public Law 11 111-148) 1-148) and th thee Healt Health h Care and E Education ducation Reconciliation Act of 2010 (P.L. 111-152). 10. Those tot totals als for major health ccare are programs include ggross ross Medicare spending (that is, they do not subtract offsetting offsetting receipts, which consist mainly of premiums paid by Medicare beneficiaries). 11. The balances of thos those e trust funds represent theontotal amount unt that the government is legally authorized to spend eachamo program.

 

7

grow much faster than GDP, increasing from 5.6 percent in 2011 to about 9 percent or 10 percent in 2035.10 (For details about the long-term projections of health care

For a discussion of the legal issues related to trust fund exhaustion, see Christine Scott, Social Security: What Would Happen If the Trust Funds Ran Out? Report for Congress  Congress RL33514 (Congressional (Congressio nal Research Service, August August 20, 2009).

CBO  

8

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 1-2.

Projected Spending and Revenues R evenues Under CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) 2011 Spending   Primary spending Social Security Medicarea Medicaid, CHIP, CHIP, and exchange subsidies Other noninterest spending

20 2 1 Extended-Baseline Scenario

20 35

4 .8 3 .7 1 .9  12.3

5.3 4.1 2.8 8.3

6.1 5.9 3.5 7.8

22 .7

20.5

23.3

  1 .4

3.4

4.1

24 .1

23.9

27.4

Revenues

14 .8

20.8

23.2

Deficit (- ) or Surplus Deficit Primary deficit or surplus Total deficit

- 7 .9 - 9 .3

0.3 - 3.1

- 0.1 - 4.2

69

76

84

Subtotal, primary spending Interestt spending Interes Tot al Spendi n g

b

Debt Held by the Public

Alternative Fiscal Scenario Spending Primary spending Social Security a Medicare Medicaid, CHIP, CHIP, and exchange subsidies Other noninterest spending

4 .8 3 .7 1 .9  12.3

5.3 4.3 2.8 9.1

6.1 6.7 3.7 8.5

22 .7

21.5

25.0

  1 .4

4.4

8.9

24 .1

25.9

33.9

Revenues

14 .8

18.4

18.4

Deficit Primary deficit Total deficit

- 7 .9 - 9 .3

- 3.1 - 7.5

- 6.6 - 15.5

69

10 1

187

Subtotal, primary spending Interestt spending Interes Tot al Spendi n g

Debt Held by the Publicb Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending refers to all spe spending nding other than interest payments on federal federal debt. The primary deficit or surplus is the difference difference between revenues and primary spending. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details details,, see Table Table 1-1 on pa page ge 4.)

CHIP = Children’s Health Insurance Program. a.

Spending for Medicare Medicare reflects reflects gross amounts. Beneficiaries’ Beneficiaries’ premiums and and certain other receipts used to offset a portion of spending for Medicare are included in other noninterest spending.

b. At the the end end of of the the year year..

CBO  

CHAPTER ONE

In the case of Social Security Security,, the aging of the population drives the projected growth of spending as a percentage of GDP. Initial Social Security benefits are based on an individual’ss earnings, indexed to the overall growth of wages. vidual’ Because benefits increase at approximately thenot same rateaverage as average earnings, economic growth does no t significantly change Social Security spending as a share of GDP. However, CBO projects that the number of workers per beneficiary will decline significantly over the next quarter century (from about three now to about two in 2035) and then continue to drift downward. In the case of the major mandatory health care programs, both aging and rapid growth of per capita health care spending (adjusted for changes in the age distribution of the population) are responsible for the projected rise r ise in federal spending as a share of GDP, GDP, because more elderly people will use increasingly expensive health care. However, CBO projects that growth in per capita spending for health care programs will moderate from past rates even if federal laws laws do not change change (see Chap Chapte terr 3). Both Medicaid and CHIP are financed jointly by the federal government and state governments, so growth in federal spending per capita is expected to slow as states move to limit their costs. And even without changes to the laws governing Medicare, growth in per capita spending on on that program is projected to slow (though to a lesser degree than for the other health programs) because of future regulatory changes to the program and changes to the health health care system system as a whole.  Spending Differences Between the Long-Term Long-T erm Scenarios. for Social Security would be identical i dentical under CBO’s CBO’ s extended-baseline and alternative fiscal scenarios. Spending for Medicaid, CHIP, and the exchange subsidies  would be slightly higher under the alternative scenario scenario because of differing assumptions about the subsidies (see Chapter 3). In the case case of Medicare, spending would be almost 1 percentage point higher relative to GDP in 2035 under the alternative fiscal scenario than under the extended-baseline scenario, and the difference would  widen further beyond beyond that. The projected spending spending paths for Medicare differ for two main reasons:  

Under the current-law assumptions of the extendedbaseline scenario, Medicare’ Medicare’s sustainable growth rate

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

for physicians would remain at their 2011 levels for the next decade.  

Growth in Medicare outlays during the following decade is assumed to be somewhat higher under the alternative fiscal scenario than under the extendedbaseline scenario. In particular, under the alternative scenario, several policies that would restrain the growth of spending for Medicare are assumed not to be in effect after 2021. By contrast, under the extended-baseline scenario, those policies are assumed to remain in effect, causing cost growth from 2022 through 2029 to be similar to the growth projected for the end of the 2012–2021 period.

The upshot of those differences is that Medicare spending in 2035 is projected to be 13 percent higher under the alternative fiscal scenario than under the extendedbaseline scenario—a difference that persists in later years because the growth rates of spending beyond that point are assumed to be the same under the two scenarios. That gap highlights the important implications of health care policies for the federal budget.

Other Federal Outlays  A larger difference between the two scenarios scenarios involves projections of federal spending for everything besides the major mandatory health care programs and Social Security.. Other primary spending (including the offsetting rity effects of Medicare premiums and other offsetting receipts) currently equals about 12 percent of GDP. GDP. It would fall to 8 percent per cent ofand GDP in 2021 2021under underthe thealterextended-baseline scenario 9 percent native fiscal scenario, declining slowly thereafter in both cases. (By comparison, such spending has represented more than 8 percent of GDP each year since the 1930s.) Interest payments by the government would increase from 1 percent of GDP now to 4 percent by 2035 under the extended-baseline scenario and then remain at that percentage. Under the alternative fiscal scenario, annual interest spending would grow to 9 percent of GDP by 2035 and would continue to rise dramatically thereafter. Other Noninterest Spending Under the ExtendedBaseline Scenario. For the extended-baseline scenario, CBO began with its baseline projections of outlays for

 

9

mechanism would reduce payment rates for physicians by nearly 30 percent in January 2012 and by additional amounts in later years. Under the alternative fiscal scenario, by contrast, Medicare’ Medicare’ss payment rates

2011 through 2021 for programs other than the major mandatory health care programs and Social Security. Security. That spending category includes a variety of other mandatory programs (such as federal feder al civilian and military

CBO  

10

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Box 1-1.

How the Aging of the Population and Rising Costs for Health Care  Affect Federal Spending on Major Mandatory Programs In the Congressional Budget Office’s Office’s (CBO’s) longterm projections of spending, growth in noninterest spending as a share of gross domestic product (GDP) is attributable entirely to increases in spending on several large mandatory programs: Social Security, Security, Medicare, Medicaid, Medicaid, and (to a lesser extent) insurance subsidies that will be provided through the health insurance exchanges established by the March 2010 health care legislation. The health care programs are the main drivers of that growth; they are responsible for 80 percent of the total projected proj ected rise in spending on those mandatory programs over the next 25 years. Two factors underlie the projected increase in federal spending on the government’ g overnment’s major mandatory health care programs and Social Security: the aging of the U.S. population, which increases the number of beneficiaries in those programs, and rapid growth in health care spending per p er beneficiary. CBO calculated how much of the projected rise in federal spending s pending for the health care programs and Social Security under the extended-baseline scenario is attributable to aging and how much is attributable to “excess “excess cost growth”—the growth ”—the extent to which health care costs per enrollee (adjusted for changes in the age profile of the population) grow faster than GDP per capita. CBO made that calculation by comparing the outlays pro jected under the extended-baseline scenario with the

Explaining Projected Growth in Federal Spending on Major Mandatory Health Programs and Social Security by 2035 and 2085, by Source (Percent) Aging

Excess Cost Growth

Major Health Care Progr Progr ams and Social Security 20 35 20 85

64 44

36 56

Major Health Care Programs 20 35 20 85 Source Sour ce::

48 29

52 71

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

outlays that would occur under two alternative paths: one with an aging population but no excess cost growth for health care programs, and one with no aging but with excess cost growth. The interaction between the aging of the population and excess cost growth g rowth accentuates their individual effects. As aging causes the number of beneficiaries of Medicare and M Medicaid edicaid to rise, higher health care spending per person per son has a larger impact. Conversely, Conversely,  when health care costs are growing, having having more Continued

retirement, certain veterans’ programs, the Supplemental Nutrition Assistance Program, and unemployment compensation) as well as all discretionary programs. In the baseline, mandatory programs are assumed to operate as they do under current law l aw,, and funding for discretionary programs is projected to grow at the rate of inflation.

Under those assumptions, other mandatory spending  would decline dramatically over over the baseline baseline period, from 3.2 percent of GDP in 2011 to 1.6 percent in 2021. Such spending is unusually high now because of the automatic increase in spending (such as for unemployment benefits and nutrition programs) that occurs during periods of

(Under the rules that govern the baseline, CBO does not make any other adjustments to discretionary spending. For example, no adjustment is made for spending that may be temporary, such as outlays for operations in  Afghanistan and Iraq.)

economic weakness. Discretionary spending would also decline as a share of GDP under the assumptions of the baseline, from 9.1 percent in 2011 to 6.7 percent in 2021. That decline occurs because discretionary spending is assumed to increase at the rate of inflation and CBO

CBO  

CHAPTER ONE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Box 1-1.

Continued

How the Aging of the Population and Rising Costs for Health Care  Affect Federal Spending on Major Mandatory Programs beneficiaries imposes a larger budgetary cost. That interaction can be identified separately—or as in CBO’ss analysis, it can be allocated according to the CBO’ shares attributable to aging and excess cost growth. Of the two factors, aging is the more mo re important over the next 25 years. With the interaction allocated between the two, aging accounts for 64 percent of the total projected growth in spending on o n Social Security and the major mandatory health care programs by 2035, and excess cost growth accounts for 36 percent (see the table on the facing page and the figure at right). The impact of excess cost growth is felt only in the health care programs; rising health care costs have no direct effect on spending for Social Security. Security. (For a discussion of the rates of excess cost growth that underlie those calculations, and the basis for them, see Ch Chap apte terr 3.) The greater importance of aging is not surprising given that the aging of the baby-boom generation will significantly expand the number of people participating in those programs.

much more caution should be applied to those longer-term longer -term projections. projections. Looking only at the major health care programs, CBO found that excess cost growth accounts for 52 percent of the programs’ projected growth by by 2035 and 71 percent by 2085. Again, future rates of aging and especially of excess cost growth could differ diff er substantially from CBO’s assumptions, particularly in the longer term.

Sources of Growth in Federal Spending on Major Mandatory Health Care Programs and Social Security, 2011 to 2035 (Percentage of gross domestic product) 16 14

12

Effect of Aging

10 8 6

on the health care programs and Social Security, Security, and the share attributable to aging falls to 44 percent. Because of the substantial uncertainties that exist about long-term rates of cost growth for health care,

0

Beyond 2021, outlays for programs other than the major mandatory health care programs and Social Security are generally assumed to remain constant at their 2021 levels

14

12

Over the longer term, however however,, the situation changes. By 2085, excess cost growth is responsible for 56 percent of the total projected growth in federal spending

projects that GDP will grow faster than inflation. With those pieces taken together, other primary spending  would equal 8.3 percent of GDP in 2021.

16

Effect of Excess Cost Growth

8

Spending in the Absence of Aging and Excess Cost Growth

4 2

2011

Source Sou rce::

10

6 4 2 0

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Of Offic fice. e.

Chapter Chap ter 3 and Chap Chapter ter 6). Because of the projected changes in those components, other primary spending is projected to decline from 8.3 percent of GDP in 2021 to 7.8 percent by 2035—lower than such spending has been at any point in the past 40 years. Other Noninterest Spending Under the Alternative Fiscal

 

11

as a share of GDP under the extended-baseline scenario. However,, premiums paid by Medicare beneficiaries, cerHowever tain payments by states to Medicare, and the refundable portions of the earned income tax credit and the child tax credit are estimated as under current law (as described in

Scenario. In the alternative fiscal scenario, primary spending apart from outlays for the major mandatory health care programs and Social Security is assumed to be somewhat higher than under the extended-baseline scenario, decreasing to 9.1 percent of GDP in 2021

CBO  

12

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

rather than to 8.3 percent. pe rcent. For the first 10 years, CBO’s CBO’s projections of other primary spending under the alternative scenario differ from the projections under the extended-baseline scenario in two ways. First, all discre-

accounted for a growing share of spending during that period, the composition of revenues has shifted. Receipts from payroll taxes have grown faster than GDP, producing a larger share of total revenue.12 At the same time, the

tionary spending is assumed to grow at the same rate as GDP over the next decade instead of at the rate of inflation. Second, the path of such spending is further f urther modified by assuming that the number of U.S. military personnel deployed abroad will decline in the next few years rather than continue at the current level.

shares contributed by corporate income taxes and excise taxes have declined.

 After 2021, other noninterest spending —except for projected changes in Medicare premiums premiums and certain payments by states to Medicare—is assumed to remain constant at the 2021 level relative to GDP under the alternative fiscal scenario. With the projected changes to those components included, other primary spending is projected to decline to 8.5 percent of GDP by 2035, well below its average percentage over the past 40 years. Interest Spending. For much of the past decade, federal debt held by the public was relatively constant as a share of GDP. GDP. Nevertheless, federal interest spending decreased (from 2.3 percent of GDP in 2000 to a 35-year low of 1.3 percent in 2009) because interest rates fell. In its baseline, CBO projects that interest spending will increase over the next 10 years—from 1.4 percent of GDP in 2010 to 2.0 percent in 2013 and 3.4 percent by 2021— as federal debt grows and as interest rates rebound from their recent unusually low levels.

For the long-term budget projections, CBO assumed that interest rates would remain stable after 2021, meaning that interest spending would grow at the same pace as federal debt. Under the extended-baseline scenario, annual interest spending would increase to 4 percent of GDP in 2035 and then remain at that level. Under the alternative fiscal scenario, interest spending would grow much faster—to 9 percent of GDP by 2035 and much more in later years—because of ballooning debt. Moreover,, those projections do not incorporate the effects of over rising debt on interest rates; as discussed in Chap Chapte terr 2, higher federal debt would lead to higher interest rates, making interest outlays even larger, particularly under the alternative fiscal scenario.

 After totaling nearly 18 percent of GDP in 2008, 2008, federal revenues fell sharply, primarily because of the severe recession, and were less than 15 percent of GDP in both 2009 and 2010. CBO expects revenues to remain near 15 percent of GDP this year. However, However, under the current-law assumptions of CBO’s baseline, revenues would rebound over the next decade with expected improvement in the economy,, the scheduled expiration of tax cuts enacted economy since 2001 (and most recently extended in 2010), and sharp growth in the number of taxpayers subject to the alternative tax. a result, revenues would reach nearlyminimum 19 percent ofAs GDP in 2013 and nearly 21 percent percent in 2021. 2021. Under the extended-baseline scenario, revenues would continue to rise gradually thereafter, reaching roughly 23 percent of GDP by 2035. That increase increase would occur largely because, under current law, real growth in income  would push people into higher tax brackets over time, and inflation-related increases in income would make more income subject to the AMT. AMT. The excise tax on certain high-premium health insurance plans plans that was enacted as part of the March 2010 health care legislation  would also contribute to the increase. All told, average tax rates (taxes as a share of income) would rise considerably, considerably, and people at various points on the income scale would pay a larger percentage of their income in taxes than people at the same points do today. today. In addition, the effective marginal tax rate on labor income would rise from f rom about 25 percent now to about 35 percent in 2035. For the alternative fiscal scenario, by contrast, CBO assumes that tax law will be changed over time to continue certain policies that are widely expected to be extended and to keep revenues at a percentage pe rcentage of GDP more consistent with past patterns. Specifically, Specifically, for this scenario, CBO assumes that all tax provisions scheduled

 The Long-Term Outlook Outlook for Revenues Federal revenues have fluctuated between about 15 percent and 21 percent of GDP over the past 40 years, averaging 18 percent. Just as mandatory programs have

to expire in the next 10 years—other than the reduction of 2 percentage points in payroll taxes for 2011—will be 12. Most payrol payrolll tax revenues come from taxe taxess designated for Social Security and Medicare; the rest come mainly from unemployment insurance taxes.

CBO  

CHAPTER ONE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

extended through 2021. Most important, the tax cuts enacted since 2001 are assumed to continue, the reach of the AMT does not expand, and the estate tax is extended  with the rates and exemption amounts scheduled scheduled to be

 A useful barometer of the federal government’s financial position is the amount of federal fe deral debt held by the public relative to annual economic output. Such debt stood at 40 percent of GDP at the end of 2008, a little above the

in effect in 2012 2012 (adjusted for inflation). inflation). Beyond 2021, 2021, CBO assumes unspecified changes in tax law that keep total revenues at the same share of GDP as in 2021. Under those assumptions, revenues would increase to 18.4 percent of GDP in 2021 (rather than to nearly 21 percent under tthe he extended-baseline scenario) scenario) and  would remain at that percentage in later later years. Thus, the revenues projected under the alternative fiscal scenario are lower than those under the extended-baseline scenario by more than 2 percent of GDP in 2021 and by about 5 percent of GDP in 2035. (For more details about CBO’s long-term revenue projections, see Chap Chapte terr 6.)

40-year average average of 37 percent. Since Since then, large deficits have caused debt held by the public to increase sharply— to 62 percent of GDP at the end of 2010 and, CBO pro jects, to 69 percent by the end of this year. year. Debt has exceeded 60 percent of GDP during only one other period in U.S. history: between 1943 and 1952, when it spiked (peaking at 109 percent percent of GDP) because of a surge in federal spending during World War War II.

 The Size of the Fiscal Imbalance

Debt held growing by the public remain high historical standards, to 84would percent of GDP inby 2035 (see Figure igure 1-2) 1-2) and staying fairly close to that level in i n later decades.

Under the assumptions about tax and spending s pending policies in CBO’s CBO’s long-term scenarios, the federal government faces a daunting long-term budgetary shortfall. How large is that imbalance? Two Two measures offer complementary perspectives: Annual amounts of federal debt show how shortfalls accumulate over time, whereas the “fiscal gap” summarizes summarizes the shortfall over a given period in a single value. Both measures show that projected revenues are insufficient to support projected spending—with a fairly modest difference under the extended-baseline scenario and a very large one under the th e alternative fiscal scenario. Looking at how the fiscal gap changes over time demonstrates the effect of delaying action to address the budgetary imbalance.

 The Accumulation Accumulation of Federal De Debt  bt  For a combination of federal spending and revenues to be sustainable over time, debt held by the public—which represents the amount that the government is borrowing in the financial fi nancial markets (by issuing Treasury Treasury securities) to pay for federal operations and activities—must eventually grow no faster than the economy. economy. That borrowing competes with other participants participants in the credit markets markets for financial resourc resources es and can crowd out out private 13 investment.  

Under the assumptions of CBO’s CBO’s extended-baseline scenario, annual budget deficits would decline to 3.0 percent of GDP by 2014. After that, deficits would generally equal between 3 percent and 4 percent of GDP.

Under the alternative fiscal scenario, deficits would also decline for the next few years and then grow again, but at a much faster pace. By 2021, debt would exceed 100 percent of GDP. After that, the growing imbalance between revenues and noninterest spending, combined with the spiraling cost of interest payments, would swiftly push debt to unsustainable levels. Debt would surpass its past peak of 109 percent of GDP by 2023 and would reach almost 190 percent of GDP in 2035. The federal government could not issue ever-larger amounts of debt relative to the size of the economy indefinitely. If debt continued to rise rapidly relative to GDP, investors at some point would begin to doubt the government’ss willingness to pay interest on the debt. (For more ment’ discussion of that risk, see Chap Chapte terr 2.) Therefore, the government would eventually need to cut spending to  well below the levels projected in the alternative fiscal scenario, increase taxes to well above their average average historical percentage of GDP, GDP, or implement some combination of those two approaches to put the federal budget on a sustainable path.

 

13

13. In contrast, debt held by trust funds and and other gove government rnment accounts—which, together with debt held by the public, make up gross federal debt—represents internal transactions of the government and thus has no effect on credit markets. For more information, see Congressional Budget Office, Federal Debt and Interes Interestt Costs  (December   (December 2010).

Current law, law, if continued, would lead to those sorts of adjustments, which is why debt would rise much more slowly relative to GDP under the extended-baseline scenario. In that scenario, revenues revenues would reach the historically high level of 23.2 percent percent of GDP in 2035 CBO

 

14

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 1-2.

Federal Debt Held by the Public Under CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) 200

Actu ctual

200

Proje roject cte ed

175

175

150

150

Alternative Fiscal Scenario 125

125

100

100

75

75

Extended-Baseline Scenario 50

50

25

25

0

0

2000

Source Sou rce::

2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: The extended-baselin extended-baseline e scenario adheres closely to current current law, law, following following CBO’s 10-year baseline baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table 1-1 on page 4.)

(compared with 18.4 percent under the alternative fiscal scenario), and spending for programs other than the major mandatory health care programs and Social Security would reach the lowest level relative to GDP since before World World War War II, 7.8 percent of GDP in 2035 (compared with 8.5 percent percent under the alternative alternative fiscal

immediate change in spending or revenues that would be necessary to keep the debt-to-GDP ratio the same at the end of a given period as at the beginning of the period. The fiscal gap is conceptually similar to the actuarial imbalance for Social Security (see Table 4-1 on page 55). 55). Both measures quantify a long-term shortfall in present-

scenario). With thescenario, current-law assumptions extended-baseline the sharp increaseofinthe outlays projected for the major health care programs and Social Security during the next few decades would be nearly balanced by the increase in revenues, and debt would grow only a little faster f aster than the economy.

value is, as single number thatof describes a flowterms—that of future revenues reven uesa or outlays in terms an equivalent lump sum received or spent today—and both can be expressed as a percentage of GDP.14

Many analysts believe that the alternative fiscal scenario presents a more realistic picture of the nation’s underlying fiscal policy than the extended-baseline scenario does— because, for example, it does not n ot allow the impact of the  AMT to expand substantially. substantially. The explosive path of federal debt under the alternative scenario underscores the need for major changes in current policies to put p ut the

14. The fiscal gap equals th thee present value ooff revenues ov over er a given period minus the present value of primary outlays over that period, adjusted to keep federal debt at its current percentage of GDP. Specifically, current debt is added to the outlay measure, and the present value of the target end-of-period debt (which equals GDP in the last year of the period multiplied by the ratio of debt to GDP at the beginning of 2011) is added to the revenue measure. The present value of a stream of future revenues is com-

nation on a sustainable fiscal course.

 The Fiscal Gap Gap How much would policies have to change to avoid unsustainable increases in government debt? A useful answer comes from looking at the fiscal gap, which measures the

puted by taking the revenues for each year year,, discounting each value to 2011 dollars, and summing the resulting series. The same method is applied to the projected stream of primary outlays. CBO used a discount rate equal to the average interest rate on federal debt held by the public, which was assumed to be 2.7 percent on an inflation-adjusted basis in the long term (as explained in Ch Chapt apter er 2).

CBO  

CHAPTER ONE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 1-3.

 The Federal Fiscal Gap Under CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) Present Prese nt Value of the Fu Future ture Stream of  Revenues or Outlays over a Given Period Projection Projecti on Period

a

Adjusted Revenues

Fiscal Gap a

Adjusted Outlays

(Outlays minus revenues)

Extended-Baseline Scenario 25 Years (2011 to 2035) 50 Years (2011 to 2060) 75 Years (2011 to 2085)

2 3.2 2 4.1 25.4

24 .1 24 .4 25 .6

0 .9 0 .4 0 .2

Alternative Fiscal Scenario 25 Years (2011 to 2035) 50 Years (2011 to 2060) 75 Years (2011 to 2085) Source Sou rce::

20.3 19.2 18.9

25 .1 25 .9 27 .2

4.8 6.6 8.3

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The fiscal gap is a measure of the difference betwe between en projected primary spending and revenues over over a given period. It represents the extent to which th e government would need to immediately and permanently either raise revenues or cut spending—or d o both, to some degree—to make the government’s government’s debt the same size (relative to gross domestic product, or GDP) at the end of the period that it was at the beginning of 2011. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that modify some current provisions that might be difficult to sustain for a long period. (For details details,, see Table Table 1-1 on pa page ge 4.) a.

To allow for the increase in the nominal v value alue of federal debt that would occur even even if that debt was maintained at its current share of GDP, outlays are adjusted by adding current debt, and revenues are adjusted by adding the present value of the target end-of-period debt. (The end-of-period debt is equal to GDP in the last year of the period multiplied by the ratio of debt to GDP at the beginning of 2011. A present value is a single number that describes a flow of future revenues or outlays in terms o f an equivalent lump sum received or spent today.)

The fiscal gap from 2011 to 2035 would amount to

alternative fiscal scenario beginning in 2012, 2015, 2020,

0.9 percent of GDP Gunder DP under the extended-baseline scenario and 4.8 percent the alternative fiscal scenario (see Table 1-3). 1-3). In other words, relative to the projections of the alternative fiscal scenario, an immediate and permanent reduction in spending or increase in revenues equal to 4.8 percent of GDP—equivalent GDP—equivalent to more than $700 billion in this year’s federal budget—would be needed to create a sustainable fiscal path for the next quarter century. century. If the change came entirely from revenues, it would amount to roughly a one-quarter increase in revenues relative to the amount projected for 2021 and later years. If the change came entirely from spending, it  would represent a cut of roughly one-fifth in primary

or 2025. Those simulationsincrease indicatethe that postponing action would substantially size of the policy adjustments needed to put the budget on a sustainable course. For example, if lawmakers wanted to close the fiscal gap through 2035 but did not begin until 2015, they  would have to reduce primary spending or increase reverevenues over that period by 5.9 percent of GDP, rather than by 4.9 percent if they acted in 2012 (see Figure igure 1-3 1-3). ). If they waited until 2020 to close the fiscal gap through 2035, they would have to cut noninterest outlays or raise revenues over the remaining period by 8.1 percent of GDP. Moreover, those simulations omit the effects that deficits and debt would have on economic growth and

 

15

spending from the amount projected for that period. pe riod.

 The Effect of of Delaying Action on the Fiscal Fisc al Imb Imbala alance nce  W  Waiting aiting to close the fiscal gap would make the necessary changes larger. To illustrate the costs of delay, CBO simulated the effects of closing the fiscal gap under the

interest rates in the intervening years; incorporating such s uch effects would make the impact of delaying policy changes even more severe.  Another perspective on the size of the fiscal gap comes from considering how much revenues would have to be increased and outlays reduced if changes were made CBO

 

16

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 1-3.

Reductions in Primary Spending or Increases in Revenues in Various Years Needed to Close the 25-Year 25-Year Fiscal Gap G ap Under CBO’s Alternative Fiscal Scenario (Percentage of gross domestic product) 14 12.5

the alternative fiscal scenario (18 percent and 25 percent, respectively). The primary surpluses that would be generated between 2024 and 2035 would be used to cover the government’s interest costs and pay off some so me of the debt accumulated between 2011 and 2023. If the fiscal gap  was closed by 2035, there would be no need to run large surpluses thereafter; instead, the ratio of debt to GDP  would be steady steady as long as budget deficits remained remained small as a percentage of GDP.

12

Uncertainty of Long-Term Long-Term Budget Bud get Projec Projectio tions ns

10 8.1

8

Future budgetary outcomes will depend in large part on future policies—as evidenced by the fact that the two scenarios analyzed in this report, which use the same assumptions about future economic conditions but dif-

5.9

6

4.9

4 2 0 Actions Begin in 2012

Source Sou rce::

Actions Begin in 2015

Actions Begin in 2020

Actions Begin in 2025

ferent assumptions about spending and tax policies, produce widely differing paths for federal fed eral debt. However, However, budgetary outcomes will depend on other factors as well, including changes in the economy, economy, demographic trends, and major military actions.15

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending re refers fers to all all spending other than interest payments on federal debt. The fiscal gap is a measure of the difference between projected primary spending and revenues over a given period. It represents the extent to which the government would need to immediately and permanently either raise tax revenues or cut spending—or do both, to some degree—to make the government’s government’s debt the same size (relative to gross domestic product) at the end of the period that it was at the beginning of 2011. The alternative fiscal scenario incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period. (For details, see Table 1-1 on page page 4.) 4.)

gradually (rather than in a single year, year, as implied by the fiscal gap). As one example of o f such gradual changes, CBO computed the paths of revenues and noninterest outlays necessary to return to the current debt-to-GDP ratio in 2035, assuming that each path would move m ove by an

Recessions and Financial Crises The greater the frequency and severity of future recessions, the worse budgetary outcomes would be. Recessions have direct effects on the budget: They reduce revenues by significant amounts and also raise outlays for programs such as unemployment insurance and nutrition assistance.16 In addition, recessions may prompt policymakers to enact legislation that further revenues and increases spending in order to help reduces people suffering suff ering from the weak economy eco nomy,, to bolster the financial condition of state and local governments, and to stimulate additional economic activity and employment. In the recent economic downturn, the combination of automatic budgetary responses and legislation such as the  American Recovery and Reinvestment Reinvestment Act of 2009 (Public Law 111-5) had a profound impact on the the federal 15. CBO has not quantified the uncertainty of its llong-term ong-term budge budgett projections,, but it has done so for its long-term Social Security projections projections; see CBO’s 2010 Long-Term Projections for Social Secu-

equal amount relative to the trajectories projected under the alternative fiscal scenario and that the changes would begin in 2015 (see Figure Figure 1-4 on page 18 18). ). Closing the 25-year fiscal gap under those assumptions would involve having revenues approach 23 percent of GDP in 2035 and noninterest outlays equal less than 21 percent of GDP,, both substantially different from their levels under GDP

rity: Additional Information (October Information (October 2010). That uncertainty analysis is not definitive because it is based on patterns of historical variation, and future fu ture variation could differ. For example, mortality could suddenly improve or deteriorate to an extent that was not experienced in the past. 16. See Co Congressional ngressional Budget Office, Office, The Effects of Automatic Stabilizers on the Federal Federal Budget  (May 2010).

CBO  

CHAPTER ONE

budget. At the beginning of 2008, federal debt equaled 36 percent of GDP, and CBO projected that it would decline slightly relative to GDP over the next few years; by the end of 2010, however, however, debt was 62 percent of GDP. Moreover, some recessions occur as a result of, or at the Moreover, same time as, financial crises that can induce large federal f ederal expenditures. For example, the federal government made substantial outlays at the end of the 1980s to resolve the savings and loan crisis and again in the past few years to stabilize the U.S. financial system. In both cases, the policy actions ultimately had smaller effects on federal debt than recessions tend to have.17 However, the costs of future interventions in financial markets could be much greater,, in part because the financial industry has become greater more concentrated.18 And if debt rose to a level that made additional government might havefederal troubleborrowing financingdifficult, the initialthe cost of a desired intervention in the financial markets, even if it expected to recoup at least part of that cost over time. Further Further,, as 17. Federal lo losses sses from the savings aand nd loan crisis have been estim estimated ated at $124 billion; see Timothy Curry and Lynn Shibut, “The Cost of the Savings and Loan Crisis: Truth and Consequences,” FDIC Banking Review , vol. 13, no. 2 (2000). Policy actions taken to stabilize the financial system in the past few years included the Troubled Asset Relief Program (TARP), the conservatorship of Fannie Mae and Freddie Mac, and a set of initiatives by the Federal Reserve. CBO estimates that the net costs of the TARP will be $19 billion (although the program’s cash flows have been much larger); see Congressional Budget Office, Report on the Troubled  Asset Relief Program Program (March  (March 2011). On a fair-value basis, the costs of the government’s takeover and continuing operation of Fannie Mae and Freddie Mac will exceed $300 billion, CBO estimates, but the net effect on federal debt is likely to be smaller than that; see the statement of Deborah Lucas, Assistant Director for Financial Analysis, Congressional Budget Office, before the House Committee on the Budget, The Budgetary Cost of Fannie Mae and Freddie Mac and Options for the Future Federal Role in the Secondary Mortgage Market  (June  (June 2, 2011). The direct effect of the Federal Feder al Reserve Reserve’’s actions to stabilize financial markets will be to increase remittances to the Treasury, reducing the budget deficit, CBO estimates. However, those actions increase uncertainty about the Federal Reserve System’s future remittances; see Congressional Congress ional Budget Office, The Budgetary Impact and Subsidy

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

recent experience has shown, the indirect effects of financial crises on the federal budget can be much larger than the direct effects, as resulting drops in economic activity can be both deep and long-lasting.

Long-Term Changes in Interest Rates on Federal Debt  Interest rates on Treasury Treasury securities have varied a good deal over time, so predicting their future f uture path is difficult. For example, the real interest rate paid on federal debt  was 4 percent percent in the 1980s but averaged -1 percent percent in the 1970s (because inflation was higher than the nominal interest rate). For the economic benchmark underlying the projections in this report, CBO assumes that the real interest rate on federal debt will rise from less than 1 percent today to an ultimate value of 2.7 percent. (For an explanation of that and other economic projections, see the section titled “CBO’s “CBO’s Long-Term Economic Benchmark” in Chap Chapte terr 2.) One particular risk is that growing federal debt would increase the probability of a fiscal crisis, in which investors would lose confidence in the government’s government’s ability to manage its budget and the government would thus lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors’ confidence faltered, warning lawmakers of the worsening situation and giving them enough time to make policy choices that could avert a crisis. Indeed, because interest rates on Treasury securities are unusually low today tod ay,, such a crisis does not appear imminent in the United States. States. But as other countries’ experiences show, show, investors can lose confidence abruptly,, and interest rates on government debt can rise abruptly sharply and unexpectedly. unexpectedly. (For more discussion of that risk, see the section titled “Other “Other Consequences of Rising Federal Federal Debt” Debt” in Chapter 2.) Budgetary outcomes could be affected significantly if interest rates differed persistently from the path that underlies the projections. CBO projects that under the alternative fiscal scenario, interest payments on debt held by the public would account for one-quarter of federal outlays by 2035. If interest rates were even moderately

 

17

Costs of the Federal Reserve s Actions During the Financial Crisis   (May 2010). 18. As an illustration, the ass assets ets of the six largest bank holding com compapanies increased from 15 percent of GDP in 1995 to about 55 percent in 2006 and 64 percent in 2010. See the statement of Simon  Johnson,  Johnso n, Profes Professor sor of Entre Entrepreneurship preneurship,, Sloan Sc School hool of Ma Managenagement, Massachusetts Institute of Technology, before the Senate Committee on the Budget, February 1, 2011.

higher or lower than projected, total federal fed eral outlays  would be significantly higher or lower, lower, and the effect  would compound over time. For example, example, if interest rates  were 0.5 percentage points lower each year than assumed, federal debt under the alternative fiscal scenario would be 175 percent of GDP in 2035 rather than almost 190 percent, as CBO projects. If interest interest rates were were

CBO  

18

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 1-4.

One Potential Path for Revenues and Noninterest Spending Sufficient to Close the 25-Year 25-Year Fiscal Fiscal Gap (Percentage of gross domestic product) 30

30

Actua ctuall

Proje roject cte ed

Lower Spending Beginning in 2015

Primary Spending Under the Alternative Fiscal Scenario

25

25

20

20

Revenues Under the Alternative Fiscal Scenario

15

Higher Revenues Beginning in 2015

15

10

10

5

5

0

0

2000

Source Sou rce::

2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The fiscal gap is a measure of the difference between projected primary spending and revenues over a given period. It represents the extent to which th e government would need to immediately and permanently either raise tax revenues or cut spending—or do both, to some degree—to make the government’s government’s debt the same size (relative to gross domestic product) at the end of t he period that it was at the beginning of 2011. The alternative fiscal scenario incorporates incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult difficult to sustain for a long period. (For details, see T Table able 1-1 on page 4.)

0.5 percentage points higher, debt would equal about 200 percent of GDP, GDP, and interest payments would make up almost 30 percent percent of federal federal outlays.

could occur gradually—for instance, if trends in fertility rates or mortality improvements diverged steadily from the assumed paths.

Long-Term Changes in Demographics, Health Status, and Health Care

The health status of the population could evolve in unexpected ways because because of changes in behavior (such as smoking rates or dietary patterns), because of new medical procedures that reduced the occurrence of certain conditions or diseases, or because of new treatments for various illnesses. Such changes in health status would affect federal spending on health care programs and on programs for people with disabilities. For example, outlays for Medicare and Medicaid depend in part on the prevalence of conditions such as obesity, obesity, depression,

Demographic factors will also affect budgetary outcomes over the long run. Federal outlays as a share of GDP are sensitive to the ratio of the number of elderly to the number of working-age adults, because because GDP depends importantly on the number of workers, and outlays for fo r Medicare, Medicaid, and Social Security are closely linked to the number of elderly people. Higher rates of fertility or immigration would cause GDP to increase

relative to federal spending, whereas whereas faster-than-expected faster-than-expected

and musculoskeletal disorders, disorders, because people with such

growth in life expectancy would cause federal spending to increase relative to GDP. Differences from the demographic trends assumed in this report could occur relatively suddenly—for example, through a medical breakthrough that reduced mortality or through the spread of a new infectious disease. Alternatively Alternatively,, such differences

conditions tend to consume more medical care. Those people are also more likely to qualify for Social Security Disability Insurance, Supplemental Security Income, and Medicaid’s long-term care program. To the extent that changes in health status led to changes in mort mortality ality,, such changes would also affect the number of Medicare and

CBO  

CHAPTER ONE

Social Security beneficiaries and outlays for entitlement programs. One of the greatest sources of budgetary budgetar y uncertainty is the future growth of health care costs. The health care system is continually evolving, and spending for health care has a large and growing effect on the federal fe deral budget—both through outlays on Medicare, Medicaid, and other health programs and through tax preferences, especially the exclusion of employer-provided health benefits from income and payroll taxes. Although those developments will be affected by whatever federal policies are pursued, great uncertainty would exist even under a specified policy. In both long-term budget scenarios, CBO projects that federal spending on health care per beneficiary will increase more slowly in the future than during the past several decades but will still substantially outpace the growth of per capita GDP. Historically, technological changes have been the main driver of increases in health care costs. Future growth rates for the per-beneficiary costs of federal health care programs will depend largely on the extent to which advances in health technology raise costs. However, changes in the structure of payment systems and the delivery of health care could also prove to be important; indeed, such changes could affect, and be affected by, advances in technology. technology. (For further discussion, see Chap Chapter ter 3.)

Long-Term Changes in Productivity 

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

path. By comparison, if productivity growth was 0.3 percentage points lower than assumed every e very year, GDP in the 10th year would be 3 percent lower than projected, but cumulative GDP over that decade would be lower by about 16 percent of one year’s year’s output, and that shortfall  would be growing at an accelerating rate. rate. In other words, the shortfall from a recession is generally g enerally temporary, temporary,  whereas a change in the long-term rate of productivity growth reduces output by an ever-increasing amount. The nation could also experience unexpectedly high growth in productivity, productivity, most likely because of faster technological improvements. Such faster growth could occur steadily (for example, from the continued integration of information technology into the economy) or could result suddenly from a specific technological breakthrough (such as the development of a new source of energy). Faster economic growth from higher productivity (in the absence of changes in other economic measures, such as the unemployment rate, interest rates, or inflation rates) would result in higher revenues but have relatively little impact on the ratio of outlays to GDP under the extended baseline scenario, so budget deficits  would be smaller. smaller. Slower economic economic growth would would lead to correspondingly larger budget deficits. Moreover, Moreover, raising taxes or reducing outlays might be less burdensome if people’ss incomes were higher and more burdensome if people’ they were lower.

Long-term economic growth could differ greatly from the

Catastrophic Events or Major Military Actions

path underlies thethe budget in this report. CBOthat assumes that in long run, rprojections un, total factor productivity will grow by 1.3 percent annually, approximately the average rate seen over the past half century. century.19 A small change in the growth of productivity can, over a long period, have a larger effect ef fect on GDP than most recessions do. For example, CBO estimates that during the depths of the recessions experienced since the 1970s, GDP was more than 4 percent lower, on average, than it could have been if the nation’ nation’s labor force and capital stock had been fully utilized; in addition, output subsequently remained below potential levels for an average of three years. Over

Natural and manmade disasters occur fairly often, and even though they may have significant short-term effects on the national economy or long-term effects on o n certain regions or economic sectors, they rarely have a lasting impact on the national economy. economy. However, an increased frequency of disasters or the occurrence of a larger catastrophe could affect budgetary outcomes by reducing economic growth over a number of years, by requiring massive additional federal spending, or both. For example, the country could experience more-frequent severe floods, hurricanes, tornadoes, and fires—as some models of climate change predict—or could experience a single

 

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the course of a lengthy recession, the cumulative loss in GDP would be substantial, but if the economy fully recovered, GDP would return to its previous growth 19. Total factor productivity is average rreal eal GDP per unit of combined labor and capital services. Thus, the growth of total factor f actor productivity is the growth of real output that is not explained by the growth of labor and capital.

massive earthquake, a nuclear meltdown that rendered a large area of the country uninhabitable, or an asteroid strike. Other possibilities include an epidemic (whether on the scale of the 1918 pandemic flu, which killed roughly one out of every 150 people in the United States, or on the scale of the current AIDS epidemic in parts of  Africa), a series of major major terrorist attacks, a large large war, war, or a number of smaller but sustained military actions. Because

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

estimates of future risk are generally based on experience, and catastrophic events are extremely rare, estimating es timating the probability of their future occurrence is difficult.

Policy Choices Government policy cannot eliminate the risk factors that create uncertainty. uncertainty. But different diff erent policy choices can allocate the effects of risk differently and affect the uncertainty of budget projections. For example, under current law,, outlays for Medicare and Medicaid depend on the law growth of health care costs, but some policymakers have proposed that growth in outlays per beneficiary be fixed f ixed in real terms, shifting both risk and control to individuals.20 Such a policy change would greatly reduce uncertainty about future federal outlays for those programs; 20. See, for exam example, ple, Congres Congressional sional Budge Budgett Office, “Long-Term “Long-Term  Analysis of a Budget Proposal Proposal by Chairman Ryan Ryan,” ,” attachment to a letter to the Honorable Honorable Paul Ry Ryan an (April 5, 2011).

however, it would increase uncertainty about future however, outlays by other parties, such as program beneficiaries and states. (Most policy changes would affect both the amount of expected federal outlays and uncertainty about those outlays, but those two aspects are separable.)  Although analysts sometimes speak of risk to the government, all risk is ultimately distributed to individuals—as taxpayers, beneficiaries of federal programs, or both. If spending turned out to be higher than projected, the additional imbalance would eventually have to be made up through higher revenues or lower outlays, or it would result in lower future incomes. Conversely, if budget imbalances were smaller than expected, future f uture tax increases and spending cuts would be smaller, or future incomes would be higher. How that risk was distributed—for example, among different income groups or generations—would depend on which specific policies  were enacted to deal with the unexpected imbalance. imbalance.

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CHAPTER 

2  The Economic Impact Impact of Long-Term Long-Term Budget Policies

T

he budget estimates presented in the other chapters of this report are based on benchmark economic projections for output, interest rates, wages, and other aspects of the economy in the long run. That benchmark is not intended as a forecast of the th e likely path of the economy under the Congressional Budget Office’s Office’s (CBO’s) two

focuses on the effects of changes in the ratio of debt to GDP and changes in marginal tax rates, although other aspects of the policies might affect the economy in different ways as well.

sets of assumptions about futureand legislative actions— the extended-baseline scenario the alternative fiscal fiscal 1 scenario.  Rather, it is meant to serve as a stable economic foundation for alternative long-run budget projections. For the first decade of the projections in this t his report (through 2021), the benchmark matches CBO’ CBO’ss January 2011 economic forecast. For later years, the benchmark is generally aligned with the economic experience of the past few decades; it also incorporates two specific assumptions about fiscal policy—that debt held by the public  will be maintained at 76 percent of gross domestic product (GDP), the level reached in 2021 in CBO’s baseline budget projections, and that the effective marginal tax

stantial unemployment anddeficits—and unused factories, and equipment, federal budget thusoffices, additional debt—generally boost demand, thereby increasing output and employment relative to what would occur with a balanced balan ced budget. budget.3 However, the effects of that greater demand are temporary because stabilizing forces in the economy (such as the responses of prices and interest rates and actions by the Federal Reserve) tend to move output back toward its long-run potential level—that is, toward the amount of goods and services ser vices that the economy can produce with a high rate of use of its capital and labor resources. Because this analysis focuses on the longrun effects of tax and spending policies, CBO’s CBO’s estimates in this chapter do not take those short-run effects on demand into account. Indeed, the estimates reflect the assumption that over the long run, output is always at its potential level.

rates income from stant on after that year. year .2 work and saving will remain conThe long-term tax and spending policies projected under the extended-baseline and alternative fiscal scenarios  would lead to different outcomes for the economy than the ones reflected in the benchmark projections. CBO’s analysis of the economic impact of those fiscal policies 1. The extended-base extended-baseline line sce scenario nario adheres adheres clo closely sely to current llaw aw,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-

In the short run, especially when the economy has sub-

Under CBO’s CBO’s extended-baseline scenario, federal debt de bt  would increase from 76 percent percent of GDP in 2021 to 84 percent of GDP in 2035, and effective mar marginal ginal tax rates on labor earnings and capital income (for example, stock dividends and interest) would rise over the same period. Marginal tax rates rise under that scenario because the tax cuts enacted since 2001 and recently

and then extending the baseline concept for the rest of the long term projection period—that is, through 2085. The alternative fiscal scenario incorporates several changes to current law that are  widely expebe expected cted to oc occur cur that would wo modify som some e provisions that might difficult to or sustain foruld a long period. Chapt Ch apter er 1  discusses the scenarios in detail. 2. The margina marginall tax rat ratee is the rat ratee that w would ould ap apply ply to an additio additional nal dollar of a taxpayer’s income. The effective marginal tax rate is the  weighted average average of marg marginal inal tax rates across all taxpayers, with with the weights depending on income.

extended in the 2010 tax act (the Tax Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Public Law 111-312) are assumed to expire as scheduled in 2012 or 2013 and because the exemption amounts for the individual alternative minimum tax 3. See Cong Congress ressional ional Budg Budget et Offic Office, e, Policies for Increasing Economic Growth and Employment Employment in 2010 and 2011 (January 2011 (January 2010).

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

revert to their 2001 levels in 2012 (see Chap Chapte terr 6 for more details). In CBO’s estimation, those factors would diminish gross national product (GNP) under the extended-baseline scenario by as much as 2 percent in 2035 when compared with GNP under the fiscal assumptions underlying the economic benchmark.4 After 2035, both the projected ratio of debt to GDP and marginal tax rates on labor income would rise further f urther for a while and then eventually fall; marginal tax rates on capital income after 2035 would rise gradually through 2085. As a result of those developments, the estimated negative economic effects under the extended-baseline scenario, relative to the benchmark projections, would also increase and then diminish. Under the alternative fiscal scenario, nearly all of the tax provisions scheduled to expire over the next 10 years— including the tax cuts enacted e nacted since 2001 and recently extended by the 2010 tax act—are assumed to be extended through 2021. Total revenues after 2021 are assumed to remain at the share of GDP they are projected to reach in 2021—that is, 18.4 percent—and effective marginal tax rates are assumed to remain at their 2021 levels. As a result, effective marginal tax rates under the alternative fiscal scenario would be a good deal lower than they would be under the extended-baseline scenario, but debt would be much greater—almost 190 percent of GDP by 2035, even before the negative economic effects of such debt were taken into account. Those changes in tax rates and debt, CBO estimates, would push GNP well below its value in the economic benchmark—for example, GNP would be 2 percent to 6 percent lower by 2025 and 7 percent to 18 percent lower by 2035. Beyond 2035, as projected debt relative to GDP under the alternative fiscal scenario grew even more, the estimated negative effects on the nation’s nation’s output would increase. 4. GNP differs differs fr from om GDP (wh (which ich is the the more co common mmon measure measure ooff

Higher levels of debt would have a number of other negative consequences that are not incorporated in those estimated effects on output:  

 

 

 As federal debt grows, so does the amount of interest that the government pays to its lenders (all else being equal). If policymakers wished to maintain the benefits and services that the government provides while its interest payments grow, grow, then tax revenues would eventually have to increase as well. Alternatively, Alternatively, policymakers could choose to offset those rising interest costs, at least in part, by reductions in benefits and services. Rising debt would increasingly restrict policymakers’ ability to use tax and spending policies pol icies to respond to unexpected challenges, such as economic downturns or financial crises. As a result, those challenges could have larger negative effects on the economy and people’s well-being. Growing federal debt also would increase the probability of a sudden fiscal crisis, during d uring which investors  would lose confidence in the government’ government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices and probably have a very significant negative impact on the country.

Under the alternative fiscal scenario, the paththe ofassumptions federal debt of would be unsustainable, and therefore major policy changes to stabilize the budget  would be required at some point. The longer the necessary adjustments were delayed, the greater would be the negative consequences of the mounting debt, the more uncertain individuals and businesses would be about future government policies, and the more drastic the ultimate changes in policy would need to be. Waiting to address the long-term budgetary imbalance and allowing debt to mount in the meantime would make future gen-

the output of the economy) primarily by including the income that U.S. residents earn from their investments abroad and excluding the income that nonresidents earn from their investments in this country. This chapter focuses on GNP because part of the growing budget deficits projected for coming years would be financed by inflows of capital from other countries. That means that over the long term, a growing portion of the nation’s income would have to be sent abroad as returns—in the form of profits or interest—on that invested capital and thus would not be available to U.S. households.

erations worse off, although some current generations could benefit from such a delay. delay.

CBO’s Long-Term Economic Benchmark  The economic benchmark that underlies CBO’s longterm budget estimates encompasses projections for a host of demographic and economic variables.

CBO  

CHAPTER TWO

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Demographic Variables

Economic Variables

Future federal tax revenues, federal spending, and the performance of the economy will all be affected by the

For 2011 through 2021, CBO’s benchmark projections of economic variables match those in its January 2011

size and composition of the U.S. population. For its longterm benchmark, CBO adopted the intermediate (midrange) values in the 2010 report of the Social Security trustees for birth and mortality rates as well as rates of disability (specifically, (specifically, the rates at which people enter and leave Social Security’ Security’s Disability Insurance program).5 

economic forecast, which underlies the agency’ agency’ss most recent budget baseline.9 Beyond that point, the economic benchmark does not reflect the effects that changing marginal tax rates or a rising debt-to-GDP ratio would have on economic growth and interest rates. Rather, for later years, the benchmark is generally aligned with the economic experience of the past few decades; it also incorporates two specific assumptions about fiscal policy—that debt held by the public will be maintained at 76 percent of GDP, the level reached in 2021 in CBO’s baseline budget projections, and that the effective marginal tax rates on income from work and saving will remain constant after that year. (Annual values for

CBO’s short-run and long-run projections for immigraCBO’s tion, however, however, differ from those of the trustees. In CBO’s view,, the recent recession has had a greater effect view eff ect on immigration than the trustees have assumed, and thus fewer immigrants have come to the United States in the past few years. (Levels of immigration immigration in recent years must be estimated because of a lack of data on the number of unauthorized immigrants.) However, However, CBO anticipates that economic recovery will lead to more immigration in the next few years than the trustees pro ject.6 Over the long term, the amount of authorized and unauthorized immigration under current law—allowing l aw—allowing for possible changes in the implementation and enforcement of that law—is subject to much uncertainty. uncertainty. Therefore, for its benchmark, CBO assumed that in the long run, the amount of immigration would maintain its historical relationship to the size of the U.S. population: 3.2 immigrants per year per 1,000 1,000 people in the popula7 tion.  On that basis, CBO projects that net immigration to the United States will increase from 1.3 million immigrants in 2021 to 1.6 million immigrants in 2085— rather than fall from 1.1 million to 1.0 million immigrants, as the trustees have assumed. CBO’s CBO’s current projections for long-term immigration are somewhat above the projections in last year’s year’s long-term budget outlook, leading to slightly faster growth of the labor force than CBO projected last l ast year.8 5. Social Social Secu Security rity Administr Administratio ation, n, The 2010 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and

selected economic variables through 2085on can be found in the supplementary data for this report CBO’s CBO’ s Web  www.cbo.gov  .cbo.gov ..)) site, www site, Interest Rates. The interest rates that CBO projects for its benchmark include the interest rate on 10-year TreaTreasury notes, the average interest rate on o n government debt, and the interest rate on holdings of the Social Security and Medicare trust funds. For the long run, CBO pro jects a real (inflation-adjusted) interest rate on 10-year 10-year Treasury notes of 3.0 percent, which is near the average of the past four decades and close to the rate CBO projected for 2021 in its January 2011 economic forecast. In the benchmark projections for interest rates, CBO took into account both the amount of debt relative to GDP, GDP, which is well above the level in recent decades, and the projected rate of growth of the labor force, which CBO estimates  will be slower slower than in recent recent decades. The effects of those two factors on the rate for 10-year Treasury Treasury notes, CBO anticipates, will roughly offset each other.

 An increase in government government debt tends to raise interest rates by leading people to allocate a larger portion of their savings to the purchase of government securities, such as

 

23

Federal Disability Insurance Insu rance T Trust rust Funds  (August  (August 9, 2010). Detailed data from the trustees’ 2011 report were not available in time for CBO to incorporate in this analysis. 6. For the latest latest report report in C CBO’ BO’ss series on immigration, immigration, see CongresImmigrant Population Population:: sional Budget Office, A Office, A Description Description of the Immigrant  An Update  Update  (  ( June  June 2011). 2011). 7. That ratio ratio equals equals the the avera average ge net flow flow of immigrants immigrants over over the the period from 1821 to 2002. See Social Security Administration, Technical Panel on Assumptions and Methods, Report to the Social Security Advisory Board  (October  (October 2003), p. 28.

Treasury bonds, and thereby “crowding out” investment in productive capital goods, such as factories and computers. By itself, that effect would imply higher interest rates than those seen in the past few f ew decades. Specifically, Specifically, 8. See Cong Congress ressional ional Budg Budget et Offic Office, e, The Long-Term Budget Outlook   (June 2010, revised August 2010). 9. See Cong Congress ressional ional Budg Budget et Offic Office, e, An  An Analysi Analysiss of the President President’s’s Budgetary Proposals for Fiscal Year 2012  (April  (April 2011).

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

if debt was 76 percent of GDP instead of its 40-year average of 37 percent, the interest rate in the long run, all else being equal, would be roughly 1 percentage point

for urban wage earners and clerical workers and the consumer price index for all urban consumers—will consumers—will be 2.5 percent in the long run. The two indexes measure the

higher, CBO estimates.

level of consumer prices using typical ““market” market” baskets of specified goods and services. The rate of 2.5 percent for the change in the prices of consumer goods and services ser vices is a little above the rate that CBO projected for 2021 in its  January 2011 forecast forecast and the same rate that CBO used for its long-term projections last year.

However, long-term trends in the labor force are expected However, to largely offset that effect ef fect on interest rates. Growth in the number of workers is likely to be slower in coming decades than in past ones because of the aging of the population and lower birth rates. Other Other things being being equal, slower growth in the labor force will increase the ratio of the capital stock (such as computers and factory equipment) to the supply of labor, labor, which will lower the productivity of incremental units of capital. That lower productivity means that investment in capital will generate a smaller return, pushing interest rates lower.10  The benchmark value for the average real interest rate on federal debt held by the public over the long term is slightly lower—at 2.7 percent—than the projected rate on 10-year Treasury Treasury notes. That difference arises because CBO projects that interest rates on short-term debt will be lower than those on long-term debt, as is typically the case, and because the average maturity of federal debt is expected to be less than 10 years. In general, CBO used the same 2.7 percent value as a discount rate for f or calculating the present value of future streams of total federal  However,, the Social Security and revenues and outlays.11 However Medicare trust funds hold longer-term debt, so CBO assumed that the rates of interest earned on the balances in those funds would be higher than the average real interest rate on federal debt. Therefore, in calculating the present value of future streams of revenues and outlays for the trust funds, CBO used 3.0 percent as the discount rate. Inflation. For its benchmark, CBO projects that inflation for consumer goods and services—as ser vices—as measured by the annual rate of change in both the consumer price index

This year, however, however, CBO has changed its assumption about inflation for productive capital goods to better align its estimates with the trend in prices over the past several decades. During that time, the prices of capital goods, on average—and especially the prices of computer equipment—increased more slowly than the consumer price indexes. This year’s year’s economic benchmark thus incorporates the assumption that over the long term, the prices of capital goods will continue to rise more slowly than the prices of consumer goods and services—and in particular that the relative price of computer equipment  will continue to fall. By contrast, for last year’ year’s benchmark, CBO assumed that changes in the prices of capital goods would move more closely in line with changes in other prices.  Another measure of inflation is the GDP GDP deflator. deflator. Unlike the consumer price indexes, with their typical market baskets of consumer goods and services, the GDP deflator measures the level of prices of all final goods and services that the economy produces. The GDP deflator grows more slowly than the consumer price indexes both because it fully accounts for the ability of buyers to shift their purchases as relative prices change and because it encompasses a greater proportion of items, such as computers, whose prices are projected to rise more slowly than the prices of most other goods and services. For its benchmark, CBO projects that over the 2021–

10. See C Congressio ongressional nal Budge Budgett Office, How Slower Growth in the Labor Force Could Affect the Return on Capital , Background Paper (October 2009). 11. The discount rate is tthe he rate of intere interest st used to translate tthose hose future cash flows into current dollars (and the higher that rate, the lower the present value of the future flows). For example, if $100 is invested on January 1 at an annual interest rate of 5 percent, it  will grow grow to $105 by January 1 of the next year. Hence, at an annual 5 percent interest—that is, discount—rate, the present value of $105 payable a year from today is $100.

2085 period, the GDP deflator will increase 0.3 percentage points less per year, on average, than the consumer price indexes will—about the same differential that CBO projects for the years through 2021. Labor Market Factors. Important projections regarding the labor market for CBO’ CBO’ss benchmark include the unemployment rate, the share of total compensation received as taxable earnings, and average hours worked.

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CHAPTER TWO

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

The Unemployment Rate. CBO Rate. CBO projects that the unemployment rate will return to the natural rate of unemployment (the rate that reflects unemployment

expensive plans, thereby reducing the share of compensation represented by health insurance premiums and increasing the share of taxable earnings. CBO’s CBO’s estimate

arising from all sources except fluctuations in overall demand related to the business cycle) by 2017 and remain equal to the natural rate thereafter. thereafter.12 CBO expects that the natural rate will remain slightly elevated over the next decade because of the aftereffects of the recent recession. (For example, some older unemployed workers  whose skills do not match those demanded by employers may not be able to find employment e mployment before they retire.)  As the recession’ recession’s lingering impact on labor markets dissipates, the natural rate of unemployment is projected to decline. All told, the unemployment rate in CBO’s economic benchmark declines from its current level of roughly 9 percent to 5.2 percent in 2017 2017 and remains at at

of the extent of that shift over the long term is now larger than the estimate incorporated in its 2010 long-term budget outlook. CBO thus projects that the effects eff ects of the excise tax on the taxable earnings share of compensation will more than offset the effects of rising costs for health care for a few decades after the tax takes effect in 2018 but that thereafter the effects of rising health he alth care 13 costs will outweigh the effects of the tax.  As a result, in CBO’s CBO’s benchmark, the share share of compensation that  workers receive as taxable earnings first rises to about 84 percent in abou aboutt 2050 and then falls, ending up near its 2021 level of 81 percent by 2085. (For more about the effects of the excise tax, see Chap Chapte terr 6; for a discussion of

that level through CBO’s 2011 economic forecast 2021, for thatmatching period; the rate January then declines to 5.0 percent in 2031 and remains at that level.

trends in costs for health care, see Chap Chapter ter 3.)  Average  Aver age Hours Worked. Worked. Different  Different segments of the population work different numbers of hours, on o n average; for example, men tend to work more hours than women do, and people between the ages of 30 and 40 tend to work more hours than people between the ages of 50 and 60 do. CBO assumes that going forward, the average number of hours worked by people in each demographic group will remain constant. However, CBO expects that the composition of the labor force will shift somewhat toward groups, such as older workers, that tend to work less, slightly reducing the average number of hours  worked in the economy as a whole. By 2085, 2085, CBO estimates, the average number of hours worked per person in the labor force will have declined by 2 percent relative to the number of hours worked in 2021.

The Taxable Taxable Earnings Share of Compensation. Workers’ Compensation. Workers’ total compensation consists of taxable earnings and nontaxable benefits, such as employers’ contributions for health insurance and pensions, paid leave, and so on. Primarily because the cost of health insurance has grown more quickly than compensation in the past several decades, the share of compensation attributable to taxable earnings has slipped from about 90 percent in 1960 to about 80 percent in 2010. Looking ahead, CBO expects that health care costs will continue to increase more rapidly than taxable earnings, a trend that by itself would further decrease the proportion of compensation that workers receive as taxable earnings. However,, the Patient Protection and Affordable Care Act However of 2010 (Public Law 111-148) instituted an excise tax on some employment-based health insurance plans that have premiums above a specified threshold. Some employers and workers will respond to that tax by shifting shift ing to less

Real GDP and Earnings per Worker. For its economic benchmark, CBO projects that from 2022 through 2085, real GDP will grow at an average annual rate of 2.2 percent and real earnings per worker will grow at an average annual rate of 1.4 percent. Those rates of growth are

 

25

12. The sources of unemp unemployment loyment cov covered ered by the natural rate include frictional unemployment, unemployment, which is associated with the normal turnover of jobs, and structural unemployment. unemployment. The latter includes unemployment caused by mismatches between the skills of available workers and the skills necessary to fill vacant positions; and unemployment caused when wages exceed their marketclearing levels (the levels that equalize the demand for and the supply of labor) because of institutional factors, such as legal minimum wages, the presence of unions, social conventions, and employers’ wage-setting practices intended to increase workers’ morale and effort.

13. For several dec decades, ades, CBO project projects, s, the excise tax will induce people to move to less expensive health care plans, which will tend to increase the taxable share of compensation. After a while, however, that effect will diminish, both because there is a limit to how little health insurance people are willing to carry and because the Patient Protection and Affordable Care Act of 2010 established minimum levels of coverage for health care plans. As the number of people moving to less expensive plans declines, the effect of that movement, in CBO’s estimation, will eventually be dominated by the effect of continuing increases in the cost of health care, which  will tend to reduce th thee taxable sh share are of com compensation. pensation.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

derived from the demographic and economic variables described earlier and from assumptions about the growth of the capital stock and productivity. productivity. The key elements underlying the projected growth of the capital stock are assumptions about federal fiscal policy, private saving, flows of capital to and from f rom other countries, and the rate of increase in the prices of capital goods. In CBO’s long-term benchmark projections and in the midrange assumptions it used for analyzing the economic effects of rising debt (described (d escribed below), CBO assumes that each dollar added to the federal budget deficit increases private saving by 40 cents and net inflows of private capital from other countries by 24 cents. Those two effects offset part of o f the decrease in investment in the domestic capital stock that would stem from higher budget deficits; as acents result, is assumed to be reduced by 36 forsuch eachinvestment dollar added to the deficit. For the benchmark, in addition to assuming that debt held by the public stays at 76 percent of GDP after 2021, CBO makes a further adjustment to the path of private saving to maintain a constant rate of return on investments in capital goods and thus a steady interest rate. Given the assumed response of international capital flows to the changes in private saving just noted, net capital inflows from other countries are projected to fall gradually relative to GDP over time.  Also influencing the projected growth of the capital stock is the assumed rate of increase in the prices of capital goods. The lower the prices of such goods, the greater the rate of increase in the real capital stock for any given nominal amount of investment. Therefore, holding all else equal, CBO’s current assumption of a slower rise in the prices of capital goods tends to boost the growth of the capital stock relative to the projection in last year’s year’s long-term budget outlook. CBO estimates that over the long term, total factor f actor

outlook. The projection for this year increased in part because of the faster growth CBO now forecasts for the capital stock and in part because of the change in the th e agency’s expectations about the long-run effects that the excise tax on certain cert ain high-premium health insurance plans will have on the ratio of taxable earnings to total compensation. CBO’s projection for the growth of real GDP—an CBO’s average rate of 2.2 percent per year from 2022 through 2085—is now above the 2.0 percent rate used for the 2010 long-term outlook. That upward revision stems from the faster projected growth in the capital stock and from CBO’s CBO’s assumption of more immigration.  Although the pace of economic growth under under the longterm benchmark is a bit faster than the pace CBO pro jected for last year’s year’s long-term outlook, it is substantially slower than the tempo of economic growth over the past few decades—primarily because of the slowdown CBO anticipates in the growth of the labor force. At the same time, interest rates in the benchmark are projected to be close to their levels in recent decades. As a result, the pro jected average real interest rate on debt held by the the public (2.7 percent) exceeds the projected average rate of growth of real output (2.2 percent)—by comparison with the experience of the past few decades, when on average interest rates were roughly equal to the growth of output. Thus, for any given policy regarding taxes and noninterest spending, debt is projected to climb faster relative to output than it would if the differential were closer to its historical average.

How Rising Debt and Changing Marginal Tax Rates Would Affect Output  CBO’s economic benchmark is based on the CBO’s t he assumptions that debt held by the public will remain at 76 percent of

productivity—real output per unit of combined labor and capital services—will grow at an annual rate of 1.3 percent. That assumption, together with the growth projected for the supply of labor and capital, leads to

GDP after 2021 and effective marginal tax rates will remain at their 2021 levels. In order to clearly identify budgetary patterns, the estimates of demographic de mographic and economic variables incorporated in the benchmark are

average projected growth in labor productivity—real output per hour worked—of 1.7 percent a year.

held unchanged for the budget projections presented in the other chapters of this report, even though those projections produce levels of debt and marginal tax rates that differ from those assumed for the benchmark. In other words, the projections in other chapters do not incorporate the effect of budgetary outcomes on economic outcomes.

The projection in the benchmark for the growth of real earnings per worker—1.4 percent, on average, over the 2022–2085 period—is slightly higher than the projection of 1.3 percent growth used for the 2010 long-term

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK

By contrast, the analysis presented in this chapter assesses asse sses how the economy would fare in the long run under the extended-baseline and alternative fiscal scenarios. In par-

inflows of capital from other countries by attracting more foreign capital to the United States and inducing U.S. savers to keep more of their money at home. Those

ticular, to the extent that the scenarios involved larger ticular, deficits and increased government borrowing, they would reduce investment and boost interest rates; reductions in investment tend to lower pretax wages, which reduces people’ss incentives to work, and increases in interest rates people’ strengthen people’s people’s incentives to save. To the extent that the scenarios involved higher marginal tax rates, those higher rates would discourage people from working and saving.

additional net inflows prevent U.S. investment from declining as much as national saving does in the face of more government borrowing.15 (In the benchmark’s longterm projections, net inflows of private capital rise by 24 cents for every dollar incre increase ase in government borrowing.) But such inflows also create the obligation for more profits and interest to flow overseas. Therefore, although flows of capital into the United United States can can help moderate a decline in domestic investment, the income earned on that additional investment does not fully accrue to U.S. residents. In this chapter, CBO emphasizes emphasizes the effects ooff fiscal policies on gross national product because, unlike the more commonly cited gross domestic product, GNP

Effects of Increased Government Borrowing  Increased government borrowing generally draws money away from (crowds out) private investment in productive capital, leading to a smaller stock of capital and lower output in the long run than would otherwise be the case. Deficits generally have that effect on private investment because the portion of people’s savings used to buy government securities is not available to finance private investment. Two factors offset off set part of that crowding-out effect. One is that additional government borrowing tends to lead to greater private saving, which increases the funds available to both purchase government debt and finance private investment. That response occurs for several reasons:  

 

 

 Additional government borrowing borrowing tends to raise interest rates, which boosts the return on saving; Some people anticipate that policymakers will raise taxes or lower spending in the future to cover the cost of paying interest on the accumulated debt, so they increase their own saving to prepare for paying higher taxes or receiving smaller benefits; and The policies that give rise to deficits (such as tax cuts

is reduced by net flows of interest and profits to foreigners and therefore better represents the resources available to U.S. households.16  The crowding out of private investment affects aff ects incentives to work and save by altering pretax wages and rates of return on saving. The reduction in the capital stock it leads to makes workers less productive p roductive and decreases pretax wages relative to what they would otherwise other wise be. Those lower wages reduce people’s people’s incentive to work. However, However, the productivity of existing capital is greater because more 14. Nation National al saving equals total saving by all sectors sectors of the economy: personal saving, business saving (corporate profits not paid as dividends), and government saving after-tax (budget surpluses). National saving represents all income not consumed, publicly or privately, during a given period. 15. Capital inflows can also affect ot other her aspects of the U.S. economy economy,, such as the distribution of income, but those effects are beyond the scope of this analysis. 16. The difference b between etween the im impact pact of rising debt on GDP and the impact on GNP depends on the amount of additional capital that foreigners invest in the United States and the rate of return they

 

27

or increases in government transfer payments, such as Social Security or unemployment benefits) put more money in private hands, some of which is probably p robably saved. Overall, however, however, the rise in private saving is generally g enerally smaller than the change in the deficit, so greater government borrowing leads to less national saving. 14   A second factor offsetting some of the crowding-out effect is that higher interest rates tend to increase net

receive on that additional investment. In recent decades, foreign investors have earned a lower average return on U.S. investments than domestic investors have. (For a related discussion, see Congressional Budget Office, Why Does U.S. Investment Abroad Earn Higher Returns Than Foreign Investment in the United States?  Issue  Issue Brief, November 2005.) However, economic theory suggests that over the long run, there should be little difference between the returns earned by foreigners on their investment investmentss in the United States and the returns earned by domestic investors on comparable investments.. In assessing the impact of rising ffederal investments ederal debt on GNP, CBO expects that the additional inflows of capital spurred by that rising debt will be invested in assets that earn the same return as that earned by domestic investments.

CBO  

28

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 2-1.

increases saving. A higher marginal tax rate on capital income has the opposite effect.

 The Effect of the Fiscal Policies  Assumed in CBO’s Long-Term Long-Term Budget Scenarios on Real GNP and GDP in 2025 and 2035 (Percentage difference from benchmark level) Extended-Baseline Scenar io GNP GD P

Alternative F iisscal Scenar io GNP GDP

2025 202 5

-0. -0.2 2 to -0.4

* to -0.2

-2.2 to -5. -5.7 7

-0.4 to -3.1

2035 203 5

-0. -0.5 5 to -1.6

-0.2 to -1. -1.3 3

-6.8 to -17. -17.6 6

-2.4 to -9.9

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Similarly, a lower marginal tax rate on labor income Similarly, increases the incentive to work, raising the number of hours people work and therefore the amount of output. However,, if that lower marginal tax rate increases people’s However people’s after-tax income from the work they are already doing, then they do not need to work as much to maintain their standard of living, which reduces the supply of labor.  Again, CBO concludes, as do most analysts, that the former effect outweighs the latter and that lower marginal tax rates on labor income increase the labor supply. A higher marginal tax rate on labor income has the opposite effect.

Notes: The extended-baseline scenario adheres closely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-t erm projection period. The alternative fiscal scenario incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period. (For details, see Table 1-1 on page 4.) Real (inflation-adjusted) gross national product (GNP) differs from real gross domestic product (GDP), the more common measure of the out put of th e economy economy,, primarily by including the income that U.S. residents earn from their investments abroad and excluding the income that nonresidents earn from their investme investments nts in this country. country.

Economic Effects of the Fiscal Policies  Assumed in CBO’s CBO’s Extended-Baseline and Alternative Fiscal Scenarios Under the extended-baseline scenario, CBO projects, real GNP would be reduced reduced slightly by 2025 and by as much as 2 percent by 2035, compared with what it  would be under the long-term economic benchmark benchmark (see Table 2-1). 2-1). Under the alternative fiscal scenario, real GNP would be from 2 percent to 6 percent lower in 2025, and from 7 percent to 18 percent percent lower in 2035, 2035, 17 than it would be under the benchmark.  

* = between -0.05 percent and 0.05 percent.

 workers are utilizing each piece of capital—for example, each computer, machine tool, or structure. That increased productivity pushes up interest rates, which strengthens the incentive to save.

Effects of Changes in Marginal Tax Rates Changes in marginal tax rates (the rates that apply to t o an additional dollar of a taxpayer’ taxpayer’ss income) also affect af fect out-

Under both long-term scenarios, GDP would be less affected by rising debt than GNP would be because the change in GDP does not reflect the increased future outflow of profits and interest generated by the additional capital inflows. Under the extended-baseline scenario, real GDP would be as much as 1 percent lower in 2035 than it would be under the benchmark (see Table Table 2-1). Under the alternative fiscal scenario, real GDP would be as much as 3 percent lower in 2025, and from 2 percent

put. For example, a lower marginal tax rate on capital income (income derived from wealth, such as stock dividends, realized capital gains, or the owner’s owner’s profits from a business) increases the after-tax rate of return on saving,

to 10 percent lower in 2035, than it would be under the benchmark.

strengthening the incentive to save; more saving implies more investment, a larger capital stock, and greater output. However, However, if that lower marginal tax rate increases people’ss after-tax returns on savings, they do not need to people’ save as much to have the same future f uture standard of living,  which reduces the supply of saving. CBO concludes, concludes, as do most analysts, that the former effect outweighs the latter, such that a lower marginal tax rate on capital income

Solow-type growth model, an enhanced version of a

CBO estimated those economic effects using the agency’s agency’s

17. By the early 2040s unde underr the alternative fiscal scenario scenario,, debt is so high relative to GDP that CBO’s model cannot reliably estimate the level of output. The assumptions about private saving and capital inflows incorporated in CBO’s model are based on historical experience. experience. If interest rates and the debt-to-GDP ratio rise to levels well outside of that experience, those assumptions may no longer be valid.

CBO  

CHAPTER TWO

 widely used model originally developed by Robert Solow. 18 In CBO’s Solow-type model, people base their decisions about working and saving primarily on current economic conditions—especially wage levels, interest rates, and government policies. pol icies. People’s responses to changes in those conditions are generally assumed in the model to mirror their responses to economic and policy developments in the past; as a result, the responses reflect people’ss anticipation of future people’ f uture policies in a general way but not their expectations of specific future developments. For example, in the model, people are assumed to increase their saving in response to an increase in deficits, in part because they anticipate the future increases in taxes or cuts in spending that typically follow a rise in deficits. However, However, they do not behave as if they anticipate the details of future changes in government policies. To reflect the high degree of uncertainty that attends estimates of the economic impact of fiscal policy, policy, CBO used ranges of assumptions about the effect of budget deficits on investment and the effect on labor supply of changes in marginal tax rates on o n labor income. Specifically, Specifically, CBO used three assumptions about the degree to which private saving would grow when deficits increased. Those assumptions imply that for each dollar that deficits rise, investment is reduced by 20 cents, 36 cents, or 50 cents. 19  Similarly,, CBO used three assumptions about how people Similarly  would adjust the number of hours they worked in response to changes in marginal tax rates:response a “strong supply response,” under which workers’ is labor on the high side of the consensus range of empirical estimates from studies based on one-year changes in labor supply; a “weak labor supply response,” under which  workers respond very little; and a “medium “medium labor supply response,” under which workers’ response is roughly mid way between strong and weak.20

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

investment and greater net payments to foreigners than the extended-baseline scenario reflects because the increase in debt is so much larger. That additional crowding out is partly offset, however, however, by the boost to labor supply and private saving from the alternative fiscal scenario’s assumption that various tax cuts are extended,  which holds down down marginal tax tax rates on labor and capital income. Yet Yet even with the negative impact of fiscal policy under the alternative scenario, real GNP per person  would be considerably higher in 2035 2035 than it is now because of continued growth in productivity (see Figure igure 2-1). 2-1). The estimated negative economic effects of fiscal policy under the alternative fiscal scenario are smaller than the impact presented in CBO’s 2010 long-term budget outlook. That change is the net result of several factors.  

First, CBO has refined its analysis to more fully reflect the effects on saving, and therefore investment, of changing after-tax returns. In contrast to last year’s year’s projections, this year’s estimates incorporate a positive effect on saving and investment from the lower marginal tax rates on capital (relative to those assumed for the economic benchmark) in the alternative fiscal scenario. That positive effect on investment tends to increase the capital stock, output, and pretax wages compared with what they would be without the effect. CBO’ss current estimates also incorporate CBO’ i ncorporate a positive effect on saving and investment from the higher pretax interest rates caused by the additional debt accruing under the alternative fiscal scenario. Because those changes increase projected investment, they imply a smaller estimated reduction in GNP under the alternative fiscal scenario.

 

29

The much greater effect on GNP under the alternative fiscal scenario reflects significantly more crowding out of 18. For detail detailss of that model, see Congres Congressional sional Budget Office,  An Analys Analysis is of the President President’s’s Budgetary Budgetary Proposals for Fiscal Year Year  2012 , Appendix A. 19. Ibid. Ibid. 20. For its estim estimates ates under the two budget scenario scenarios, s, CBO used data from a large sample of taxpayers to account for the effects on labor supply of changes in marginal tax rates and after-tax income. The estimates incorporated incorporated a larger response to changes in marginal tax rates among secondary earners (workers in a household other than the main breadwinner) than among primary earners.

 

Second, this year’s year’s estimates incorporate a response in the supply of labor to changes in wages. Under the alternative fiscal scenario, two forces push wages in opposite directions. The lower productivity of the labor by the smaller capital pretaxforce wagescaused and therefore the supply of stock labor.reduces However, the lower marginal tax rates on the income from labor raise after-tax wages (for any given level of o f pretax  wages) and increase labor supply. supply. Early in the projection period, the effect of lower marginal tax rates dominates, after-tax wages are higher, and labor supply is greater than in the benchmark, implying a smaller CBO

 

30

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 2-1.

 The Effect of the Fiscal Policies Assumed in CBO’s Long-Term Long-Term Budget Scenarios on Real Gross National Product per Person (2010 dollars) Extended-Baseline Scenario

70,000

70,000

60,000

60,000

50,000

50,000

40,000

40,000

0 2010

2015

2020

2025

2030

0 2035

Alternative Fiscal Scenario 70,000

70,000

60,000

60,000

50,000

50,000

40,000

40,000

0 2010

2015

GNP with No Economic Effects of the Fiscal Policies

2020

2025

GNP with Weaker Economic Effects of the Fiscal Policies  

2030

GNP with Stronger Economic Effects of the Fiscal Policies

0 2035

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-baseline scenario adheres clos closely ely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see T Table able 1-1 on page 4.) The range of estimates shown stems from varying assumptions about how much deficits “crowd out” investment in capital goods such as factories and computers (because a larger portion of people’s savin savings gs is being used to purchase government securities) securities) and how much people respond to alterations in after-tax wages and interest rates by changing the number of hours they work and the amount they save. Real (inflation-adjusted) gross national product, or GNP, differs from gross domestic product (the more common measure of t he output of the economy) primarily by including the income that U.S. residents earn from their investments abroad and excluding the income that nonresidents earn from their investments in this country. a.

The highest highest estimated estimated v value alue for for GNP per pers person on in each year year..

b.

The lowest lowest estimate estimated d value ffor or GNP per pers person on in each year year..

CBO  

CHAPTER TWO

estimated reduction in GNP under the alternative fiscal scenario. By 2035, under most of CBO’s assumptions about the responsiveness of labor supply and investment, the effect of lower pretax wages dominates, after-tax wages are lower, lower, and labor supply is reduced relative to the benchmark’s benchmark’s levels, implying a larger estimated reduction in GNP under the alternative fiscal scenario.  

Third, for this year’s analysis, CBO altered its assumption about the rate of return earned on the th e additional foreign-owned assets in the United States that result from capital inflows associated with increases in government debt. CBO now assumes that rate of return  will equal the rate earned on domestic investments. By contrast, the 2010 2010 estimates reflected reflected the assumption that the rate earned on additional foreign-owned fo reign-owned assets would equal 80 percent of the domestic rate in the long run. The change change in CBO’ CBO’ss assumption for this year tends to increase the estimated flow of payments to foreigners, implying a larger estimated reduction reductio n in GNP. GNP.

 

Finally, this year’s analysis corrects some errors in the 2010 estimates, which incorporated too low a pro jected path for private saving under the alternative fiscal scenario. Correcting those errors yields a smaller s maller estimated reduction in GNP under that scenario.

In addition to those changes, this year’s year’ s long-term budget outlook presents a range of results r ather rather than a single point estimate for the economic effects of fiscal policy under the scenarios. Differences in the levels of economic activity and interest rates under the two budget scenarios analyzed in this report would, in turn, affect budgetary outcomes. Incor-

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

scenario by about 2 percentage points in 2035 (see Figure igure 2-2). 2-2). The increase in interest rates and the reduction in output are much larger under the alternative fiscal scenario, so the increase in the projected debt-to-GDP ratio from incorporating the economic changes is much greater—22 to 64 percentage points—leading to a total of roughly 210 percent to 250 percent.

 The Effects of Waiting to Resolve the Long-Term Long-T erm Budgetary Imbalance In a previous analysis, CBO assessed the economic impact of waiting a decade to resolve the long-term budgetary imbalance.22 It compared economic outcomes under a policy that would stabilize the ratio of debt to GDP starting in 2015 with outcomes under a policy that  would delay stabilizing that ratio until 2025. 2025. Any number of government policies could be implemented to keep the ratio of debt to GDP from increasing; CBO analyzed two possible policies: raising marginal tax rates or reducing government transfer payments (which were assumed to go mainly to older people). CBO performed that analysis using a model of the economy that differs from the Solow-type model used for the projections presented in this chapter. That model, a life-cycle growth model, incorporates the assumption that people make decisions about how much to work and save on the basis of current and anticipated government policies and economic conditions (such as wages and interest rates). CBO’ss analysis suggested that, depending on the policy CBO’ used to stabilize the debt, delaying action for 10 years, and thus allowing the debt-to-GDP ratio to rise by an additional 40 percentage points under the assumptions of that analysis, would cause output to be lower lower in the long run—by between 2½ percent and 7 percent—than

 

31

porating those effects would change the projections of of debt as a percentage of GDP relative to the initial paths presented in Chap Chapte terr 1. Under both scenarios, interest rates are higher than they are in the benchmark, and the growth of output is slower. slower. Higher interest rates would increase interest payments on government debt and thus—if noninterest spending and revenues were kept unchanged—would lead to higher debt relative to GDP. GDP. In addition, slower growth of output means that for any amount of debt, the ratio of debt to GDP would be higher.21 Those effects are quite small for the extendedbaseline scenario, so their impact on budgetary outcomes is quite small: Incorporating the economic effects of fiscal policy boosts the projected debt-to-GDP ratio under that

it would have been if the ratio had been stabilized earlier at a lower level. (Despite those potential reductions, 21. The slower gro growth wth of output also implies slowe slowerr growth of revenues and, under the assumptions governing the two budget scenarios, slower growth of noninterest spending. In this chapter’s analysis of the economic effects of fiscal policies, as a rough r ough approximation,, CBO assumed that changes in output would approximation affect revenues and primary (noninterest) spending by about the same percentage, so the net impact on the primary budget deficit (that is, on the total budget deficit excluding net interest) of changes in output would be small. 22. Congress Congressional ional B Budget udget Office, Economic Impacts of Waiting to Resolve the Long-Term Fiscal Imbalance , Issue Brief (December 2010).

CBO  

32

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 2-2.

Federal Debt Held by the Public, With and Without the Economic Effects of the Fiscal Policies Assumed in CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) Extended-Baseline Scenario 250

250

200

200

150

150

100

100

50

50

0

0 2010

2015

2020

2025

2030

2035

Alternative Fiscal Scenario 250

250

200

200

150

150

100

100

50

50

0 2010

0 2015

Debt with

2020

2025

Debt with

2030

Debt with

2035

No Economic Effects of the Fiscal Policies

Source Sou rce::

Weaker Economic Effects of the   Fiscal Policies

Stronger Economic Effects of the Fiscal Policies

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-baseline scenario adheres closely to current law law,, following CBO’s 10-year baseline budget projections t hrough 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see T Table able 1-1 on page 4.) The range of estimates shown stems from varying assumptions about how much deficits “crowd out” investment in capital goods such as factories and computers (because a larger portion of people’s savin savings gs is being used to purchase government securities) securities) and how much people respond to alterations in after-tax wages and interest rates by changing the number of hours they work and the amount they save. a.

The lowest lowest ratio ratio of deb debtt to GDP for for eac each h year year.

b.

The highest highest ratio ratio of de debt bt to GDP GDP for ea each ch ye year ar..

CBO  

CHAPTER TWO

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

output would continue to be higher than current levels because of continued growth in productivity productivity.) .) Most of

To the extent that additional tax revenues were generated by boosting marginal tax rates, those higher rates would

the declineout in of output would in stem from twocapital, factors:which the crowding investment productive  would cause the capital stock to be from 7 percent to 18 percent smaller if action was delayed, and the effects of higher marginal tax rates on people’s incentives to  work and save (in the case of the policy involving higher taxes).

24 and saving, further discourage peopleand from working reducing output incomes.  Alternatively,f urther policymakers could choose to offset the rising interest costs, at least in part, by reductions in benefits and services.

 Another conclusion of CBO’s CBO’s analysis was that generations born after about 2015 would be worse off if action to stabilize the debt-to-GDP ratio was postponed from 2015 to 2025. People born before 1990, however, however, would be better off if action was delayed, largely because they  would partly or wholly avoid the policy changes needed to stabilize the debt (with the exception of the negative effects stemming from a possible fiscal crisis and the government’ss reduced flexibility to respond to economic ernment’ challenges, which are discussed below). Generations born between 1990 and 2015 could either gain or lose from a delay,, depending on the details of the policy used to stadelay bilize the debt (again, with the exception of some other effects of growing debt). In the long run, a 10-year delay  would reduce the well-being of all future generations by amounts equivalent to a cut of roughly 1 percent to 3 percent in their lifetime spending, depending on the specific policies that were adopted.

Other Consequences of Rising Federal Debt  Persistent, large budget deficits that are not related to Persistent, economic downturns—like the deficits that CBO pro jects for coming decades—have a number of significant negative consequences beyond those incorporated in

To be sure, slowing the growth of government g overnment debt to hold down future interest payments would require increases in taxes or reductions in government benefits and services anyway. But increases in interest costs as a share of the budget make attaining fiscal balance more difficult. Earlier action would permit the necessary changes in policy to be smaller and more gradual, and it would give people more time to adjust to them— although it would also require more sacrifices sooner from older workers and retirees for the benefit of younger  workers and future generations.

 A Reduced Ability to R Respond espond to D Domestic omestic aand nd International Problems Having a small amount of debt outstanding gives policymakers the ability to borrow to address significant unexpected events such as recessions, financial crises, and wars. In contrast, a large amount of debt leaves less flexibility for government actions to address financial and economic crises, which in many countries have been very ver y 25 costly for the governments as well as the residents.  A large amount of debt could also harm national security by constraining military spending in times of crisis or limiting the country’s country’s ability to prepare for a crisis. In the United States, the level of federal debt a few years ago gave the government the flexibility to boost spending and cut taxes to stimulate economic activity, activity, to provide public funding to stabilize the financial f inancial sector, and to continue paying for other programs even as tax revenues

 

33

CBO s quantitative estimates. Those negative consequences include both budgetary and economic effects.23

 The Need for for Higher Ta Taxes xes or Les Lesss Spending on Government Programs  As federal debt grows, so does the amount of interest that the government pays to its lenders (all else being equal). If policymakers wished to maintain the benefits and services ser vices that the government provides while interest payments grow,, tax revenues would eventually have to rise as well. grow 23. For an additional discus discussion, sion, see Congressional Congressional Budget Office, Federal t he Risk of a Fiscal Crisis , Issue Brief (July 2010). Federal Debt and the

24. Tax revenues could also be incre increased ased without raising marginal tax rates by, for example, reducing tax expenditures (that is, special exclusions,, exemptions, or deductions from gross iincome; exclusions ncome; preferential tax rates; or deferrals of tax liabilities). 25. See Carmen M. Reinhart and Kennet Kenneth h S. Rogoff, Banking Crises:  An Equal Equal Opportunity Men Menace, ace, Discussion Paper DP7131 (London: Centre for Economic Policy Research, January 2009). The authors estimate that debt in countries that undergo banking crises increases by an average of 86 percent in the three years after those crises. See also Luc Laeven and Fabian Valencia, Systemic Banking Crises: A New Database , Working Paper No. 08-224 (Washington, D.C.: International Monetary Fund, November 2008).

CBO  

34

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

dropped sharply because of the decline d ecline in output and incomes. If the amount of federal fe deral debt (relative to out-

a number of cases, a crisis crisis was triggered by news that a government would, for any number of reasons, need to

put) stayed atwould its current ordifficult increasedtofurther, the government find itlevel more undertake similar policies in the future. As a result, future recessions and financial crises could have larger negative effects on the economy and people’s well-being. Moreover, Moreover, the reduced financial flexibility and increased dependence on foreign investors that would accompany rising debt could  weaken the United States’ States’ international international leadership.

borrow anlost unexpectedly amountrates of money. investors confidencelarge and interest spiked,Then, bor- as rowing became more difficult and expensive for the government. That development forced policymakers either to immediately and substantially cut spending and increase taxes to reassure investors—or to renege on the terms of the country’s country’s existing debt or increase the supply of money and boost inflation. In some instances, the crisis made borrowing more expensive for private borrowers as well, because uncertainty about the government’s policy response to the crisis raised risk premiums throughout the economy.27 Higher private interest rates, combined  with reductions in government spending and iincreases ncreases in taxes, have tended to worsen economic conditions in the short term.

 An Increased Increased Chance of a Fiscal C Crisis risis  A rising level of government debt would have another significant negative consequence. consequence. Combined with an unfavorable long-term budget outlook, it would increase the probability of a fiscal crisis for the United States.26 In such a crisis, investors become unwilling to finance all of a government’s government’s borrowing needs unless they are compensated with very high interest rates; as a result, the interest rates on government debt rise suddenly and sharply relative to rates of return on other assets. Unfortunately, Unfortunately, there is no way to predict with any confidence whether and  when such a crisis might occur in the the United States. States. In particular,, there is no identifiable tipping point ooff debt particular relative to GDP that indicates a crisis is likely or imminent. All else being equal, however, the larger the debt, the greater the risk of such s uch a crisis. Fiscal crises around the world have often begun during

If a fiscal crisis occurred in the United State States, s, policymakers would have only limited and unattractive options for responding to it. In particular, the government would need to undertake some combination of three actions: restructuring its debt (that is, seeking to modify the contractual terms of its existing obligations); pursuing inflationary monetary policy (that is, increasing the supply of money); and adopting adopting an austerity program of spending cuts and tax increases. Thus, such a crisis would confront policymakers with extremely difficult choices and probably have a very significant negative impact on

recessions and, in turn, have often exacerbated them. In

the country.

26. See Congressio Congressional nal Budge Budgett Office, Federal Debt and the Risk of a Fiscal Crisis .

27. The risk premium is th thee additional ret return urn (over the risk-free rate) that investors require to hold assets whose returns are uncertain.

CBO  

CHAPTER 

3  The Long-Term Long-Term Outlook for Mandatory Spending on Health Care

S

pending for health care in the United States has been growing faster than the economy for many years, posing a challenge not only for the federal government’s government’s

changes allowed under the law, and the increasing pressure of premiums and cost-sharing requirements, such as copayments and deductibles, on enrollees’ finances.

two major but health programs, Medicare and Medicaid, alsoinsurance for state and local governments and the private sector. Measured as a percentage of the nation’’s gross domestic product (GDP), nation ( GDP), total spending on health care services and supplies increased from 4.8 percent in 1960 1960 to 9.8 percent in 1985 and 16.5 percent in 2009, the most recent calendar year for which data are available. Federal spending for Medicare and Medicaid rose from 2.2 percent of GDP in fiscal year 1985 to 5.5 percent in 2010. 2010. Underlying Underlying those trends, health care spending per person has grown faster than the nation’’s economic output per person by an average of a nation little less than 2 percentage points per year during the

Even assuming that such changes occur, the Congressional Budget Office (CBO) anticipates that federal spending on the government’s major mandatory health care programs will continue to rise relative to GDP. GDP. CBO has projected spending for those health care programs— Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and the insurance subsidies that will be provided through the health insurance exchanges that  will be established starting in 2014—under two two scenar1 ios.  Under the extended-baseline scenario, which reflects current law, law, federal spending for those programs would grow from 5.6 percent of GDP today to about 9 percent p ercent

past decades. Keythe factors contributing to that use fasterseveral growth have been emergence and increased of new medical technologies, rising personal income, and the expanding scope of health insurance coverage.

of GDP to in Medicare, 2035; about percent of GDPwould wouldbebespent devoted and6 about 3 percent on Medicaid, CHIP, and the exchange subsidies. For the alternative fiscal scenario, CBO assumes that several policies designed to restrain federal spending on health care  will not be continued. As a result, under that scenario, scenario, mandatory federal spending on health care programs

Such rates of growth cannot continue indefinitely, however, because because if they did, total spending on health care

 would eventually account for all of the countrys country s economic output—an implausible outcome. Instead, over time, people will try to limit their spending for health care in order to maintain their consumption of other goods and services. In addition, state governments—  which pay a large share of Medicaid’ Medicaid’ss costs and have considerable influence on those costs—will need to reduce spending growth in order to balance their budgets. Thus, even in the absence of changes in federal law, law, growth in spending on Medicaid and on health care in the private sector will gradually slow. slow. The rate of growth of spending on Medicare is also expected to slow without changes in federal law, but to a lesser extent, reflecting changes in medical practices common to all patients, regulatory

 would grow faster, faster, reaching about 10 percent percent of GDP by 2035. Medicare spending would grow to about 7 percent of GDP, while federal spending on Medicaid, CHIP, and the exchange subsidies subsidies would reach about about 4 percent of 1. In this this report, federal d discretionary iscretionary spending spending on health care—that is, is subjectfor to other annualnoninterest appropriations—is in spending the budgetthat projections spending included (see Ch Chapt apter er 5 and Table 1-2 on page page 8). Such discretionary spending includes federal support for health research and federal spending on health care provided by the Veterans Health Administration. Some mandatory spending on health care (for example, spending for care for federal retirees) is also included in other noninterest noninterest spending; that mandatory spending represents a very small share of the federal budget.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

GDP, both slightly higher than under the extendedGDP, ex tendedbaseline scenario. Beyond 2035, federal health care

Overview of Major Government Health Care Programs

spending would continue to climb relative to GDP under both scenarios.

Today, a combination of private and public sources finances the provision of health care in the United States. CBO estimates that about about 48 million people are are covered by Medicare Medicare and that 56 million are covered by Medicaid, the two main sources of o f public financing.4  Medicare provides nearly universal coverage for the elderly and also covers several million nonelderly people; Medicaid covers a variety of low-income individuals, including both the elderly and the nonelderly. nonelderly. The majority of Americans under the age of 65, however, however, have private health insurance. CBO estimates that about 150 million million nonelderly nonelderly people currentl currentlyy have an

Quantifying the extent to which the rate of growth of health care spending will decline under current law is difficult. The growth of such spending relative to the growth of the economy has varied greatly from year to year during the past several decades, so projections of the likely difference in growth rates during the next few decades are very uncertain. As the projection period lengthens, the uncertainties mount because the likelihood of significant changes in medical practice and technology increases. As a result, CBO’s projections of health care spending for the next few decades probably provide more real information than do its projections for the longer term. The enactment in March 2010 of the Patient Protection Protection and Affordable Care Act, or PPACA (Public Law 111148), as amended by the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152), has significant implications for federal spending. The projections reported here are consistent with CBO’s previous estimates of the effects of that legislation through the end of the 2020s (except as modified to reflect different diff erent policies 2 under the alternative fiscal scenario).  Looking beyond the next two decades, projecting the impact of the legislation on federal health care spending is very difficult because the uncertainties involved are so great. Consequently,, CBO’s approach in formulating the longer-term quently projections in this report has been to incorporate the projected effects of the legislation on the level  of  of federal spending for health care over the next one or two decades

employment-based health plan as their primary source of coverage, and about about 13 million people have primary insurance coverage purchased directly from fro m an insurer.  At any given time during this year, year, in CBO’ CBO’ss estimation, about 50 million people will be uninsured. In 2009, the most recent calendar year for fo r which data are available, total spending for health care in the United States amounted amounted to about $2.3 trillion, or 16.5 percent of the nation’s GDP.5 In that year, 51 percent of spending  was financed privately; the rest of the spending came from public sources (see Figure igure 3-1 3-1): ):  

Paymentss by private health insurers were the largest Payment component of private spending, making up 34 percent of total expenditures on health care. Consumers’ outof-pocket expenses, which include payments made to

3. Fo Forr further discussi discussion on of the chal challeng lenges es of projecting projecting th thee long-

(depending on the scenario) and to extrapolate such spending beyond those periods using the same growth same  growth rates  that  that would have been applied in the absence of the legislation. The use of that mechanical approach reflects CBO’ss judgment that the CBO’ t he agency does not have an analytic basis for projecting the effects of the March 2010 health care legislation on the growth rate of federal health care spending over the very long term. 3 2. See the state statement ment of Douglas W. Elmendo Elmendorf, rf, Direct Director, or, Congressional Budget Office, before the Subcommittee on Health, House Committe Committeee on Energy and Commerce, CBO’s Analysis of the Major Health Care Legislation Enacted in March 2010   (March (Mar ch 30, 2011). 2011).

term effects of legislation on federal health care spending, see Congressional Congressi onal Budget Office, letter to the Honorable Max Baucus about different measures for analyzing current proposals to reform health care (October care (October 30, 2009). 4. Some people h have ave cov coverage erage from more th than an one ssource ource at a time. Currently, about 7.7 million people with Medicaid coverage are also covered by Medicare, which is their primary source of coverage. All of the estimates here reflect average monthly enrollment during the year. 5. This report report defines “to “total tal health health care care spending” spending” as health consumption expenditures as defined in the national health expenditure accounts maintained by the Centers for Medicare and Medicaid Services. That concept excludes spending on medical research, structures, and equipment. Under a broader definition that includes those categories, total national health expenditures in 2009 were 17.6 percent of GDP.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Figure 3-1.

 Affairs, and by the Department of Defense, as well as by workers’ compensation programs.

Distribution of Spending for 2009 Health Services and Supplies, Other Public Spending  (11%)

Medicaid and CHIP  (17%)

Private Health Insurance  (34%)

Medicare In 2011, Medicare will provide federal health insurance for 48 million people who are elderly or disabled (the elderly make up nearly 85 percent of enrollees) or who have end-stage renal disease or amyotrophic lateral sclerosis (also known as Lou Gehrig’s Gehrig’s disease). People become eligible for Medicare on the basis of age when they reach 65; disabled individuals become eligible for the program 24 months after they qualify for benefits under Social Security’’s Disability Security Dis ability Insurance program. The Medicare program provides a specified set of bene-

Medicare  (22%)

Consumers' Out-of-Pocket Expenditures  (13%)

Other Private Spending  (4%)

Source:: Source

Congre Congression ssional al Budget Budget Office Office base based d on da data ta from the

fits. Hospital Insurance (HI), or Medicare Part A, as primarily covers inpatient services provided by hospitals well as skilled nursing, home health care, and hospice care. Part B mainly covers services provided by physicians and other practitioners and by hospitals’ outpatient departments, and Part D provides a prescription drug benefit. Most enrollees in Medicare are in the traditional fee-forservice program, in which the federal government pays for covered services directly directly,, but enrollees can instead obtain coverage for Medicare’s benefits through a private health insurance plan under Part C of Medicare. In 2010, gross spending for Medicare was $520 billion.

Centers for Medicare and Medicaid Services. Note: CHIP = Childr Children’s en’s Health Health Insurance Insurance Program. Program.

satisfy deductibles and copayments for services covered by insurance, as well as payments for services not covered by insurance, accounted for 13 percent of of 6 those expenditures.  Other sources of private funds, such as philanthropy, philanthropy, accounted for 4 percent of total

The various parts of the program p rogram are financed in different  ways. Part Part A benefits are financed primarily by a pay payroll roll tax (currently 2.9 percent of taxable earnings), the revenues from which are credited to the HI trust fund. Beginning in 2013, 2013, an additional 0.9 percent tax on wages wages over $200,000 ($250,000 for couples) will also be credited to the HI trust fund.7 For Part B, premiums paid by

 

37

health care spending.  

Federal spending for Medicare made up 22 percent of total expenditures on health care care in 2009, 2009, and federal and state spending spending for Medicaid Medicaid and CHIP accounted for 17 percent. Another 11 percent was accounted for byrun various other programs, including those by state andpublic local governments’ health departments, by the Department of Veterans

6. In this analysis analysis,, out-o out-of-pocket f-pocket payments payments d doo not include the the premipremiums that people pay for health insurance (because premiums fund the payments that insurers provide, which are already included in the measure of private spending).

beneficiaries cover about one-quarter of outlays, and the government’s general funds cover the rest. (Payments to private insurance plans under Part C are financed by a blend of funds from Parts A and B.) Enrollees’ premiums under Part D are set to cover about one-quarter of the cost of the basic prescription drug benefit, although many low-income enrollees receive larger subsidies; general funds cover most of the remaining cost. Taking Taking all of the parts of Medicare together, together, in calendar year 2010, about 35 percent of gross federal spending was financed by the payroll tax, about 12 percent by beneficiaries’ premiums, and about 39 percent by amounts transferred 7. Those Those thre thresho sholds lds wil willl not be ind indexed exed fo forr inflat inflation. ion.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

from general funds of the federal fe deral government. Various Various other sources, including a portion of the federal income

replaced by subsequent legislative action. From 2015 through 2019, the target growth rate is the average of

taxes that people pay on their Social Security benefits, provide the remainder of the funding for Medicare.

inflation in the economy generally and inflation for medical services in particular; in subsequent years, the target growth rate is the percentage increase in per capita GDP plus 1 percentage point. The 2010 health care legislation places a number of limitations on the actions available to the IPAB, including a prohibition against modifying Medicare’’s eligibility rules or reducing benefits. AccordMedicare ing to CBO’s CBO’s projections, under current law, growth in Medicare spending will remain below the IPAB’s IPAB’s target 10 growth rate during the next decade.  In subsequent years, however, the IPAB mechanism would be expected to generate savings because Medicare spending is pro jected to grow at rates that generally exceed the IPAB’ IPAB’ss

Cost-sharing requirements in Medicare vary widely, widely, and the program does not set an annual cap on the amount of health care costs for which beneficiaries are responsible. However,, the vast majority However maj ority of beneficiaries who receive care in the fee-for-service portion of Medicare have supplemental insurance that covers many or all of the program’s program ’s cost-sharing requirements. According to one recent study, study, the most common sources of supplemental coverage in 2006 were plans for retirees offered by former employers (held by 38 percent of beneficiaries in the fee-for-service part of percent Medicare), individually purchased medigap policies (33 of beneficiaries), and 8 Medicaid (17 percent). The March 2010 health care legislation contained numerous provisions that, on balance, will reduce federal spending on Medicare. The provisions with the greatest effect on the projected growth of Medicare spending impose permanent reductions in the annual updates to Medicare’’s payment rates for many types of fee-for-service Medicare health care providers (other than physicians). Under prior law,, those payment updates generally would have been law equal to the estimated change in the average cost of of providers’ inputs (such as labor and equipment). eq uipment). Under current law, law, however, those updates will equal those changes in costs minus the estimated rate of economy wide growth in productivity—a measure measure that seeks to capture, for the economy as a whole, how much more output is being produced from a given level of inputs.

target of per 1 percentage in GDP capita. point more than the rate of growth

Medicaid, CHIP, and the Health Insurance Exchanges Medicaid is a joint federal/state program that pays for health care services for a variety of o f low-income individuals. As a result of the major health care legislation enacted in March 2010, most nonelderly people with income below 138 percent of the federal poverty level (FPL) will become eligible for Medicaid starting in 2014. 11 The people who are gaining eligibility for Medicaid under that legislation consist primarily of nonelderly adults with low income who are not parents of dependent children. Most low-income children and some of their parents already qualified for Medicaid under prior law, although the income thresholds vary by state. The federal government’s government’s share of Medicaid’s spending for benefits varies among the states. That share histori-

(Under certain circumstances, the law also specifies addi ad di 9 tional reductions in the update factors.) The March 2010 health care legislation also established an Independent Payment Advisory Board (IPAB), which  will be required to submit submit proposals to reduce Medicare’ Medicare’s spending per enrollee if the growth of such spending is projected to exceed certain targets. Those proposals  would go into effect automatically unless blocked or 8. Estimate Estimatess are base based d on informa information tion in Med Medicare icare Payme Payment nt  Advisory Commission, Commission, A  A Data Book: Healthcar Healthcaree Spending and the  Medicaree Progr  Medicar Program am (June 2010), p. 65. 9. In the the past, payment upd updates ates have frequently been set set to be be lower lower than the estimated increases in providers’ costs, but those adjustments have generally not been permanent, applying for one year or a few years instead.

cally has averaged 57 percent, but legislation has temporarily boosted it in response to the economic downturn; in 2010, the federal share averaged two-thirds. Beginning in 2014, the federal government will pay all of 10. The IPA IPAB B mechanism can either result result in savings or have no budgetary effect; it cannot increase in crease spending. Taking Taking into account the probabilities of no budgetary effect and of savings of various probabilities amounts, CBO estimates that eliminating the IPAB mechanism  would be expected expected to increase spe spending nding modestl modestlyy during the 10-year budget window. 11. PPAC PPACA A expanded eligibilit eligibilityy for Medicaid to include nonelderly nonelderly residents with income up to 133 percent of the federal poverty level. A provision of the Health Care and Education Reconciliation Act of 2010 effectively increased that threshold to 138 percent of the FPL. The FPL is currently $22,350 for a family of four.

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the costs of covering enrollees newly eligible under the program’’s expansion. From 2017 to 2020, the federal program share of that spending will decline gradually to 90 percent, where it will remain. A According ccording to CBO’s CBO’s estimates, those changes will increase the average federal share of Medicaid spending to 61 percent by 2020. In fiscal year 2010, federal spending for Medicaid was $273 billion, of which $250 billion covered benefits for enrollees. (In addition to t o benefits, Medicaid’ Medicaid’ss spending included payments to hospitals that treat a “disproportionate share” of low-income patients, costs for the Vaccines for Children program, and administrative ad ministrative expenses.) According to the Centers for Medicare and Medicaid Services, states spent $127 billion on Medicaid in calendar year 2009, the most recent year for which data are available. States administer their Medicaid programs under federal guidelines that specify a minimum set of services se rvices that must be provided to certain categories of low-income l ow-income individuals. Required services include inpatient and outpatient hospital services, services provided by physicians and laboratories, and nursing home and home health care. To To be eligible for Medicaid, a person must have a low income and (in certain cases) only a few assets— although the minimum financial thresholds vary depending on the basis for f or an enrollee’s enrollee’s eligibility. Groups that must be eligible include low-income children and families  who would have qualified for the former Aid to Families Families  with Dependent Children program, certain other lowlowincome children and pregnant women, and most elderly and disabled individuals who qualify for the Supplemental Security Income program.

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

populations and benefits accounted for about 60 percent of the Medicaid program’ program’s total spending in 2001. 12  About 70 million people will be enrolled in Medicaid Medicaid at some point during 2011, CBO CBO estimates; the average enrollment over the course of the year will be about 56 million. Those two ways of measuring measuring enrollment yield such divergent estimates because many people are eligible for Medicaid for only part of the year. year.  About half of Medicaid’s Medicaid’s enrollees enrollees are children in lowincome families, and another one-quarter are either the parents of those children or low-income pregnant  women. The elderly and disabled constitute the remainremaining one-quarter of Medicaid’s Medicaid’s enrollees. Expenses tend to be higher for beneficiaries who are elderly and disabled, di sabled, many of whom require long-term care, than for other beneficiaries. About one-third of Medicaid’s spending is for long-term care, which includes nursing home services, ser vices, home health care, and other medical and social services ser vices for people whose disabilities prevent them from living independently.. Medicaid accounts independently accounts for 40 percent of total spending on long-term care services and 43 percent of total spending on nursing home care in the United States.13 Overall, the elderly and disabled account for about two-thirds of o f the program’ program’s spending. sp ending.14 CHIP is a joint federal/state program that provides p rovides health insurance coverage coverage for uninsured children children living in families with income that is relatively low but too high for them to qualify for Medicaid.15 Like Medicaid, CHIP is administered by the states within broad federal guidelines. Unlike Medicaid, however, CHIP is a matching-grant program with a fixed nationwide cap on federal spending. In 2010, federal spending spending on CHIP

 

39

Subject to those requirements and other statutory limits, states have flexibility in administering the Medicaid program and determining its scope. Partly as a result, the program’’s rules are complex, and it is difficult to generalprogram g eneralize about the types of enrollees covered, the benefits offered, and the cost sharing required. States may choose to make additional groups of people p eople eligible (such as individuals with income above the mandatory eligibility thresholds and those who have high medical expenses relative to their income) or to provide additional benefits (such as coverage for prescription drugs and dental services), and they have exercised those options to varying degrees. Moreover, Moreover, many states seek and receive federal  waivers that allow them to provide benefits benefits and cover groups that would otherwise be excluded. By one estimate, federal and state expenditures on optional op tional

 was $7.9 billion, and about 8 million people (mostly  12. See Kaiser Co Commission mmission on Me Medicaid dicaid and the Uni Uninsured, nsured,  Medicaid Enrollment and Spend Spending ing by “Mandatory” “Mandatory” and “Optional” Eligibility and Benefit Categories (Washington, D.C.: Henry J. Kaiser Family Foundation, June 2005), p. 11. 13. Kaiser Commiss Commission ion for Medicaid and th thee Uninsured Uninsured,, Medicaid and Long-Term Care Services and Supports  (Washington,  (Washington, D.C.: Henry J. Kaiser Family Foundation, October 2010). 14. As the March 2010 he health alth care legislatio legislation n is implemented, some of those proportions are expected to shift; for instance, by 2020, CBO estimates, the elderly and disabled will account for about one-fifth of people enrolled in the program and just over half of the program’s spending. 15. Under certain cond conditions, itions, parents of enrol enrolled led children are also eligible for CHIP, but they constitute a very small percentage of the program’s enrollment.

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40

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

children) were enrolled in the program at some point during the year. The federal share of CHIP spending varies among the states but usually averages 70 percent. Under current law, law, in 2014 certain people with income up to 400 percent of the FPL will be eligible for federal subsidies, provided through newly established health insurance exchanges, to reduce their cost of obtaining private health insurance. Subsidies will limit the percentage of income that eligible people have to pay to purchase a relatively inexpensive plan providing a specified level of benefits; people choosing more expensive plans will have to pay additional amounts. In 2014, the percentages of income will range from 2 percent for the lowest-income households to 9.5 percent for households ho useholds with income between 300will percent and 400 of theInitially, FPL. Those T percentages be indexed in percent future years. Initially , hose the percentages of income that enrollees must pay are indexed so that the subsidies will cover roughly the same share of the total premiums over time. After 2018, however, an additional indexing factor will probably apply; if so, the shares of income that enrollees have to pay will increase more rapidly, rapidly, and the shares of the premiums that the subsidies cover will decline.16 People with income below 250 percent of the FPL will also be eligible to receive subsidies to reduce their costsharing requirements. People will not be eligible to receive subsidies through the exchanges if they already qualify for public coverage—including Medicaid—or Medicaid—or if they are offered coverage through their employment, unless they would have to pay more than a specified share of their income for such coverage or if the benefits covered fall below a certain threshold.

2000, when spending for health care remained relatively stable as a share of the economy. Many analysts have attributed that lull in growth to a substantial rise in the number of people enrolled in managed care plans as well as to excess capacity among some types of providers,  which increased the leverage that health plans plans had in negotiating payments. Also, economic growth was relatively rapid in that period. Spending for Medicare and Medicaid has also grown quickly in recent decades, in part because of rising enrollment and in part because of rising costs per enrollee. Between 1985 and 2010, gross federal spending for Medicare rose from 1.7 percent of GDP ttoo 3.6 percent, and federal spending for Medicaid increased from 0.5 percent of GDP to 1.9 percent. Over that same same period, total spending for Medicaid (including spending by the states) increased from 1.0 percent of GDP to 2.7 percen percent. t.

Underlying Factors  A crucial factor underlying the rise in per capita spending for health care in recent decades has been the emergence, adoption, and widespread diffusion of new medical technologies and services.17 Major advances in medical science allow providers to diagnose and treat illnesses in ways that previously previously were impossible. Many of those innovations rely on costly new drugs, equipment, and skills. Other innovations are relatively inexpensive, but their costs add up quickly quickly as growing numbers numbers of providers and patients make use of them. Although technological advances can sometimes reduce costs, in medicine such advances and the resulting changes in clin-

ical practice have generally increased total spending.

 The Historical Growth of Health Care Spending  Total spending for health care in the United States—that States—that is, private and public spending combined—has risen significantly as a share of GDP over the past several decades. Such spending has grown relative to GDP in most years,  with the notable exception of the period from 1993 to 16. The additional index indexing ing factor will apply in any year (after 2 2018) 018) in which the total costs of exchange subsidies exceed a specified percentage of GDP. CBO’s baseline projections account for uncertainty about whether the additional indexing factor will apply apply,, but CBO expects that eventually it will. See Congressional Budget Office, “Additional Information About CBO’s Baseline Projections of Federal Subsidies for Health Insurance Provided Through Exchanges” (May Exchanges” (May 12, 2011).

Other factors that have contributed to the growth of per capita health care spending include increases in personal p ersonal income and the expanded scope of health insurance coverage. Demand for medical care tends to rise as real (inflation-adjusted) family income increases. Moreover Moreover,, the expanding scope of insurance coverage in recent decades, as evidenced by the substantial reduction in the percentage of health care costs that people pay out of of pocket, has also increased demand, because insurance coverage reduces the cost of medical care for consumers. (The share of the population with health insurance has declined slightly in recent decades.) Spending on health 17. See Co Congressional ngressional Budget Office, Office, Technological Change and the Growth of Health Care Spending (January 2008).  

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CHAPTER THREE

care would also be expected to grow if people were developing more health problems or were becoming more likely to contract diseases, but the evidence is mixed on  whether those factors have substantially substantially increased the use of health care in the past few f ew decades.18 Disentangling the effects of technology, technology, income, and insurance on the growth of health care spending is difficult because the growth of income and insurance coverage has increased the demand for new technologies. A recent study estimated that new medical technologies te chnologies and rising income were the most important factors explaining the growth in health care spending since 1960, with the two accounting for similar shares of that growth.19 But the study also noted that the effect eff ect of the expansion in insurance coverage on spending growth is highly uncertain. Another recent study concluded that the expansion of insurance coverage resulting from the introduction of Medicare had a substantial impact on national health care spending—raising costs not just for the elderly el derly patients  who gained coverage but for nonelderly patients as well. It attributed part of the impact to more rapid and widespread adoption of existing treatment methods (such as those provided by cardiac intensive care units) but concluded that questions remained about the magnitude of those effects.20 Studies that have analyzed the sources of spending growth in the past have consistently found that the aging of the population has had only a small effect. eff ect. Although older adults generally have higher average medical expenses than younger adults do, the age composition of the 18. For additiona additionall discussion, see Congre Congressional ssional Budget Office Office,, 

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

population has not changed sufficiently to account for much of the increase in per capita spending. Aging has had a larger effect on federal spending for health care, however,, because nearly all U.S. residents become eligible however for Medicare when they turn 65. Since 1985, the share of the population that was age 65 or older grew by about 10 percent—from almost 12 percent to 13 percent. percent.

Excess Cost Growth  When analyzing historical historical trends in the growth of health care spending and developing projections for future growth of that spending, it is useful to distinguish between various components of that growth. As part of that analysis, it is common to calculate the increase in health care spending per person relative to the growth of GDP per person after removing the effects of demographic changes on health care spending—in particular, particular, changes in the population’ population’s age distribution. The remaining difference in growth rates is generally referred to as “excess “exc ess cost growth.” The phrase is not intended to imply that growth in per capita spending for health care is necessarily excessive or undesirable; it simply measures the extent to which the growth in such spending (adjusted for changes in the age composition of the population) exceeds the growth in per capita GDP. CBO’s calculations indicate that rates of excess cost CBO’s growth have ranged between 1.1 and 2.4 percentage points across programs and during various periods in the 3-1).21 Excess cost growth past several decades (see Table 3-1).  was lower, lower, on average, during the 1985–2007 period than during the longer 1975–2007 period. 22 That slowing

 

41

Key Issues in Analyzing Major Health Insurance Proposals  (December 2008), p. 23. See also Congressional Budget Office, How Does Obesity in Adults Affect Spending on Health Care , Issue Brief (September (Septem ber 2010). 19. Sheila Smith, Jos Joseph eph P P.. Newhouse, and Mark S. Freeland, “Income, Insurance, and Technology: Why Does Health Spending Outpace Economic Growth?” Health Affairs , vol. 28, no. 5 (September/October 2009), pp. 1276–1284. 20. Amy Finkelst Finkelstein, Aggregate of He Health alth Insurance: Quarterly Journal of Evidence fromein, the“The Introduction ofEffects Medicare,” Economics   vol. 122, no. 1 (February 2007), pp. 1–37. One factor that may have contributed to that study’s findings was the relatively generous payment system that Medicare adopted. Following the common practice of private insurers at the time, Medicare initially paid hospitals on the basis of their incurred cos costs—an ts—an approach that gave hospitals little incentive to control those costs. The increase in hospital spending that resulted from Medicare’s creation might have been smaller under a less generous payment system.  ,

probably stems, at least in part, from two important shifts: First, private health insurance moved away from indemnity policies—which generally reimburse enrollees for their incurred medical costs and which predominated 21. For Medic Medicare, are, CBO also adjusts for changes in the projected projected life expectancy (time until death) of beneficiaries. For Medicaid, CBO adjusts for changes in the program’s case mix—that is, the proportions of beneficiaries who are children, disabled people, elderly people, and other adults—rather than for changes in age composition. The introduction of Medicare’s Part D drug benefit in 2006 resulted in a one-time shift in some spending from Medicaid to Medicare; to adjust for that shift, CBO assumed that excess cost growth in 2006 for both Medicare and Medicaid was equal to the average of excess cost growth in the two programs for that year. 22. CBO exclude excluded d data for 2008 and 2009 from the calculat calculation ion because the recent economic downturn led to rates of excess cost growth for those two years that probably do not represent longerterm average rates of excess cost growth.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 3-1.

Excess Care Cost Growth in Spending for Health (Percentage points)

19 75 t o 20 07 19 80 t o 20 07 19 85 t o 20 07 19 90 t o 20 07 Source Sou rce::

Medic dicare

Medic dicaid

All Other her

Tot Total

2.4 2.2 1.4 1.6

2.0 1.7 1.3 1.1

1.9 2.0 1.9 1.5

2 .0 2 .0 1 .7 1 .5

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: Exce Excess ss cost gr growth owth refers refers tto o the extent extent to which which the annual annual growth rate of Medicare or Medicaid spending per beneficiary or of all other health care spending per capita— adjusted for demographic characteristics of the relevant populations—exceeded populations—excee ded the annual growth rate of nominal gross domestic product per capita, on average.

before the 1990s—and toward greater management of care. Second, Medicare shifted from cost-based payment methods to fee schedules that constrain price increases. Excess cost growth was even lower, lower, on average, during the shorter 1990–2007 period, but that average gives a good deal of weight to the years in the 1990s when managed care was spreading most rapidly; some of that difference probably represented a one-time downward shift in health care costs rather than a change in the underlying growth rate. In CBO’s CBO’s judgment, the average rate of excess cost growth since 1985—1.7 percentage points—best reflects features of the health care and health insurance systems

because of the considerable uncertainties involved. A  wide range of changes could could occur—in people’s people’s health, in the sources and extent of their insurance coverage, and in the delivery of medical care—that are are almost impossible to predict but that could have a significant effect on federal health care spending. Therefore, to project mandatory federal spending on health care for the longer term, CBO has adopted a relatively formulaic approach. In contrast, the projections for the next two decades d ecades reflect more-detailed analysis. For the extended-baseline scenario, the projections for the next 10 years match CBO’ss March 2011 baseline budget projections, which CBO’ reflect a comprehensive analysis of each program, assuming that existing laws remain unchanged. For the alternative fiscal scenario, the baseline projections for the next 10 years were adjusted to account for certain assumed changes in law. For both scenarios, the projections for the decade beyond the initial initial 10-year span involve involve transitions from growth rates for that initial span to longerlo ngerterm growth rates based on the projections of eligible populations and economic conditions described else where in this report and projections projections of excess cost growth growth in health care.

 The Paths Paths of Exc Excess ess Cost Growth iin n the Lo Longer nger T Term erm CBO’s projections of spending on federal health care proCBO’s grams over the longer term are based largely on the rate of excess cost growth observed health carethat system between 1985 and 2007 andin thethe assumption this rate  will decrease over time in response response to the pressures created by rising costs.

that are likely to endure for a number of years. That percentage, with various adjustments, serves as a basis for fo r CBO’ss long-term projections of health care costs. CBO’

CBO’s Methodology for Long-Term CBO’s Projections CBO projected mandatory federal spending on health care under two scenarios: an extended-baseline scenario,  which is intended to reflect the provisions of current law law,, and an alternative fiscal scenario, which incorporates several changes to current law that are widely expected to occur or that would modify provisions that might be difficult to sustain over a long period. CBO adopted different approaches for its projections for different time horizons. Projecting federal health care spending for decades into the future is very difficult

Longer-Term Responses to Rising Health Care Costs.   Health care expenditures cannot rise more quickly than t han GDP per capita forever. When health care expenditures increase as a share of GDP, they absorb a rising share of people’ss income, reducing growth in the consumption people’ of other goods and services. Thus, continued growth in health care spending will create mounting pressure to slow the growth of costs, even in the absence of changes in federal law.

The private sector and state s tate governments will probably respond to rising costs for health care by instituting various changes. Employers can intensify their efforts to reduce the costs of the insurance plans they sponsor—for example, by working with insurers to make the delivery of health care more efficient or by reducing the extent of the insurance coverage they offer. To To avoid higher premiums, employees can shift to plans with more tightly 

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CHAPTER THREE

managed benefits or higher cost-sharing requirements. The excise tax included in the March 2010 health care legislation on certain health insurance plans with high premiums will also encourage individuals and employers to choose plans with lower premiums. State governments can respond to growing costs for Medicaid by limiting the services they choose to t o cover or by tightening eligibility to reduce the number of beneficiaries. Because the federal government’s government’s spending for Medicaid depends on  what the states spend, actions by the states that reduce the growth of their Medicaid spending will also slow the growth of federal spending for the program.

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

the private sector have more flexibility to respond to the t he pressures of rising health care spending than does the federal government. Consequently Consequently,, CBO projects that excess cost growth in Medicaid spending and in premiums in the insurance exchanges will slow more than it  will in Medicare spending.

Many features of the Medicare program cannot be altered without changes in federal law. law. Still, a slowdown

Specifically, CBO assumed that the rate of excess cost Specifically, growth for both Medicaid and premiums in the insurance exchanges in 2085 (the final year of the current 75-year projection period) would be zero, whereas the rate of excess cost growth for Medicare in 2085 would be 1.0 percentage point. To To define an underlying rate of excess cost growth, CBO assumed a starting point in 2022 of 1.7 percentage points—which is the average rate

in spending growth outside of Medicare will affect Medicare, which is integrated to a significant degree deg ree with the rest of the health care system. In particular, Medicare Medicare  will probably experience some reduction reduction in cost growth to the extent that actions by individuals, businesses, and states result in lower-cost “patterns “patterns of practice” by physicians, slower development and diffusion of new technologies, and cost-limiting changes to the structure of the overall health care system. Moreover, Moreover, the federal fed eral government will probably make regulatory changes aimed at slowing the growth of spending for Medicare (and Medicaid), and the demand for health care services by Medicare beneficiaries will be constrained as the pro-

of excess cost growth observed in the health care system between 1985 and 2007. CBO further assumed that, between 2022 and 2085, excess cost growth would decline linearly—that is, by the same fractional number of percentage points each year. That linear decline reflects a judgment that, over time, the steps needed to keep reducing growth rates will become increasingly onerous but that the pressure to take them will also intensify because of continued increases in health care spending. Under the extended-baseline scenario, for Medicare and subsidies in the insurance exchanges, CBO modified the underlying rates of excess cost growth just described, incorporating a period of adjustment adj ustment during the 2020s to

gram’s premiums and cost-sharing amounts consume a growing share of beneficiaries’ income.

reflect the projected effects ef fects of provisions of current law. law.

 A sizable slowdown in excess excess cost growth in the health care system, which CBO projects will occur over the long

It may be difficult to envision how excess cost growth in Medicare’s Medicare’s spending could outstrip spending s pending for Medicaid and health insurance premiums in the ex-

 

43

term even in the absence of changes in federal law, probably can be achieved only through significant changes in the nature of health care, access to care, the amount that households pay directly for care, or policies at the state and local levels. For example, in the private sector, households will probably face increased cost sharing; new and potentially useful health technologies will probably be introduced more slowly or be used less frequently than they would without the pressures of rising costs; and more treatments and interventions may simply not be covered by insurance. In addition, households that would otherwise receive health insurance through Medicaid might become ineligible because of tightened eligibility rules or might be eligible but find that the scope of covered services has been reduced.  The Projected Slowdown Slowdown in Excess Cost Cost Growth. In the absence of changes in federal law, state governments and

changes over such a long period, but such an outcome can occur. occur. For instance, actions taken to reduce spending growth in the private sector could weaken the incentives to develop and disseminate new medical technologies for nonelderly people but have less of an effect on new technologies focused on diseases that principally affect the elderly.. Indeed, excess cost growth in Medicare has elderly exceeded that for other health care spending by as much as half a percentage point over periods of a few decades (even though past growth rates reflect changes in law that have probably helped to slow growth in Medicare’s Medicare’s costs).

 The Extended-Basel Extended-Baseline ine Scenar Scenario io For 2012 through 2021, CBO’s projections of spending for Medicare, Medicaid, CHIP, and exchange subsidies under the extended-baseline scenario match those in its March 2011 baseline budget projections. Those projections reflect the assumption that Medicare spending will CBO

 

44

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

be constrained by the sustainable growth rate mechanism,  which determines the program’ program’s payment rates for physicians’ services. Under current law, those payment rates will be reduced reduced by nearly 30 percent in January January 2012 and by additional amounts in subsequent years, CBO projects. In addition, in its baseline, CBO assumes that payment rates for many other types of o f health care providers will follow the provisions of the March 2010 health care legislation, which specifies slower growth in payments than would have occurred under prior law. Through those changes and numerous others, the 2010 legislation significantly decreased Medicare outlays relative to what they would have been under prior law.23  Over the 2012–2021 period, CBO’s CBO’s baseline projections proje ctions imply an average annual rate of excess cost growth for Medicare of -0.4 percentage points; that that is, spending per beneficiary for Medicare is projected to grow more slowly than per capita GDP. For Medicaid, no comparable provisions of federal law to constrain the growth of spending are in place; as a result, the implied rate of excess cost growth of federal Medicaid spending over the 2012–2021 period is 1.7 percentage points, which is consistent with historical experience.24 To project spending under the extended-baseline scenario beyond the initial 10-year span, CBO transitioned from the growth rates based on a detailed analysis of each program to the growth rates in the long-term paths described above:  

For Medicare, Medicare, from 2022 through 2029, CBO used a rate of excess cost growth equal to the average rate for the final two years of the initial i nitial 10-year projection

growth in Medicare would follow the path of underlying excess cost growth described above. With those different rates (the one through 2029 and the underlying path beginning the next year) combined, excess cost growth for Medicare averages 1.2 percentage points per year during the 2022–2085 period. CBO projected the number of Medicare beneficiaries to grow with the size of the population po pulation over age 65 adjusted for changes in the age distribution and with the number of Social Security Disability Insurance recipients.  

 

 

For Medicaid, CBO projected spending beyond the initial 10-year span by using the path of underlying excess cost growth described above. As a result, excess cost growth for Medicaid averages 0.8 percentage points per year during the 2022–2085 period. CBO projected the number of Medicaid beneficiaries to grow with the size of the population adjusted for f or changes in the age distribution. Currently, spending on CHIP is subject to a statutory Currently, cap. CBO projected that spending on the program  would be constant as a share of GDP after 2021. To project federal subsidies of health insurance premiums for plans in the exchanges from 2022 through 2029, CBO used a growth rate consistent with what it estimates for theCBO’s latters projections part of the initial 10-year pro jection period. CBO’ of those subsidies beyond the end of the 2020s are based on the same path of underlying excess cost growth described above and on projected growth in the number of people

period (2020 and 2021), which is 0.8 percentage points. That figure reflects the projected effects of the March 2010 health care legislation as well as all other provisions of current law. Because of the growing uncertainty involved in projecting the effects of that legislation on cost growth still farther into the future, CBO assumed that beginning in 2030, excess cost

23. See theBudget statement of Douglas W W..Subcommittee Elmendorf, Director Director, , Congressional Office, before the on Health, House Committee on Energy and Commerce, CBO’s Analysis of the  Major Health Health Care Legislation Legislation Enacted Enacted in March March 2010  (March  (March 30, 2011). 24. The expansio expansion n of Medicaid bene benefits fits to people with income up to 138 percent of the federal poverty level will increase total Medicaid spending but not per capita Medicaid spending. Because excess cost growth reflects the increase in health care spending per person relative to the growth of GDP, the expansion is not expected to have a large impact on excess cost growth.

and on projected growth in the number of people receiving different amounts of subsidies. CBO expects that a smaller percentage of people will be eligible for exchange subsidies over time because incomes are projected to increase more quickly than the eligibility thresholds. Moreover, Moreover, because of the additional indexing factor described above, CBO projects that federal subsidies will cover a declining share of the premiums for the plans available through the exchanges.

 The Alternative Alternative Fisca Fiscall Scenario For the first 10 years, the alternative fiscal scenario differs from the extended-baseline scenario in two respects: First, the additional indexing factor for exchange subsidies is assumed not to apply. apply. Second, rather than assuming as suming that Medicare’’s payment rates for physicians’ services would Medicare be reduced as projected under current law, CBO assumed that those rates would be maintained at their 2011 levels through 2021. That approach is consistent with the

CBO  

CHAPTER THREE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

observation that since Medicare’s current mechanism for

 would be modified after 2029 to ensure that the the shares of

updating physicians’ payment to rates wasscheduled enacted inreduc1997, it has regularly been modified keep tions from taking place.25 Under this scenario, excess cost growth for Medicare spending averages 0.2 percentage points per year during the 2012–2021 period.

the with incomes to the various population ranges of subsidies would corresponding remain constant. Second, CBO assumed that the additional indexing factor described above would not take effect, so the federal subsidies would cover a constant share of the premiums per enrollee over time. Consequently, Consequently, the projections proje ctions for the alternative fiscal scenario imply that more people  would be eligible for exchange subsidies and that the subsidies would cover a higher share of the premiums over time than would be the case under the extendedbaseline scenario.

Because Medicaid policies are assumed to be the same in the two scenarios during the initial 10 years, the average annual rate of excess cost growth for federal Medicaid spending for that period is 1.7 percentage points under the alternative fiscal scenario, the same as under the extended-baseline scenario. Spending on CHIP is also assumed to be the same in the alternative fiscal scenario as in the extended-baseline scenario. Beyond the initial 10-year span, CBO assumed that three Medicare policies that might be difficult to sustain over a long period—further reductions in payment updates for most providers in the fee-for-service program, the sustainable growth rate mechanism for payment rates for physicians, and the IPAB—would not continue past 2021. Without those policies in place, CBO expects that excess cost growth will follow the path of underlying excess cost growth described above. As a result, excess cost growth for Medicare averages 1.3 percentage points po ints between 2022 and 2085. Projections of the number of Medicare beneficiaries are the same as those under the extended-baseline scenario. Projected federal spending on Medicaid and CHIP is the same in the alternative fiscal scenario as in the extended-

Long-Term Projections of Mandatory Long-Term M andatory Spending on Health Care

Federal spending on mandatory health programs is pro jected to increase significantly as a share of the economy in the coming decades under both the extended-baseline and the alternative fiscal scenarios. In all of the projections, the outlays for exchange subsidies are presented in combination with outlays for Medicaid and CHIP both for ease of exposition expo sition and to reflect the fact that they all constitute federal subsidies for health insurance for lowerl owerand moderate-income households.

Projected Spending  In 2011, federal spending on Medicare, Medicaid, and CHIP will amount to 5.6 percent of GDP, GDP, CBO expects,  with Medicare accounting accounting for 3.7 percent of GDP and federal spending on Medicaid and CHIP adding 1.9 percent of GDP. Under the extended-baseline scenario,

 

45

baseline scenario because there are no assumed policy differences between the scenarios for those two programs. Thus, for the alternative fiscal scenario, CBO projected Medicaid spending after the initial 10-year period by applying the same path of underlying excess cost growth used for the extended-baseline scenario, and the agency assumed that CHIP spending would remain a constant share of GDP. GDP. To project health insurance f or in the exchanges, CBO applied thepremiums same pathfor of plans underlying excess cost growth used for the extended-baseline scenario. However, However, CBO assumed that the law regarding the subsidies for those premiums would be altered in two t wo  ways. First, CBO assumed assumed that the eligibility thresholds 25. In 2002, p payment ayment rates for services on on the physician fee schedule schedule  were reduced reduced by 4.8 percent. SSince ince then, the payment rates have been increased by an average of about 1 percent a year.

federal spending for those programs and for the exchange subsidies would total about 9 percent of GDP in 2035; about 6 percent would be for Medicare, and about 3 percent would be for Medicaid, CHIP, and the exchange subsidies (see Fi Figur guree 3-2). 3-2).26 Under the alternative fiscal scenario, mandatory federal spending on the major health 26. Although th thee subsidies of premiums are structure structured d as tax credits, most of the funds involved will be classified as outlays because their value will often exceed what enrollees’ income tax liability  would otherwise otherwise be. T Too the ext extent ent that re receiving ceiving a tax credit credit reduces what a person owes in taxes, the credit results in a reduction in revenues. Because the tax credits are refundable, however, people can receive a credit that exceeds their income tax liability, in which case a cash payment will be made for the portion beyond the liability; such payments appear in the federal budget as outlays. In addition, the subsidies to reduce enrollees’ cost sharing  will be classified as outlays. Th This is chapte chapterr present presentss the effects of the subsidies on outlays; the smaller effects on revenues are included in the projections presented in Chapte Chapterr 6.

CBO  

46

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 3-2.

on health care. To To do so, s o, CBO combined its projections

Mandatory Federal Spending on Health Care, by Category, Category, Under CBO’ss Extended-Baseline Scenario CBO’

of mandatory federal spending on health care with rough projections of other health care spending (see Bo Boxx 33-1 1).  According to that analysis, analysis, national spending on health care as a share of GDP will continue to rise—from about one-sixth of GDP now to more than a quarter of o f GDP by 2035. 2035.

(Percentage of gross domestic product) 10

10

Actu Actual al Proj Projec ecte ted d

Projections Under Alternative Assumptions 8

8

Medicaid, CHIP, and Exchange Subsidies

6

6

4

4

Medicare

2

2

 Although all long-term economic and demographic trends are uncertain and thus difficult to forecast, excess cost growth in health care spending during the next 75 years may be parti particularly cularly so. The current systems of health care and health care financing have existed for only a few decades, and medical technology continues to evolve rapidly. rapidly. The projections in this report will undoubtedly prove to be inaccurate in one direction or another.. And judging their accuracy will be difficult even another

0

0 2000

2005

Source Sou rce::

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-basel extended-baseline ine scenario adheres close closely ly to curren currentt law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-t erm projection period. (For details, see Table able 1-1 on pa page ge 4.) CHIP = Children’s Health Insurance Program.

Figure 3-3.

Mandatory Federal Spending on Health Care Under U nder CBO’s Long-Term Long-T erm Budget Scenarios (Percentage of gross domestic product) 12

12

Actua ctuall

care programs would be higher because CBO assumed that several policies designed to limit that spending  would not continue. Specifically Specifically, Medicare’ Medicare’s spending

10

8

Pro roje ject cte ed Alternative Fiscal Scenario

10

8

 would grow to almost 7 percent of GDP by 2035, 2035, and federal spending on Medicaid, CHIP, CHIP, and the exchange subsidies would reach almost 4 percent of GDP—so total federal spending on those programs p rograms would be just over 10 percent percent of GDP GDP (see Fi Figur guree 3-3). 3-3). Both the aging of the population po pulation and excess cost growth are responsible for the projected rise in federal spending on the major health care programs and will drive d rive total national spending on health care in the future as well. Over the next 25 years, each accounts for about half of the programs’ spending growth; over a longer period, excess cost growth is the predominant factor (see Box 1-1 on page 10.) However, However, future rates of aging and especially e specially of excess cost growth could differ substantially from CBO’ss assumptions, particularly in the longer term. CBO’  Although the focus of this chapter is federal spending on health care, CBO also projected total national spending

Extended-Baseline Scenario

6

6

4

4

2

2

0

0

2000

2005

2010

2015

2020

2025

2030

2035

Source:: Con Source Congre gressi ssiona onall Budg Budget et Of Offic fice. e. Note:: The exte Note extendednded-basel baseline ine scenario scenario adher adheres es closely closely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal scenario incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period. (For details, see Table 1-1 on page 4.)

CBO  

CHAPTER THREE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Box 3-1.

National Spending on Health Care The Congressional Budget Office (CBO) has a limited ability to project national spending on health care because the agency does not track several components of those expenditures as closely as it analyzes the components that are part of the federal budget. To generate projections of total expenditures on on health care over the longer term, the agency has combined its own projections with estimates and pro jections developed by by the Office of the Actuary in the Centers for Medicare and Medicaid Services (CMS).1 

To project total spending for health care after 2021, CBO again started with its projections of federal spending on the government’s major mandatory health care programs. The agency then added estimates of other spending on health care by combining its projections of demographic and economic changes  with assumptions about excess cost growth for such spending (that is, growth in spending per person that exceeds the growth of gross domestic product [GDP] per person, after adjusting for changes in the popula3

The projections are rough involve substantial uncertainty—especially as and one looks farther into the future—and thus should be viewed with caution. To project total spending for health care for the 2012–2021 period, CBO started with its projections of federal spending spe nding on the government’s government’s major mandatory health care programs—Medicare, progr ams—Medicare, Medic Medicaid, aid, the Children’s Health Insurance Program, and the subsidies of health insurance premiums for plans in the exchanges to be established starting in 2014 under the March 2010 health care legislation (the Patient Protection Protection and Affordable Affo rdable Care Act and the Health Care and Education Reconciliation Act of 2010). Other spending for health care includes payments by private health insurers, out-of-pocket payments by households, and other public spending.

tion’s the average of excess age costdistribution). growth from CBO 1985 used through 2007 forrate total health care spending—1.7 percentage points—as the initial rate of excess cost growth for the longer-term projections.4 CBO then assumed that the rate of excess cost growth for other health care spending  would slow to zero in 2085 in reaction to the prespressures from rising spending. Between Be tween 2022 and 2085, excess cost growth, CBO assumed, would decline linearly—that is, by the same number of fractional percentage points each year. year. Since 1985, total spending on health care, measured as a share of the economy, has increased by about two-thirds, growing from 9.8 percent to 16.5 percent of GDP in 2009. Under CBO’s extended-baseline scenario, which reflects current law, total spending

 

47

CBO projected such spending using its estimates of payments by private health insurers and the CMS actuaries’ projections of all other categories. Because those projections by CMS are available only through 2019, CBO used the historical rate of excess cost growth to extend them for the following f ollowing two years.2 

for health care would increase to about 26 percent of GDP by 2035. Under the agency’s agency’s alternative fiscal scenario, in which several policies designed to restrain federal spending on health care are assumed not to continue, total spending on health care as a share of of GDP would be about 1 percentage point higher in 2035. The gap in spending between the two scenarios  would widen after 2035.

1. As used here here,, “total “total hea health lth car caree spending” spending” is health health consumption expenditures expenditures as defined in the national health expenditure accounts accounts maintained by CMS. That concept excludes spending on medical research, structures, and equipment.

3. For the the co components mponents derived u using sing CMS’s proje projections, ctions, CBO used the historical rate of excess cost growth beginning in 2020 and reduced that rate beginning in 2023, which is consistent with the treatment of other categories of health care spending.

2. See Andrea M M.. SSisko isko and others, “Nationa “Nationall Hea Health lth Spending Spending Projections: The Estimated Impact of Reform Through 2019,” Health Affairs , vol. 29, no. 10 (October 2010), pp. 193 1933–19 3–1941. 41.

4. CBO exclud excluded ed data fo forr 2008 and and 2009 from from the calcula calculation tion because the recent economic downturn led to rates of excess cost growth for those two years that are probably not representative of longer-term average rates of excess cost growth.

CBO  

48

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 3-4.

Mandatory Federal Spending on Health Care Under CBO’s CBO’s Alternative Fiscal Scenario and Different Assumptions About Excess Cost Growth After 2021 (Percentage of gross domestic product) 12

12

Excess Cost Growth of 2.0 Percentage Points

10

10 a

Slowing Growth 8

8

No Excess Cost Growth

6

6

4

4

0

0

2011

Source Sou rce::

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Excess cost growth refe refers rs to the extent to which the annual growth rate of health care spe spending nding per beneficiary—adjuste beneficiary—adjusted d for demographic characteristics of the relevant populations—is assumed to exceed the annual growth r ate of nominal gross domestic product per capita. The alternative fiscal scenario incorporates incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult difficult to sustain for a long period. (For details, see T Table able 1-1 on page 4.) a.

In the alternative alternative fiscal scen scenario, ario, the rate of excess excess cost growth is assumed assumed to decline each each year from an initial value of 1.7 percentage points in 2022.

after the fact, because they assume no changes in federal fe deral law or policies, and such changes are certain to occur. occur.

observed since 1985—mandatory spending for health care would grow grow to almost 11 percent of GDP by 2035. 2035.

Even without policy changes, though, actual spending for health care could b bee much lower or much higher than the figures contained in CBO’s and other forecasters’ projections.

 Trust  Trust Fund Measures

For comparison purposes, CBO projected federal spending for Medicare, Medicaid, CHIP, CHIP, and the exchange subsidies using varying assumptions about excess cost growth after 2021 under the alternative al ternative fiscal scenario. If excess cost growth for those programs follows the paths

Projections of the balances in the Hospital Insurance Trust Fund offer another way to look at the financial status of Part A of Medicare. A commonly used measure is the actuarial balance—that is, the present value of noninterest revenues plus the current trust fund balance minus the present value of outlays and the desired trust fund balance (one year of outlays) at the end of o f a speci27 fied period.

described such is projected be about 10 percentabove, of GDP in spending 2035. A projection in to which excess cost growth is held constant at zero is useful because it isolates the effect that the aging of the population has on Figur guree 3-4). 3-4). In that case, the federal govspending (see Fi ernment’ss mandatory spending on health care would ernment’ increase from 5.6 percent of GDP in 2011 to 8.5 percent by 2035. If, instead, excess cost growth for those programs equaled 2 percentage points starting in 2022 and continuing indefinitely—or roughly the average rate

27. A present value is a single numbe numberr that expresses a flow of current and future income or payments in terms of an equivalent lump sum received or paid today. Here, it is calculated over 75 years using a 3 percent real discount rate. That discount rate is equal to the interest rate that trust fund f und securities are projected to receive in the long term. The rate differs from f rom the effective rate on debt held by the public because of differences in the term structure of the debt.

CBO  

CHAPTER THREE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 3-2.

a combination of the two approaches yielding the same

Financial Measures for Medicare’s Medicare’s Hospital Insurance Trust Fund Under CBO’ss Extended-Baseline Scenario CBO’

total effect could be used to address the imbalance.

(Percentage of taxable payroll) Projection Period Projection (Calendar yea years) rs)

Income Rate

Cost Rate

Actuar ial Balance

25 Yea rs ( 2011 t o 2035 )

3.6

4.6

- 1.0

50 Yea rs ( 2011 t o 2060 )

3.8

5.7

- 1.9

75 Yea rs ( 2011 t o 2085 )

4.0

6.9

- 2.8

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Over the re relevant levant periods, the income ra rate te is the present value of annual noninterest revenues (including the initial trust fund balance), and the cost rate is the present value of annual outlays (including the target trust fund f und balance at the end of the period), each divided by the present present value of taxable payroll. The actuarial balance is the difference between the income and cost rates. The extended-baseline scenario adheres closely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-t erm projection period. (For details, see Table 1-1 on page 4.)

That difference is usually shown as a percentage of the present value of taxable payroll over the same period. A negative actuarial balance means that outlays plus the desired trust fund balance will exceed revenues plus the

Using CBO’s CBO’s current projections for the extendedbaseline scenario, the actuarial imbalance for the HI trust fund over 75 years is 2.8 percentage points, which is the difference between projected income equal to 4.0 percent of taxable payroll and projected costs totaling to taling 3-2). Eliminating 6.9 percent percent of taxable payroll payroll (see Table 3-2). a gap of that size would require, require, as an example, either either an immediate increase in the basic rate of HI payroll taxes taxes from its current current 2.9 percent to 5.7 percent, percent, or an immediate cut of about one-third in spending on Part A. Given the tremendous uncertainty surrounding long-term projections of spending for health care, however, a more useful metric may be the actuarial imbalance in the nearer term. CBO estimates that the imbalance over 25 years is 1.0 percentage point under the extended-baseline scenario. (The projected imbalances are somewhat larger under the alternative fiscal scenario because, under that scenario, Medicare spending is higher and tax revenues are lower.)  Another commonly used measure of the program’ program’s sustainability is the trust fund’s exhaustion date. According to CBO’s CBO’s March 2011 baseline projections, the HI trust fund will be exhausted in 2020. Once the HI trust fund is exhausted, the Centers for Medicare and Medicaid Services will no longer have legal authority to pay health plans and providers. Annual outlays would therefore be

 

49

current balance; the value of the actuarial balance represents the amount by which revenues as a percentage of taxable payroll (the income rate) would have to be increased immediately and in every year of the projection period to cover all projected costs and provide p rovide the desired balance in the trust fund at the end of the period. Alternatively,, outlays as a percentage of taxable payroll (the natively cost rate) could be reduced by an equivalent amount—or

limited to annual revenues. If payments to health plans and providers could be made only from annual revenues,  which are inadequate to cover cover total costs, beneficiaries beneficiaries’’ access to health care services could be reduced. Projections in this report incorporate an assumption that Medicare benefits would continue to be paid regardless of the financial financial status status of the HI trust fund.

CBO

 

CHAPTER 

4  The Long-Term Long-Term Outlook for Social Security 

T

he federal government spends more on Social Security than it does on any other single program. Created in 1935, the program has long consisted of two parts: Old Age and Survivors Survivors Insurance (OASI), which which pays benefits to retired workers and to their dependents and survivors, and Disability Insurance (DI), which makes payments to disabled workers who have not reached full retirement age (the age of eligibility e ligibility for full retirement benefits) and to their dependents. In all, about 56 million people will receive Social Security benefits in 2011. The Congressional Budget Office (CBO) estimates that outlays for that program in fiscal year 2011 will total about $733 billion, accounting for one-fifth of all federal spending. During the program’s first four decades, spending for Social Security increased increased relative to the size of the econ-

How Social Security Works Social Security is often characterized as a retirement program because a majority of its beneficiaries— 69 percent—are re retired tired workers or the spouses and children of those people. In general, workers qualify for retirement benefits if they are age 62 or older and have h ave paid sufficient Social Security taxes for at least 10 years. However,, Social Security also provides other types of benHowever efits, such as those to deceased workers’ survivors, who make up 12 percent of beneficiaries. In addition, workers younger than the full retirement age who have had to limit their employment because of a physical or mental disability can qualify for DI benefits, in many cases with a shorter employment history. Disabled workers and their spouses and children account for 19 percent of beneficia1

omy, reaching about 4 percent of gross domestic product omy, (GDP) in the mid-1970s. That increase was caused largely by repeated expansions of the program. Costs rose to 4.9 percent of GDP in 1983, the year that the last major piece of legislation affecting Social Security was enacted. Between 1984 and 2008, spending for Social Security fluctuated between 4.1 percent and 4.6 percent of GDP. GDP. During the most recent recession, GDP contracted and Social Security outlays increased more rapidly than they would have with stable economic growth because the number of OASI and DI claimants rose as the job market deteriorated. As a result, outlays grew to 4.8 percent of GDP in 2009 (see Fi Figur guree 4-1). 4-1). CBO anticipates that, if the full benefits specified under current law are paid, spending for Social Security will reach 6.1 percent of GDP in 2035 and remain close to that figure in ensuing decades.

ries.  In dollar terms, retired workers and their depend ependents receive 67 percent of Social Security benefits, survivors receive 15 15 percent, and disabled workers and and their spouses and children receive 18 percent of benefits.2 The benefits that retired or disabled workers initially receive are based on their individual earnings histories, although those earnings and the formula used to compute initial benefits are indexed to changes in average annual

Disability   1. See Cong Congress ressional ional Budg Budget et Offic Office, e, Social Insurance: Participation Trends and TheirSecurity Fiscal Implications,  Implications, Issue Brief (July 2010). 2. The distribut distributions ions of beneficiari beneficiaries es and benefits benefits are not comp complete letely ly consistent; some beneficiaries beneficiaries receive more than one type of benefits. For instance, some retired workers also are entitled to survivors’’ benefits. Those beneficiaries are classified as retired survivors  workers for the the distributio distribution n of beneficiaries, but their b benefit enefit payments are prorated between the retired worker and survivor sur vivor categories for this analysis.

CBO  

52

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 4-1.

ings indexed to overall average wages and because wages grow over time, the real (inflation-adjusted) value of benefits will rise over time.

Spending for Social Security Under CBO’ss Long-Term Budget Scenarios CBO’ (Percentage of gross domestic product) 7

Actual

7

Projected

6

6

5

5

4

4

3

3

2

2

1

1

0

0

2000

2005

Source Sou rce::

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: Projec Projected ted spen spending ding for Social Social Security Security is identica identicall under CBO’s two long-term budget scenarios, the extendedbaseline scenario and th e alternative fiscal scenario. (For details of the scenarios, see Table 1-1 on page 4.)

earnings for the workforce as a whole. In subsequent years, a cost-of-living adjustment is applied to the initial benefit to reflect annual growth in consumer prices.

The Social Security program is funded by two sources of dedicated tax revenues. Roughly 96 percent of those revenues derive from a payroll tax—generally, tax—generally, 12.4 percent of earnings—that is split evenly between workers and their employers.4 Only earnings up to a maximum annual amount ($106,800 in 2011) are subject to the payroll tax. That amount, referred to as the taxable maximum, generally increases each year at the same rate as average earnings in the United States. However, However, the share of economywide earnings that falls below the taxable maximum varies each year as the distribution of earnings changes. When earnings inequality increases, as it has in recent decades, the taxable share of earnings declines. CBO projects that earnings inequality will grow some what during the next few decades and that the share of earnings subject to the payroll tax, which has been above 85 percent in recent years, will decline to around 82 percent in 2035. The remaining share of tax revenues— 4 percent—is collected collected from income taxes on benefits. benefits. Single filers must pay taxes on Social Security benefits if the sum of their non-Social Security income and half of their benefits exceeds $25,000. The threshold for joint filers is $32,000. Under current law, law, those thresholds remain fixed, with no adjustment for earnings growth or

 W  Workers orkers born before 1938 could receive receive full retirement benefits at the age of 65. The full retirement age increases gradually for people born later; it will be 67 for people born after 1959. The age at which workers may start receiving reduced benefits, 62, remains the same.3 The Social Security Administration estimates that workers who retire at age 65 in 2011 and who had average annual earnings—earnings equal to the average earnings of all workers in the country—throughout their career  will qualify for an annual annual benefit of about $17,100. That amount will replace approximately 40 percent of their preretirement earnings. In coming decades, the replacement rate will be lower for workers with average earnings  who retire at age 65, mainly as a result result of the scheduled increase in the full retirement age. Nevertheless, because initial benefits are based on beneficiaries’ previous earn3. For a more detailed description of the Social SSecurity ecurity prog program, ram, see Congressional Congressional Budget Office Office,, Social Security Policy Options   (July 2010), “An Overview of Social Security,” pp. 1–4.

inflation. Revenues from both sources are credited to the two Social Security trust funds (the Old-Age and and Survivors Insurance Trust Fund and the Disability Insurance Trust Fund). Social Security benefits and the program’s administrative costs are paid from those funds; benefit payments represent roughly 99 percent of total outlays for the program. Interest on those balances is credited to the trust funds, but because those interest transactions represent payments from one part of the government (the general fund of the Treasury) Treasury) to another (the Social Security trust funds), they do not affect federal feder al budget deficits or surpluses. The balances currently credited to the funds ($2.6 trillion at the end of May 2011) have 4. The workers workers’’ portio portion n of the payr payroll oll tax wa wass reduc reduced ed by 2 percentage points points for 2011, but the reduction in tax revenue revenuess is being made up by reimbursem reimbursements ents from the Treasury’ reasury’ss general fund to the two Social Security trust funds. In this report report,, Social Security tax revenues include those reimbursements.

CBO  

CHAPTER FOUR

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Figure 4-2.

 The Population Age 65 or Older as a Percentage of the Population  Ages 20 to 64 (Percent) 40

40

Ac Actu tual al Pr Proj ojec ecte ted d

35

35

30

30

25

25

20

20

15

15

10

10

5

5

0

0

2000

Source Sou rce::

2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

accumulated over many years, during which revenues and interest received by the trust funds have exceeded the benefits paid from those funds.

 The Outlook for Social Security

 will increase by almost 90 percent between now and 2035, compared with an increase of just 11 percent over that period in the number of people ages 20 to 64. Today, that older group is about one-fifth the size of the younger group; at those rates of growth, it will be more than a third the size of the younger group by 2035 (see Fi Figur guree 4-2 4-2). ).  About 97 million people people will collect collect benefits in in 2035, CBO projects, compared with 56 million who will receive them this year. Moreover, the average benefit will have grown nearly as fast as GDP per person. CBO therefore estimates that, unless changes are made to Social Security, spending for the program will rise from 4.8 percent of GDP today to 6.1 percent by 2035. Spending will then dip slightly as members of the baby-boom generation die, but it will later turn upward again a little as a result of beneficiaries’ increasing life spans. Projections for Social Security benefits were based on CBO’ss detailed microsimulation model, which starts CBO’ star ts with individual-level data from a representative sample of the population and projects demographic and economic outcomes for that sample through time. For each individual in the sample, the model simulates birth, death, de ath, immigration and emigration, marital pairings and transitions, fertility, labor force participation, hours worked, earnings, payroll taxes, and claims for and amounts of Social Security benefits.7 5. CBO expects expects that p private-sector rivate-sector costs for heal health th car caree will continue

 

53

Spending and Revenues The cost of the Social Security program will rise significantly in coming decades—a development that analysts have long foreseen. Average benefits per beneficiary tend to grow over time because the earnings on which those benefits are based also increase.5 In addition, as more members of the baby-boom generation reach retirement age, and as longer life spans lead to longer retirements, a significantly larger share of the population will draw Social Security benefits.6 As a result, the total amount of benefits scheduled to be paid under current law will grow faster than the economy. economy. In 2010, for the first time since the enactment of the Social Security Amendments of 1983, annual outlays for the program exceeded annual revenues excluding interest credited to the trust funds. CBO projects that the gap will continue; outlays will be somewhat greater than such revenues (by around 4 percent) over the next five years. By the end of this decade, an increasing number of baby boomers  will have reached reached retirement retirement age, age, and the shortfall shortfall will grow. CBO projects that the population age 65 or older

to grow more quickly than compensation over the long-term projection period. That trend alone would reduce the share of compensation that workers receive as wages subject to the Social Security payroll tax. However, the Patient Protection and  Affordable Care Ac Actt (Pub (Public lic Law 111-148) instituted an excise tax on some high-premium employment-based health insurance plans. Some people will respond by shifting to less expensive plans, thus reducing the share of compensation represented by health insurance premiums and increasing the share of cash wages. (See Cha Chapte pterr 2, “The Taxable Earnings Share of Compensation,” on page page 25 25.) .) CBO projects that the effect effectss of the excise tax will more than offset the effects of rising health care costs for several decades but that the reverse will be true thereafter. The share of compensation compensat ion workers receive as taxable wages will first rise and then fall, ending up near the 2021 level by 2085, and Social Security revenues and benefits will be greater than they would be if health insurance premiums remained a constant share of compensation. 6. For analysis ooff the outlook for the baby b boomers oomers’’ financial situation in retirement, see Congressional Congressional Budget Office, Will the Demand for Assets Fall When the Baby Boomers Retire?  Background Paper (September 2009); and The Retirement Prospects of the Baby Boomers,  Issue Brief (March 2004). Boomers, 7. See Cong Congress ressional ional Budg Budget et Offic Office, e, CBO’s Long-Term Model: An Overview,  Background Paper (June 2009). Overview,

CBO  

54

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

CBO’s projections of outlays for Social Security are the CBO’s same under both of the scenarios discussed in this report—the extended-baseline scenario and the alternative fiscal scenario—but projections of Social Security revenues depend somewhat on which scenario is used. The revenues generated by payroll taxes are identical under the two scenarios; however, projections of revenues derived from the taxation of Social Security benefits are higher under the extended-baseline scenario. s cenario.8 Under that scenario, which is based on the assumption that current laws remain unchanged, both the number of Social Security beneficiaries subject to taxes on benefits and average income tax rates would increase from current levels. 9 As a result, income taxes on Social Security benefits would grow to 4 percent  percent of benefits in 2015 and exceed 6 percent in 2035. Under the alternative fiscal scenario, which is based on the assumption that tax revenues remain closer to their historical average share of o f GDP, GDP, the income taxes on Social Security benefits that are credited to the Social Security trust funds would equal 4 percent of benefits in 2021 and later. Consequently, Consequently, the projections proje ctions of Social Security’s finances are somewhat less favorable under the alternative fiscal scenario than they are under the extended-baseline scenario. According to CBO’s CBO’s extended-baseline scenario, by 2035, the benefits scheduled to be paid under current law would exceed dedicated revenues (the combination of payroll taxes and taxes on benefits) by about 24 percent; under the alternative fiscal

Social Security, Security, that difference d ifference is traditionally presented as a percentage of the present value of taxable payroll. Under its extended-baseline scenario, CBO estimates that over the next 75 years, the program has an actuarial shortfall equal to 1.6 percent of taxable payroll, or 0.6 percent percent of GDP (see (see Table 4-1). 4-1). Thus, to bring the program into actuarial balance through 2085, payroll taxes could be increased immediately by 1.6 percent of taxable payroll and kept at that higher rate, or scheduled benefits could be reduced by an equivalent amount. Under the alternative fiscal scenario, the shortfall is estimated to be 2.0 percent of taxable payroll, or 0.7 percent of GDP.  Another commonly used measure of the program’ program’s sustainability is the trust funds’ exhaustion date, which CBO projects will be 2038 under the assumptions of the extended-baseline scenario or 2036 under those of the alternative fiscal scenario.11 Once the trust funds are depleted, the Social Security Administration would no longer have legal authority to pay full benefits. In the years after the exhaustion of the trust funds, annual outlays would therefore be limited to annual revenues. As a result, the benefits that can be paid under current law are substantially below those that are scheduled to be be paid. Thus, benefits can be projected in two ways: as “payable benefits,” which reflect the limits imposed by the availability of balances in the trust funds, or as

scenario, benefits would exceed dedicated revenues by about 28 percent.  A commonly used measure of the sustainability of a program that has a trust fund and a dedicated revenue source is its actuarial balance over a given period; that is, the sum of the present value of tax revenues and the current trust fund balance minus the sum of the present value of outlays and a target balance at the end of o f the period.10 For 8. Those projections do not incorporate the ec economic onomic effects effects of of the two scenarios. 9. For information about about C CBO’ BO’ss projec projections tions of of total income ttaxes axes under the two scenarios, see Chapte Chapterr 6. For details on the impact of differing assumptions about income taxes on Social Security benefits, see Congressional Budget Office, The Outlook for Social Security  (June  (June 2004), Box 3-1. 10. To account for the difference between the trust fund’s current current balance and the desired balance at the end of the period, the balance at the beginning is added to the projected tax revenues and an additional year of costs at the end of the period is added to projected outlays. The present value is a single number that expresses a flow of current and future income or payments in terms of an equivalent lump sum received or paid today.

scheduled benefits, which reflect the benefit formulas scheduled specified in law, regardless of the trust funds’ balances. This report uses the latter approach, which is consistent  with a long-standing requirement that that CBO, in its baseline projections, assume that laws are implemented as specified and that funding for entitlement programs is adequate adequate to make all payments. payments.12  11. Under bot both h scenarios, CBO anticipates th that at the Disability Insurance Trust Fund will be exhausted in 2017. According to the extended-baseline extended-bas eline scenario, the Old-Age and Survivors Insurance Trust Fund will be exhausted in 2040; under the alternative fiscal scenario, it will be exhausted in 2038. However, this document focuses on the combined trust funds. In 1994, the annual report of the Social Security Trustees projected that the DI trust fund  would be exhausted exhausted in 19 1995. 95. That outcome outcome was prevented b byy legislation that redirected revenues from the OASI trust fund to the DI trust fund. In part par t because of that experience, it is a common analytical convention to consider the DI and OASI trust funds as combined. 12. Section 257 of the B Balanced alanced Budget and Emerg Emergency ency Deficit Control Act of 1985 specified the rules for generating baseline projections.. Although that statutory requirement has expired, projections CBO continues to follow those baseline construction rules as requested by the House and Senate Committees on the Budget.

CBO  

CHAPTER FOUR

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 4-1.

Financial Measures for Social Security Under CBO’ CBO’ss Long-Term Long-Term Budget Scenarios Projection Period Projection (Calendar years)

Income Rate

Cost Rate

Actuarial Balance

As a Percentage of Taxable Payroll Extended-Baseline Scenario 

25 Years ( 2 011 t o 2 035)

1 5.3

15.4

- 0 .1

50 Years ( 2 011 t o 2 060) 75 Ye ars ( 2 011 t o 2 085)

1 4.5 1 4.3

15.6 15.9

- 1 .1 - 1 .6

Alternative Fiscal Scenario 

25 Ye ars ( 2 01 1 t o 2 035) 50 Ye ars ( 2 01 1 t o 2 06 0)

15.1 14.2

1 5.4 1 5 .6

- 0 .3 - 1 .4

75 Ye ars ( 2 01 1 t o 2 08 5)

13.9

1 5 .9

- 2 .0

As a Percentage of Gross Gro ss Domes Domestic tic Product Extended-Baseline Scenario 

25 Ye ars ( 2 01 1 t o 2 03 5) 50 Ye ars ( 2 01 1 t o 2 06 0) 75 Ye ars ( 2 01 1 t o 2 08 5)

5.6 5.4 5.3

5 .7 5 .8 5 .9

- 0 .1 - 0 .4 - 0 .6

Alternative Fiscal Scenario 

25 Ye ars ( 2 01 1 t o 2 03 5) 50 Ye ars ( 2 01 1 t o 2 06 0) 75 Ye ars ( 2 01 1 t o 2 08 5) Source Sou rce::

5.6 5.3 5.2

5 .7 5 .8 5 .9

- 0 .1 - 0 .5 - 0 .7

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Over the rele relevant vant periods, the income ra rate te is the present value of annual annual tax revenues (incl (including uding the initial trust fund balance), and the

 

55

cost rate is the present value of annual outlays (including the target trust fund balance at the end of the period), each divided by the present value of taxable payroll or gross d omestic product. The actuarial balance is the difference between between the income and cost rates. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table 1-1 on page 4.)

CBO

 

CHAPTER 

5  The Long-Term Long-Term Outlook for Other Federal Spending 

I

n 2010, just over one-half of federal spending went toward programs other than the major mandatory health care programs (Medicare, Medicaid, and the Children’s Health Insurance Program), Social Security, Security, and interest payments on debt held by the public. That category,  which is referred to in this report as other federal spending, includes discretionary programs funded through the annual appropriation process and mandatory programs (other than the health care programs and Social Security) that usually are funded according to underlying statutes that establish eligibility and payment standards. s tandards.1 This category of mandatory spending also includes the refundable portions of the earned e arned income tax credit and the child tax credit, which the budget records as outlays, and offsetting receipts such as Medicare premiums paid by beneficiaries and some other payments collected from the

relative to GDP after 2021, reaching 7.8 percent in 2035 under this scenario.  

In the alternative fiscal scenario, other federal spending for 2011 through 2021 is on a higher trajectory trajector y than in the 10-year baseline projections for reasons that are explained below, but it still declines to 9.1 percent of GDP in 2021. Beyond 2021, 2021, other spending stays at the same share sh are of GDP projected for 2021 ex except cept for Medicare Medicare premiums and certain payments by states to Medicare, which are projected separately; all told, such spending declines to 8.5 percent of GDP in 2035 under this scenario.

Other Federal Spending Over the

public.

Pastt Four Pas Four Decad Decades es

During the past 40 years, federal spending other than that for the major mandatory health care programs, Social Security, Security, and interest payments on the public debt has averaged 11 percent of GDP. Such spending declined from 14 percent of GDP in 1971 to 8 percent in the late 1990s, stayed close to 10 percent through 2008, and then spiked to more than 13 percent in 2009 before receding slightly to about 12 percent of GDP in 2010.

The Congressional Budget Office (CBO) projected other federal spending under under two scenarios, scenarios, an extendedbaseline scenario and an alternative fiscal scenario (see Fi Figur guree 5-1): 5-1): In the extended-baseline scenario, other federal spending for 2011 through 2021 equals the amounts in CBO’s 10-year baseline projections under current law. Given the assumptions that guide the baseline projections, such spending drops from 12.2 percent of gross domestic product (GDP) in 2010 to 8.3 percent in 2021. Beyond 2021, other spending stays at the same share of GDP projected for 2021 except that three components—Medicare premiums, certain payments by states to Medicare, and some refundable tax credits—are projected separately. Including those components, other federal spending declines slightly

 

Discretionary Spending  A distinct pattern in the federal budget since the 1970s 1970s has been the diminishing share of spending that is provided through annual appropriations. As a share of total federal spending, discretionary spending fell from 58 percent in 1971 to 39 percent in 2010. Measured relative to the size of the economy, economy, discretionary spending declined from 11.3 percent of GDP in 1971 to 9.3 percent in 2010.

1. For a discussion discussion of fe federal deral spe spending nding cate categories, gories, ssee ee Congressional Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years  2011 to 2021 (January 2021 (January 2011), Box 3-1.

Defense Discretionary Spending. Over the past four decades, defense discretionary spending has declined

CBO  

58

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 5-1.

Other Federal Spending Under CBO’s Long-Term Budget Scenarios

(Percentage of gross domestic product) 16

Ac Actu tual al

16

Pr Proj ojec ecte ted d

14

14

12

12

10

10

Alternative Fiscal Scenario

8

8

Extended-Baseline Scenario 6

6

4

4

2

2

0

0

1971

Source Sou rce::

1975

1979

1983

1987

1991

1995

1999

2003

2007

2011

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Other federal spending is all spending other than for the major mandatory health care programs, Social Security, and interest payments on debt held by the public. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table Table 1-1 on page 4.)

significantly,, on net, as a share of the economy (see significantly

associated with the federal government’s response to the

Fi Figur guree 5-2). 5-2). At the peak of the Vietnam War War in the late 1960s, that category of spending reached a peak of 9.5 percent of GDP. GDP. After 1975, it dropped to around 5 percent until the defense buildup between 1982 and 1986, when it averaged 6 percent. Defense spending then fell again relative to GDP after the end of the Cold Co ld War, War, to a low of 3.0 percent of GDP at the turn of the the century. century. In 2002, however, however, spending began to climb again; it reached 4.7 percent of GDP in 2009 and 2010, 2010, mainly as a result of operations in Iraq and Afghanistan and related activities. Nondefense Discretionary Spending. Nondefense discre-

tionary spending—including spending for education, transportation, income security, veterans’ health care, and homeland security—totaled 4.5 percent of GDP in 2010. Over the past 40 years, nondefense discretionary spending has usually ranged between about 3 percent and 4 percent of GDP, GDP, although from 1976 to 1981 it averaged 5 percent of o f GDP. GDP. In the past two years, funding f unding from the American Recovery and Reinvestment Act of 2009 (Public Law 111-5), along with other funding

recent recession, helped boost that share.

Other Mandatory Spending  Mandatory spending other than for fo r Medicare, Medicaid, the Children’s Health Insurance Program, and Social Security totaled about 2.9 percent of GDP in 2010. The category includes unemployment compensation, federal civilian and military retirement benefits, the Supplemental Nutrition Assistance Program (formerly known as Food Stamps), veterans’ benefits, and other income security programs. The category also includes offsetting offsett ing receipts, such as Medicare premiums, the government’s contributions to the federal civilian and military retirement programs, and proceeds from energy leases on the Outer Continental Shelf. Other mandatory spending averaged almost 4 percent of GDP from the mid-1970s mid-1970s until the early-1980s. early-1980s. Then, between the mid-1980s and 2008, it moved up and down around an average of a little more than 2 percent pe rcent of GDP GDP.. In 2009, the amount of such spending relative to GDP more than doubled, doubled, to 4.7 percent, because of the

CBO  

CHAPTER FIVE

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Figure 5-2.

Other Federal Spending, Spending, by Category Category, 1971 to 2010

(Percentage of gross domestic product) 8

8

Defense Discretionary Spending 6

6

Nondefense Discretionary Spending

4

4

2

2

Other Mandatory Spending

0

0 1971

Source Sou rce::

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

Con Congre gressi ssiona onall Budge Budgett Office. Office.

Note: Other federal spending is all spending other than for the major m mandatory andatory health care programs, Social Se Security curity,, and interest payments on debt held by the public.

recession and the federal government’ government’ss response to it. Other mandatory spending then fell back to 2.9 percent of GDP in 2010; much of the change was attributable to unusually large negative outlays recorded for the TrouTrou-

 The Extended-Basel Extended-Baseline ine Scenar Scenario io In the extended-baseline scenario, CBO used the projections for other federal spending from its 10-year baseline for 2011 to 2021.2 In the baseline, funding for discretion-

 

59

bled Asset Relief Program (reflecting reductions in the estimated cost of the program) and deposit d eposit insurance (reflecting advance payments of premiums) and to a decline in payments to Fannie Fannie Mae and Freddie Mac (two institutions that facilitate the flow of funding for home loans nationwide). CBO’s projections do not include a recurrence of the very large negative outlays for the Troubled Troubled Asset Relief Program; other mandatory spending therefore is estimated to increase to 3.2 percent of GDP in 2011.

Projections of Other Federal Spending Under CBO’s Long-Term Budget Scenarios The extended-baseline scenario and the alternative fiscal scenario embody two possible paths for other federal spending. Under the extended-baseline scenario, other federal spending declines from 12.3 percent of GDP in 2011 to 7.8 percent in 2035; under the alternative fiscal scenario, it declines to 8.5 percent in 2035.

ary programs is projected to the grow at the rate of does inflation. Under the rules that govern baseline, CBO not make any other adjustments to discretionary spending; for example, no adjustment is made for spending that may be temporary, such as outlays for operations in  Afghanistan and Iraq. Because CBO CBO projects that GDP  will grow faster than the rate of inflation, discretionary discretionary spending declines as a share of GDP GDP,, from 9.1 percent in 2011 to 6.7 percent in 2021 (see Table 5-1). 5-1). In the baseline, mandatory programs are assumed to operate as they do under current law. Other mandatory spending is elevated now by the automatic increases in spending spe nding (for unemployment insurance and federal nutrition programs, for example) that occur during periods of economic  weakness.3 As the economy improves and that spending declines, other mandatory spending is projected to decline from 3.2 percent of GDP in 2011 to 1.6 per percent cent 2. CBO’s CBO’s most recent 10-year b baseline aseline projections projections were p published ublished in An in An Analysis of the President President’s’s Budgetary Budgetary Proposals for Fiscal Year Year  2012  (April   (April 2011). 3. See Cong Congress ressional ional Budg Budget et Offic Office, e, The Effects of Automatic Stabilizers on the Federal Budget  (April  (April 2011).

CBO  

60

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 5-1.

CBO’s Baseline Projections CBO’s P rojections of Other Oth er Federal Federal Spendi Spending  ng  (Percentage of gross domestic product) Discretionary Spending Discretionary Defen se spe nd i ng Nondefense Nondefens e spending Ed uc ucat iio on , em p plloym e en n t, t, and soci a all services Transport at i on Income securit y Hea lt h A dmi nist rat i on of j ust i ce Ve t era ns' bene fi t s Inte rna ti on al affai rs Ot he r Subtotal Total Discretionar y Spending Other Mandatory Spending Ci vi l ian and mi l ita ry ret i re men t Une mpl oyme nt comp en sat i on Nut ri ti on prog rams Ea rned income an d chi ld t ax credi t s Ve t erans' be nefi t s Su pp l eme nt a l Se curi t y In com e

20 11

20 2 1

4.7

3 .6

0.8 0.6 0.5 0.4 0.4 0.4 0.3  1.0

0 .5 0 .4 0 .3 0 .3 0 .3 0 .3 0 .3 0 .7

4.4

3 .1

9.1

6.7

1.0 0.8 0.6 0.5 0.5 0.4

0 .8 0 .3 0 .4 0 .2 0 .4 0 .3

0.5 percent of GDP in 2011 and are projected to increase increase at the same rate as gross Medicare outlays. As those offsetting receipts rise, total spending falls. In addition, the refundable portions of the earned income tax credit and the child tax credit, which the budget records as outlays,  were modeled as part of the projections of total federal revenues. Those outlays are expected to equal 0.5 percent p ercent of GDP in 2011 but are projected to fall with the 2012 expiration of the temporary increase in the child tax credit and then to decline even more over time as incomes rise. CBO projects that the outlays for refundable tax credits will be 0.2 percent of GDP by 2021. Because of the projected changes in those components, other federal spending is projected to decline to 7.8 percent of GDP in 2035.

 The Alternative Alternative Fisca Fiscall Scenario In the alternative fiscal scenario, the projections of other federal spending during the next 10 years differ from f rom 4 such spending in the baseline.  First, all discretionary spending is assumed to grow with GDP rather than with inflation. In addition, whereas the baseline carries for ward the current amount amount of spending for operations in Iraq and Afghanistan, the alternative fiscal scenario incorporates an assumption that there will be a reduction in in the number of U.S. military personnel deployed abroad

Offse t t i ng recei pt s Ot he r Total Other Mandatory Spending All Other Other F Federal ederal Spending Source Sou rce::

- 1.3  0.7

- 1 .3 0 .6

3.2

1.6

12.3

8.3

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: Other fed federal eral spending is all spending other than for the major mandatory health care pro grams, Social Security, and interest payments on debt held by the public.

in 2021. In all, other federal spending is projected to equal 8.3 percent of GDP in 2021—its lowest share since the 1930s. Under the extended-baseline scenario, most other federal spending after 2021 is assumed to remain constant as a share of GDP, GDP, although CBO modeled three components of that spending separately. Premiums Premiums paid by Medicare beneficiaries and certain payments by states to Medicare (both classified in the budget as offsetting receipts, which are recorded as negative outlays) are estimated to total

and therefore a reduction reduction in spending spending for overseas military operations. Given those two differences, other fedf ederal spending is projected to equal 9.1 percent of GDP in 2021 2021.. Under the alternative fiscal scenario, other federal spending after 2021 is modeled in the same way as it is under the extended-baseline scenario. Specifically, Specifically, other federal spending is assumed to consume a constant share of GDP except for projected changes in Medicare premiums and certain payments by states to Medicare. (In this scenario, after 2021, total federal revenues and refundable tax credits remain a constant share of GDP.) In all, other federal spending is projected to decline to 8.5 percent of GDP by 2035 2035.. 4. For more discussion of th these ese alternative assumptions, see Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011 to 2021, 2021 , “Alternative Paths for Discretionary Spending,” pp. 79–81.

CBO  

CHAPTER 

6

 The Long-Term Long-Term Outlook for Revenues Revenues

F

ederal revenues come from various sources, including individual and corporate income taxes, social insurance (payroll) taxes, excise taxes, estate and gift

and the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152). In addition, the ongoing economic recovery,, real (inflation-adjusted) growth in incomes over recovery

taxes, and other taxes and fees. Currently, Currently, proceeds from fro m individual income taxes and payroll taxes account for more than 80 percent of the federal government’s revenues.

the long run, and the interaction of the tax system with inflation would cause revenues to grow more rapidly than GDP. GDP. Taking Taking all of those factors together, revenues  would rise from about 15 percent of GDP in 2011 2011 to nearly 19 percent in 2013, 2013, about 21 percent percent in 2021, and about 23 percent percent in 2035, 2035, for a total increase increase of more than 8 percentage percentage points points over over that period period (see Figure igure 6-1). 6-1). By 2035, the tax system would be quite difd ifferent from what it is today. Households at all points on the income scale would pay a higher share of their income in taxes than similar households pay today, today, and a much larger share of households—nearly half—would be sub ject to the AMT. AMT.2

Predicting the amount of revenues that will be collected in the future is difficult because revenues are sensitive to economic developments and because policymakers frequently make changes to tax law. This analysis examines revenues under two sets of assumptions about future f uture policy—the extended-baseline scenario and the alternative fiscal scenario.

The extended-baseline is based on theinassumption that the provisionsscenario of current law remain effect,  which is the same assumption that underlies the Congressional Budget Office’s (CBO’s) 10-year baseline projections. Under that scenario, the tax cuts that were enacted since 2001 and most recently extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 tax act, Public Law 111-312) are assumed to expire as scheduled in 2012 or 2013. In addition, the exemption amounts for the individual alternative minimum tax (AMT) revert to their 2001 levels in 2012.1  Under the extended-baseline scenario, revenues would rise considerably over time as a share of gross domestic product (GDP). The scheduled expiration of various tax reductions would boost receipts, as would the scheduled tax increases enacted in March 2010 in the Patient Patient Protection and Affordable Care Act (PPACA, P.L. 111-148) 1. In recent recent years, years, the Congress Congress has has enact enacted ed temporary temporary incr increase easess in the AMT exemption amounts; the most recent increase is scheduled to expire at the end of 2011.

The alternative fiscal scenario, by contrast, 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. For revenues, the scenario embodies the continuation of certain tax policies that have now been in place for a number of years. Specifically, Specifically, nearly all of the tax provisions scheduled to expire over the next 10 years—including the tax cuts enacted since 2001 and most recently extended by the 2010 tax act—are assumed to be extended through 2021; the sole exception is the temporary payroll tax cut enacted in the 2010 tax act, which is assumed to expire as scheduled after 2011. Therefore, under that scenario, individual income tax provisions and the tax rates and 2. The long-ter long-term m revenu revenuee projec projections tions re reflec flectt the bench benchmark mark assumption that economic conditions are stable after 2021; thus, they exclude the effects of rising marginal tax rates on people’s behavior. (The marginal tax rate is the rate that would apply to an additional dollar of a taxpayer’s income.) See Cha Chapte pterr 2 for an analysis of the economic impact of the fiscal policies and marginal tax rates under the extended-bas extended-baseline eline and alternative fiscal scenarios.

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62

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 6-1.

 Total  Total Revenues Under CBO’s Long-Term Long-Term Budget Scenarios (Percentage of gross domestic product) 25

Actu ctual

25

Proj rojecte cted

Extended-Baseline Scenario

20

20

Alternative Fiscal Scenario

15

15

10

10

5

5

0

0

2000

Source Sou rce::

2005

2010

2015

2020

2025

2030

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: The extended-baselin extended-baseline e scenario adheres closely to current current law, law, following following CBO’s 10-year baseline baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table 6-1.)

effective exemption amounts for the estate and gift taxes scheduled to be in effect in 2012 would be extended, along with the relief from the AMT that is in effect in

that average at different times but have typically returned to somewhere near the average, suggesting that changes in policy have offset the effects of other aspects of the tax

2011 as well as all corporate and miscellaneous tax provisions scheduled to expire in the next decade (see Table 6-1). 6-1).  After 2021, the alternative fiscal scenario is based based on the assumption that tax policy evolves over time to maintain total revenues at the share of GDP reached in 2021,  which CBO estimates to be 18.4 percent. percent. In constructing this scenario, CBO did not make assumptions about the specific changes in tax provisions that would be made by policymakers, except to assume that payroll taxes will be the same as under the extended-baseline ex tended-baseline scenario and that the effective marginal tax rates on capital and labor will remain constant at the levels they reach in 2021.3 Revenues have averaged 18.0 percent of GDP during the past four decades. They have moved above and below 3. For this scenario, scenario, CBO also assumes assumes that either th thee excise tax on certain health insurance plans with high premiums (enacted in the major 2010 health care legislation) remains in place or that other policies are adopted that cause taxable earnings to be the same share of total compensation as in the economic benchmark discussed in Ch Chapt apter er 2.

system that otherwise would have increased revenues relative to GDP over time. In the alternative fiscal scenario, those sorts of policy changes are assumed to continue, although with revenues at a slightly higher share of GDP   than their 40-year average. As a result, revenues would rise from about 15 percent of GDP in 2011 to 17 percent in 2013 and 18.4 percent in 2021 and beyond. Under that scenario, revenues would be considerably lower than those projected under the extended-baseline scenario—by more than 2 percent of GDP in 2021 and by about 5 percent of GDP in 2035.

Revenues Over the Past Pa st 40 Years Years Over athe pastof40 years, total of fe deral federal from high 20.6 percent GDPrevenues (in 2000)have to aranged low of 14.9 percent (in 2009 and 2010), averaging 18.0 percent,  with no evident trend over time (see Figure 6-2 on page 64). During that that period, however, however, the various sources of revenue have changed in importance. Individual income taxes, which account for about half of all revenues now, now, have varied from slightly more than 10 percent of GDP (in 2000) to slightly more more than 6 percent (in 2010).

CBO  

CHAPTER SIX

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 6-1.

 Assumptions About Revenues Underlying CBO’s CBO’s Long-Term Budget Scenarios Extended- Ba seline Sc enario Individual Income Taxes

As sc heduled under c urrent law

Alternative Fisc al Sc ena rio All prov isions sc heduled to ex pire in the next 10 y ears a arre extended through 2021, including the income tax reductions and AMT relief temporarily extended in the 2010 tax act; revenues remain constant as a share of GDP thereafter

a

Pay roll Taxes

As sc heduled under current law

As scheduled under current law

Corporat Corpo rate e Incom Income e Taxe Taxess

As schedul scheduled ed und under er curre current nt la law w through through 202 2021; 1;

All provisi provisions ons schedul scheduled ed to expire expire in the ne next xt 10 years are

remai remaini ning ng consta constant nt as a sha share re of GDP th ther erea eaft fter er

ext exten ende ded d tthro hroug ugh h2 202 021; 1; re reven venue uess remai remain n const constan antt as as a share of GDP thereafter

Exc ise Tax es

As sc heduled under c urrent law

All provisions sc heduled to ex pire in the next 10 y ears are extended through 2021; revenues remain constant as a share of GDP thereafter

Estate and G iifft Tax es

As sc heduled under c urrent law

The 2012 tax rates and ex emption amount (adjusted for inflation) continue through 2021; revenues remain constant as a share of GD P thereafter thereafter

Other Sources Sources of Revenue

As schedul scheduled ed under under current law throu through gh 2021;

All provisi provisions ons scheduled scheduled to expire in the next 10 years are

remai remaini ning ng consta constant nt as a sha share re of GDP th ther erea eaft fter er

ext exten ende ded d tthro hroug ugh h2 202 021; 1; re reven venue uess remai remain n const constan antt as as a share of GDP thereafter

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

 

63

Notes: The extended baseline scenario adheres clos closely ely to current law, law, following CBO s 10 year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. AMT = alternative minimum tax; 2010 tax act = Tax Relief, Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312); GDP = gross domestic product. a.

These assumptions are identical to those in the the seventh and eighth policy alternativ alternatives es in Congres Congressional sional Budget Office, Office, The Budget and Economic Outlook: Fiscal Years Years 2011 t o 2021  (January  (January 2011), Table 1-7.

Payroll taxes, which generate about one-third of total to tal revenues now, now, have grown from 4 percent to 6 percent of GDP over the past 40 years. (Those taxes consist primarily of payroll taxes credited to the Social Security and Medicare Hospital Insurance Trust Funds.) Corporate income taxes have fluctuated between about 1 and 3 percent of GDP since the 1970s, as have combined revenues from other sources. Some of the variation in the composition of total tax revenues has stemmed from interactions between the tax code and the economy. economy. For example, many excise taxes are levied on the quantity of a good purchased (for instance, cents per gallon of gasoline) as opposed oppo sed to a percentage of the price paid. Because those levies l evies are not

indexed for inflation, revenues derived from excise taxes have declined relative to GDP as the general level of of prices has risen. With individual income taxes, in contrast, receipts tend to grow relative to GDP in the absence of legislated tax reductions. That increase occurs because rising income tends to push a greater share of income into higher tax brackets (a phenomenon known as “reall bracket creep”). “rea creep”). Before 1984, when none of the parameters of the individual income tax were indexed for inflation, inflation by itself caused revenues to increase as a greater share of income was taxed at higher rates.4 Even 4. The parameters parameters of the tax syste system m are the am amounts ounts th that at define the various tax brackets, the amounts of the personal exemption and standard deductions, and tax rates.

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 6-2.

Revenues, by Source, 1971 to 2010 (Percentage of gross domestic product) 25

25

20

20

Total

15

15

10

10

Individual Income Taxes

Social Insurance (Payroll) Taxes

5

5

Corporate Income Taxes 0

0 1971

Source Sou rce::

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

since 1984, when many of the parameters of the tax system have been indexed for inflation, growth in real income has caused a greater share of income to be taxed at higher rates (and because not all of the parameters of

that new provisions of law will go into effect ef fect as scheduled. The specific assumptions are the following:  

The provisions of the Economic Growth and Tax

Relief Reconciliation Act of 2001 (EGTRRA), the  Jobs and Growth Growth Tax Tax Relief Reconciliation Act Act of 2003 (JGTRRA), and the American Recovery and Reinvestment Act of 2009 (ARRA) that were extended by the 2010 tax act will expire as scheduled; 6

the tax system are indexed for inflation, rising prices have continued to have some effect). Tax revenues as a share of GDP have also varied over time as a result of legislative changes. In the past 40 years, lawmakers have enacted at least a dozen pieces of o f legislation that have raised or lowered revenues by at least 0.5 percent of GDP per year.

Revenue Projections Under CBO’s CBO’s Long-Term Long-T erm Budget Scenarios

 

The AMT exemption amounts will return to their 2001 amounts in 2012, as scheduled, and the parameters of the AMT will not be indexed for inflation; and

The extended-baseline scenario and the alternative fiscal scenario embody two possible paths for revenues over

Tax increases scheduled to go into effect eff ect in future years as a result of the 2010 health care legislation will be implemented as specified in current law law.. Such increases include new taxes on earnings and invest-

future decades. CBO’s assumptions about particular revenue sources under the two scenarios are summarized in Table 6-1. 6-1.

ment income (beginning in 2013) and a new tax on certain employment-based health insurance plans with high premiums (beginning in 2018).

 The Extended-Baseli Extended-Baseline ne Scenari Scenario o The extended-baseline scenario follows current law, beginning with CBO’s 10-year baseline projections for fo r 5 revenues from March 2011.  As was the case with the March baseline, the scenario is based on the assumption that certain tax provisions will expire as scheduled and

 

In the extended-baseline scenario, current law is assumed to remain in place indefinitely after 2021, extending 5. See Cong Congress ressional ional Budg Budget et Offic Office, e,   An An Ana Analysis lysis of the President President’s’s Budgetary Proposals for Fiscal Year 2012  (April   (April 2011). 6. Those three laws are Public Laws 10 107-16, 7-16, 108-27, 108-27, and 11 111-5. 1-5.

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CHAPTER SIX

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 6-2.

Sources of Growth in Total Revenues as a Share of GDP Between 2011 and 2035 Under CBO’s Extended-Baseline Scenario Percentage of GDP

Source of Growth Impact of Economic Recovery on Individual Income Taxes Expiring Individual Income Tax Pr Provisions, ovisions, Inc Including luding t he A MT New Tax Provisions Provisions Enacted in t he 2010 Health Care Legislation Other Structural Structural F eatures of the Income Tax System (Including real brack bracket et creep) Demographic Trends Other Factors (Including corporate, corporate, payroll, excise, and estate and gift ta xes)a Growth in Total Revenues over the 2011–2035 Period Source Sou rce::

0.9 2.9 1.2 1.8 0.5  1.1 8.4

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-baseline scenario adheres clos closely ely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table Table 6-1 on page 63.) “Real bracket creep” refers to the phenomenon in which rising real (inflation-adjusted) income causes an ever-larger proportion of income to be subject to higher tax rates. GDP = gross domestic product; AMT = alternative minimum minimum tax. a.

Excludes Excludes the effects effects of provisions provisions enacted enacted in the 2010 healt health h care legisl legislatio ation. n.

those baseline assumptions for the rest of o f the long-term

continues to recover, with most of that growth coming

 

65

projection period. Under those assumptions, tax revenues  would sharply increase in the next few years and then then continue to rise more slowly s lowly relative to GDP, GDP, by a total of 8.4 percentage points between 2011 and 2035. The individual income tax system would be responsible for much of the increase in the ratio of total revenues to GDP because of the various ways in which its structure interacts with the economy. Under the extended-baseline scenario, individual income tax receipts would rise as a share of GDP by 6.6 percentage points between 2011 and 2035. That projected increase reflects several factors, f actors, including the ongoing economic recovery; the assumed expiration of tax-relief provisions that were extended by the 2010 tax act; scheduled future tax increases enacted

from individual income taxes. Certain sources of income that had been unusually small during the downturn (for instance, capital gains realizations) are expected to recover and return to levels consistent with an economy slowly moving closer to its long-term path for growth. Under the extended-baseline scenario, the effects of the recovery  would increase revenues revenues from individual income taxes as a share of GDP by a total of o f 0.9 percentage points through 2035, CBO estimates; most of that would occur by 2015 (see Table 6-2). 6-2).

in 2010 healthstructural care care legislation; growi ng impact thethe AMT AMT; ; various featuresthe of o fgrowing the income tax of system; and demographic trends. Total Total revenues would also increase relative to GDP because of the assumption that the estate tax rates and exemption amounts in 2013  will be those scheduled to be in effect before the temporary changes enacted in 2001 and 2010 and because of certain other factors.

since 2001 and extended by the 2010 tax act are scheduled to expire after December 31, 2012. If that happens as scheduled, certain features of the tax code would revert to prior law: Tax Tax rates would rise, the value of some tax credits would decrease, other credits would expire, and thresholds for certain tax rates would change. Those changes would raise receipts as a share of GDP in 2013 and beyond.

Economic Recovery. CBO anticipates that revenues will grow faster than GDP in 2012 and 2013 as the economy

 Another factor that would increase increase revenues relative to GDP under the extended-baseline scenario is the growing 

Expiring Individual Income Tax Provisions, Including  the AMT. AMT. If left unchanged, certain aspects of current tax law would also cause an increase increase in individu individual al income tax revenues relative to GDP. GDP. Most of the provisions enacted

CBO  

66

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 6-3.

Individual Income Tax Revenues Under CBO’s Extended-Baseline Scenario and Two Variants (Percentage of gross domestic product) 14

14

13

13

12

12

Extended-Baseline Scenario

11

11 10

10

Variant 2: All Expiring Provisions,

9

9

Including AMT Relief, Extended

8

8

Variant 1: All Expiring Provisions Except AMT Relief Extended

7

7

6

6

0

0

2011

Source Sou rce::

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The extended-baseline scenario adheres clos closely ely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept concept for the rest of the long-term projection period. (For details, see T Table able 6-1 on page 63.) AMT = alternative minimum tax.

impact of the AMT. AMT. The alternative minimum tax is a parallel individual income tax system that provides fewer exemptions, deductions, and rates than the regular income tax. Households must calculate the amount they owe under both the AMT and the regular income tax and then pay the higher amount.7 The parameters that determine the amount owed under the AMT are not indexed for inflation. Therefore, as inflation increases people’s people’s income over time, more taxpayers become subject to the  AMT and that tax claims a larger share of GDP. The effects of the expiration of tax provisions enacted since 2001 and extended by the 2010 tax act and of the growing reach of the AMT can be identified by comparing CBO’s CBO’s projection of individual income tax revenues under the extended-baseline scenario, which follows current law, law, with two variants. The first variant is based on the assumption that policymakers will deviate from current law by permanently extending all the regular income tax provisions scheduled to expire in the next 7. Technically echnically,, a taxpaye taxpayerr owes the re regular gular income tax plus any amount that, under the AMT, exceeds the regular tax. For more information on the AMT, see Congressional Budget Office, The Individual Alternative Minimum Tax , Issue Brief (January 2010).

10 years but will not index the AMT for inflation; inflation; the second variant reflects the assumption assumption that policymakers policymakers  will extend those regular income tax provisions provisions and also index the AMT. Relative to the extended-baseline scenario, extending the regular tax provisions alone would lower individual income tax revenues by 1.4 percent of GDP in 2014 and 0.9 percent in 2035 (see Fi Figur guree 6-3). 6-3). The decline in revenues as a share of GDP would lessen over time for two reasons. First, the revenue reductions stemming from provisions allowing for accelerated depreciation of property would diminish over time as deferred revenues from prior years offset future-year deferrals. And second, the impact of the AMT would grow steadily: As a greater share of individual income taxes was paid through the  AMT,, the effect of extending the regular tax provisions  AMT  would diminish because many of those provisions do not benefit taxpayers who are subject to the AMT. AMT. Relative to the extended-baseline scenario, both extending the regular tax provisions of the 2010 tax act and permanently indexing the AMT for inflation would lower revenues from individual income taxes by 1.9 percent of GDP in 2014 and 2.9 percent in 2035. That

CBO  

CHAPTER SIX

effect would increase over time as cumulative inflation caused more taxpayers to be subject to the AMT under current law. New Tax Provisions Enacted in the 2010 Health Care Legislation. Under current law, the implementation of several provisions of the 2010 health care legislation  will raise revenues as a share of GDP. One key provision of the legislation is an excise tax starting in 2018 on certain high-premium health insurance plans. Under that provision, employment-based plans with premiums exceeding a specified threshold will generally be subject to an excise tax of 40 percent. That tax, which will be

levied on insurers but most likely passed on to their customers, will increase revenues in two ways. First, in those cases in which the tax applies, it will generate additional excise tax revenues. Second, many individuals and employers will probably respond to the presence of the excise tax by shifting to lower-cost insurance plans to reduce the excise tax paid or to avoid paying it altogether.  As a result, total payments of health insurance premiums premiums for those individuals will be less than they would have been in the absence of the tax. Because total compensation paid by employers would not be affected over the

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

$200,000 and on families with income in excess of $250,000. Those thresholds are not indexed for inflation. Because those new surtaxes would affect an increasing share of earnings and investment income over time, they  would boost revenues by a small but growing growing share of GDP over the years, CBO projects. Other provisions of the health care legislation would also raise revenues by a small amount as a share of GDP. Other Structural Features of the Income Tax System.   Even if the AMT was indexed for inflation and the tax provisions enacted since 2001 and temporarily extended by the 2010 tax act were made permanent, individual

income tax revenues would continue to rise as a percentage of GDP. GDP. Most of the parameters of the individual income tax apart from the AMT are indexed for inflation,  which prevents average tax rates rates from rising when incomes are increasing only with inflation. Rising real incomes, however, however, cause an ever-larger proportion of income to be subject to higher tax rates. Rising real incomes also increase taxes by reducing taxpayers’ eligibility for various credits, such as the earned income tax credit and the child tax credit. In addition, some provisions of the tax code are not indexed for inflation, so

 

67

long term, lower expenditures for health insurance would mean higher taxable wages for employees and, as a result,

cumulative inflation would generate some increase in receipts relative to GDP. GDP. All told, even if the AMT was

higher payments of income and payroll taxes. In CBO’s CBO’s estimation, whether policyholders pay the excise tax through higher premiums or avoid it by switching to lower-cost plans, total tax revenues will ultimately rise compared with what they would have been in the absence of the ne new w excise excise tax.

indexed and the expiring tax provisions were extended, growth in people’s incomes would increase income tax revenues relative to GDP by 1.8 percentage points between 2011 and 2035, CBO estimates.

 Although the threshold for the tax on high-premium health insurance plans is indexed for changes in overall consumer prices, health care costs will grow faster than prices over the long term, CBO projects; consequently consequently,, a greater share of premiums premiums would be subject to the excise excise 8  Accordingly,, CBO projects p rojects that the tax over time.  Accordingly excise tax would increase total revenues by more more than 0.7 percent of GDP in 2035 and higher percentages percentages thereafter.

Demographic Trends. Over the next few decades, the retirement of members of the baby-boom generation will also cause income tax revenues to increase as a share of GDP. Although certain contributions to retirement plans—such as 401(k) plans and individual retirement accounts—are tax-exempt when they are made and the income earned on assets in those accounts accounts is also also exempt from taxes, withdrawals from plans with deduct9

Last year’s year’s health care legislation also imposed additional taxes on earnings and on investment income, which will be assessed on individuals with income in excess of

ible contributions subject to taxation.  Likewise, compensation thatare is deferred under em ployer-sponsored employer-sponsored defined-benefit plans is not taxed when it is earned but is taxed when the benefits are paid. As baby baby boomers  withdraw money from retirement accounts accounts and receive pension benefits, those sums will boost taxable income to an increasing extent. Thus, the Treasury Treasury will receive

8. The thresholds thresholds are initially set in sstatute tatute for 2018 and are index indexed ed to general inflation plus 1 percent for 2019 and to general inflation for 2020 and subsequent years.

9. Contribut Contributions ions to certain certain oth other er 401(k) 401(k) plans and individua individuall retirement retireme nt accounts are not tax-deductible, but withdrawals from those accounts are untaxed.

CBO  

68

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

significant tax revenues that have essentially been deferred def erred for years, which will tend to boost tax receipts relative to GDP. GDP. As a result, under the extended-baseline scenario, revenues as a share of GDP would climb by about 0.5 percentage points between 2011 2011 and 2035. 2035. That upward trend will end in the mid-2030s, when essentially all of the baby boomers will have reached retirement, so beyond that point, revenues from taxable withdrawals  would no longer grow faster than GDP. Other Factors Affecting Revenue Projections. Factors besides those already discussed would also affect the

growth of federal revenues a share of GDP the extended-baseline scenario.asCBO projects thatunder corporate income tax revenues will rise as a share s hare of GDP over the next 10 years, reflecting an anticipated rebound during the continued economic recovery from their historically low share of GDP in 2011 and the expiration of provisions allowing for accelerated depreciation of property after 2012. Estate and gift taxes are projected to increase as a share of GDP after 2013. Starting in that year, year, the estate tax rate is scheduled to rise and the dollar amount of an estate that is exempt from taxation is set to fall to

 

 

 

Certain provisions enacted in EGTRRA, JGTRRA, and ARRA and subsequently extended by the 2010 tax act, including the $1,000 child tax credit, marriage-penalty relief, and lower tax rates for all taxpayers;  AMT relief, which which is scheduled to expire at the end of 2011 and which would be extended by indexing the 2011 exemption amount and tax brackets for inflation after 2011; Estate tax rates and exemption amounts scheduled to be in effect during 2012 and which would be extended by indexing the exemption amount for inflation after 2012 (rather than reverting to the rates and exemption amounts scheduled to apply in 2013 before the law was changed in 2001); and

 

 All other provisions scheduled to expire during the next decade, including a provision allowing for accelerated depreciation of property and the tax credit for f or 10 research and experimentation.

Under those assumptions, the growth in revenues

$1 million and will not be indexed for inflation; as a result, a greater share of wealth will become subject to the

between 2011 and 2021 would amount to less than 4 percentage points of GDP compared with the projected

tax over time. Excluding the excise tax on high-premium health insurance plans, excise taxes are projected to decline slightly as a share of GDP over time because many excise taxes are assessed as a fixed dollar amount per quantity of a good that is purchased and not as a percentage of the price paid for that good. Therefore, as the general price level rises over time, excise taxes tend to fall as a share of GDP. Finally, the expiration of the temporary payroll tax cut after 2011 will raise revenues as a share of GDP by about 0.5 percentage points. On balance, under current law, law, CBO projects that, apart from the effects e ffects of the 2010 health care legislation, revenue from corporate income taxes, estate and gift taxes, federal excise taxes, payroll taxes, and other miscellaneous sources would rise by a combined 1.1 percent of GDP between 2011 and 2035 and by a smaller amount thereafter thereafter..

increase of 6 percentage points under theinextendedbaseline scenario. The projected growth receipts is largely attributable to factors that also matter in the extended-baseline scenario: the anticipated economic recovery over the next few years and the rise in estate, gift, and corporate tax receipts.

 The Alternative Alternative Fisca Fiscall Scenario The alternative fiscal scenario is based on the assumptions that certain tax policies that are scheduled to expire will be extended through 2021 and that tax policies will be adjusted so that revenues remain at a constant share of GDP thereafter. Specifically, Specifically, the following policies are assumed to be extended:

For the alternative fiscal scenario, CBO assumes that after 2021, a series of changes in the tax code will be enacted to offset certain factors that under the extended-baseline scenario would increase revenues over time relative to GDP; as a result, revenues remain constant as a share of GDP. GDP. The chief features of the current tax system that  would cause revenues to rise are real bracket bracket creep, tax parameters that are not indexed to inflation, an increase in taxable withdrawals from retirement accounts, and the long-term growth of the excise excise tax on certain highhighpremium health insurance plans. Under this scenario, revenues would reach 18.4 percent of GDP in 2021 and remain at that level through 2035, about 5 percentage points less in that year than under the extended-baseline scenario. 10. The sole exce exception ption is the temporary payroll tax cut enacted enacted in the 2010 tax act, which is assumed to expire as scheduled after 2011.

CBO  

CHAPTER SIX

Long-Term Implications for Tax Rates and the Tax Burden The tax system that would be in place under either the extended-baseline scenario or the alternative fiscal scenario would differ, in a variety of ways, from the current system. Under the extended-baseline scenario, inflation and income growth over many years would force many more taxpayers to pay the AMT, AMT, push up marginal and average tax rates, and cause the dollar value of o f some tax parameters to fall sharply in real terms and even more sharply relative to incomes. Changes to the tax system stemming from the expiration of provisions enacted since 2001 andand extended bytax therates. 2010Astaxa result act would boost marginal average o f allalso of of those changes, people at various points on the income scale  would pay a larger percentage of their income in taxes than people at the same points pay today, today, and many taxpayers would have diminished incentives to work and save. In the alternative fiscal scenario, CBO assumes that unspecified policy adjustments will be made after 2021 to keep revenues constant as a share of GDP. GDP. A wide range

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

at the end of 2012 of the income tax cuts extended by the 2010 tax act—the AMT would affect 18 18 percent of households, CBO projects. In 2013, 2013, the share of households affected by the AMT is estimated to fall to 11 percent because of the expiration of the income tax cuts extended by the 2010 tax act. In subsequent years, the share of households who owed more under the AMT than under the regular tax would gradually rise. By 2035, nearly half of the nation’s nation’s households would be subject to the alternative tax. The AMT would also account for an increasing share of individual income tax liability over time. By 2035, roughly 12 percent of individual income tax liability  would be attributable to the AMT, AMT, compared with less than 4 percent in both 2011 and 2013 (see Fi Figur guree 6-4). 6-4). Because taxpayers’ liability under the AMT is calculated as the excess amount over the regular tax owed, the  AMT’ss contribution to income tax receipts is much  AMT’ smaller than the share of people affected aff ected by the tax. Under the extended-baseline scenario, both the share of households subject to the AMT and the share of income

 

69

of policy alternatives could produce that outcome, and the specific choices that might be made would have significant effects on the economy and on the share of income paid in taxes by people at various income levels.11   As a result, CBO assessed the long-term implications of the extended-baseline scenario for tax rates and the tax burden but could not assess the corresponding implications for the alternative fiscal scenario.

Impact of the AMT  If current law regarding the AMT remained unchanged, as assumed in the extended-baseline scenario, the alternative minimum tax would ultimately affect aff ect a significant share of taxpayers. Just 3 percent of households will pay the AMT in 2011—the last year in which temporarily higher exemption amounts are in effect under current law.. However, law in 2012—following expiration of  AMT relief at the end of 2011 but the before the expiration 11. As noted earlier in the chapte chapter, r, the only specific specific assumptions that CBO made about tax provisions in the alternative fiscal scenario in the long run were payroll taxes would be the same as under the extended-baseline extended-b aseline scenario, effective marginal tax rates on capital and labor would remain constant at the levels they reach in 2021, and either the excise tax on certain health insurance plans with high premiums (enacted in the March 2010 health care legislation) would remain in place or other policies would be adopted to keep taxable earnings at the same share of total compensation as in the economic benchmark discussed in Ch Chapt apter er 2.

tax revenues attributable to that tax would continue to rise after 2035. Sometime around 2060, revenues generated by the AMT are projected to level off as a share of GDP as real bracket creep caused a greater share of income to be subject to the top marginal rate under the regular income tax. (Less bracket creep would occur under the AMT because most of the income subject to the AMT would be taxed at the top AMT rate by then.) Therefore, the amount of additional tax liability under the AMT would decline as the amount of tax calculated under the regular tax rose. The AMT would continue to apply to many taxpayers, but the additional revenues attributable to it would diminish relative to GDP.

Marginal Tax Rates on Income from Labor Lab or and Ca Capit pital al  With the expiration of AMT relief and the temporary payroll tax reduction after 2011, marginal tax rates on income from labor would rise considerably under the extended-baseline scenario. CBO estimates that under that scenario, the marginal tax rate on labor income  would increase by about 3 percentage points between 2011 and 2012 with the expiration of AMT relief and the temporary payroll tax reduction after 2011 (see Table 6-3). 6-3). In 2013, the marginal tax rate on labor income would rise by another percentage point because of the expiration of tax provisions extended by the 2010 CBO

 

70

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure 6-4.

 The Impact of the Alternative Minimum Tax on Individual Income Tax Tax Liability Under CBO’s Extended-Baseline Scenario (By calendar year, in percent) 60

60

50

50

40

40

Share of Households Affected by the AMT

30

30

Additional Liability Generated by theIndividual AMT as a Share of Total Income Tax Revenues

20

20 10

10

0

0 2011

Source Sou rce::

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The shares of households and revenues rise in 2012 after the temporary increase in the AMT exem exemption ption expires. After 2012, the shares initially fall because the amount of regular income tax owed rises with the expiration of certain provisions of the Tax Tax Relief, Unemployment Insurance Reauthorization, Reauthorization, and Job Creation Act of 2010 (Public Law 111-312).

The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept concept for the rest of the long-term projection period. (For details, see T Table able 6-1 on page 63.) AMT = alternative minimum tax.

tax act and the introduction of the additional tax on earnings over $250,000. Between 2013 and 2035, the marginal tax rate on labor income would increase by an additional 6 percentage points. That increase includes the impact of real bracket creep under the regular income tax, the effects of the AMT reaching a rising number of taxpayers, and the growing impact of both the additional tax on earnings and the excise tax on certain high-premium health insurance plans that is due to take effect eff ect in 2018.12 The marginal tax rate on capital income under the extended-baseline scenario would rise by about 8 percentage points between 2011 and 2013 following the expiration of certain provisions enacted since 2001 (most notably those allowing for more rapid depreciation of property) and the introduction of the additional tax on on investment income over $250,000. Marginal rates on capital income would remain roughly the same between 12. The additional ta taxx on earnings will apply to a gr greater eater share of labor income over time because the $250,000 threshold will not be indexed for inflation. Likewise, the excise tax on certain highpremium plans will affect a larger share of compensatio compensation n over time because health costs are projected to rise faster than the threshold for the tax, which will increase with general prices.

2013 and 2035 because the impact of real bracket creep and the expanding reach of the AMT would have little effect on the tax rate on capital income. (After 2013, a large share of capital income would already be taxed at the top rate.) The increase in the marginal tax rate on labor would reduce people’s people’s incentive to work, and the increase in the marginal tax rate on capital would reduce their incentive to save. However, the reduction in earnings and savings from higher taxes would create an incentive to work and save more, if people wished to maintain the same amount of after-tax income and savings. On net, evidence suggests that the former effects eff ects typically prevail and thus that higher marginal tax rates tend to discourage some economic activity. activity. The overall effect ef fect of taxes on economic activity would depend not only on those marginal tax rates but also on future budget deficits and therefore the amount of debt the government held relative to the size of the economy—as analyzed in Chap Chapte terr 2 of this report.

 Average  Ave rage T Tax ax Rates o on nT Typical ypical Ho Households useholds Over the coming decades, average tax rates will increase because the cumulative effect of rising prices will sharply

CBO  

CHAPTER SIX

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

Table 6-3.

Estimates of Effective Marginal  Tax  Tax Rates Under CBO’s ExtendedBaseline Scenario (Percent) 2011

2012

2013

2035

Margi nal Tax R ate on Labor Income

25

28

29

35

Margi nal Tax R ate on Capit al Income

12

14

20

20

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: The effectiv effective e federal marginal tax ra rate te on income from labor labor is the share of the last do llar of earnings in the economy that is taken by federal indivi individual dual income and payroll taxes. The effective federal marginal tax rate on income from capital is the share of the last dollar of such income that is taken by federal individual and corporate income taxes. The extended-baseline scenario adheres closely to current law law,, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-t erm projection period. (For details, see

The fact that most tax parameters are not indexed for real income growth and that some are not even indexed for inflation has significant implications over the long term. Parameters Paramete rs such as the personal exemption, standard deduction, and the amount of the child tax credit decline relative to income over time, causing tax rates as a share s hare of income to rise. Because the relative decline in the value of those parameters is larger relative to income for lower-income taxpayers, they see a greater increase in their income taxes as a share of income as this occurs. Under current rules for indexing tax parameters, individual income taxes as a share of income would grow by varying amounts for households at different points in the income scale. For example, a typical couple with two children, earning the median income of $95,700 (including both cash income and other compensation) in 2011 and filing a joint tax return, will pay about 4 percent of their income in individual income taxes this year (see law,, a similar Table 6-4). 6-4).13 By 2035, under existing tax law couple earning the median income would pay 12 percent

 

71

Table 6-1 on page 63.)

reduce the value of some parameters of the tax system that are not indexed for inflation. Under the extendedbaseline scenario, CBO estimates that the estate tax exemption, which will be $1 million in 2013 under current law, law, would be worth about $600,000 (in 2011 dollars) by 2035; the same is true for the amount of mortgage debt eligible for the mortgage interest deduction, which is also limited to $1 million under current law.. The portion of Social Security benefits subject to taxlaw ation would increase from about 30 percent now to about 50 percent by 2035, CBO estimates, because the t he thresholds for taxing benefits are fixed in nominal terms. Even tax parameters that are indexed for inflation would lose value relative to income over the long term. The current $3,700 personal exemption is projected to rise by almost 70 percent by 2035 because it is indexed for inflation, but income per household is projected to more than double during that period, so the value of the exemption relative to income would decline by about 30 percent.  Without legislative changes, the proportion of taxpayers claiming the earned income tax credit would fall from 16 percent this year to 1 11 1 percent in 2035 2035 as growth in real income moved more taxpayers out of the eligibility range for the credit.

of their income in individual income taxes, an increase of 8 percentage points. By comparison, comparison, if the same same couple earned four times the median income, the share of income that they would pay in individual income taxes  would rise from 18 percent in 2011 2011 to 22 percent by 2035, an increase of 4 percentage points. After 2035, income taxes as a share of income would continue rising at both income levels—but again, by a greater proportion for the couple earning the median income. T Taxes axes as a share of income for households at various other points in the income distribution would also be very different d ifferent than they are today. Despite rising average tax rates, households in the future f uture  would have higher after-tax income than similar households at the same point on the income distribution have today because of growth in real income. For example, from 2011 to 2035, real after-tax income for a typical couple earning the median income is projected to grow by 37 percent under the extended-baseline exte nded-baseline scenario, despite the increase in taxes as a share of income. The growth in pretax income would more than offset the increase increase in ta taxes. xes. 13. In the example examples, s, all income receive received d by taxpayers is assumed to be from compensation. For details about the calculations, see Table 6-4.

CBO  

72

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Table 6-4.

Individual Income and Payroll Taxes as a Share of Income Under CBO’ss Extended-Baseline Scenario CBO’ Cash Income (2011 dolla dollars) rs)

Total Income ( 2011 dollar s)

Taxes as as a Share of Income Under th the e Extended-Baseli Extended-Bas eline ne Scenario (Percent) Income Income and Taxes Payroll Taxes

Taxpayerr F ili Taxpaye iling ng a Single Return Half the Median Income 20 11 20 35

1 1,6 00 1 5,4 00

17,3 00 26,3 00

* 3

10 12

Median Income 20 11 20 35

2 7,7 00 3 9,1 00

34,7 00 51,8 00

6 8

19 19

Twice the Median Income 20 11 20 35

5 9,9 00 8 6,4 00

69,400 102,800

10 14

23 27

12 5,4 00 18 3,3 00

138,700 205,000

14 20

26 32

Four Times the Median Income 20 11 20 35

Married Couple with Two Children Filing a Joint Return Half the Median Income 20 11 20 35

a

3 1,6 00 4 3,1 00

47,8 00 73,8 00

-9 4

1 13

Median Income 20 11 20 35

7 6,0 00 10 8,5 00

95,7 00 144,2 00

4 12

16 24

Twice the Median Income 20 11 20 35

16 4,9 00 23 9,3 00

191,300 285,400

11 19

24 32

Four Times the Median Income 20 11 20 35

35 0,5 00 51 3,5 00

382,600 568,200

18 22

28 32

Source:

Congressional B Budget udget Office based on data from the March 2010 Current P Population opulation Survey Survey..

Notes: All income is assumed to be from compensa compensation, tion, which includes employm employment-based ent-based health insurance and the employer’s employer’s share of payroll taxes. For 2035, the premium on employment-based health insurance is assumed not to exceed the excise tax threshold set forth in the Patient Protection and Affordable Care Act of 2010 (Public Law 111-148), as amended by the Health Care and Education Reconciliation Reconcil iation Act of 2010 (P.L. 111-152). 111-15 2). Tax Taxpayers payers are assumed to itemize if implied itemized deductions are greater than the standard deduction. State and local taxes are assumed to be 8 percent of wages; other deductions are assumed to be 15 percent of wages. Taxes in 2011 exclude the effect of the temporary payroll tax cut in effect for that year, enacted in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312). The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept concept for the rest of the long-term projection period. (For details, see T Table able 6-1 on page 63.) * = between zero and 0.5 percent. a.

The examples examples fo forr the married married couple as assume sume that that each spou spouse se earns e equal qual inc income. ome.

CBO  

 A P P E N D I X 

A

Changes in CBO’s Long-Term Projections Since June 2010

espite some changes in estimating assumptions and new data, the long-term projections of federal revenues, outlays, and debt presented in this report are generally similar to the ones that the Congressional Budget Office (CBO) published in 2010.1 As in last year’s report, the analysis focuses on two scenarios. s cenarios. Under the extended-baseline scenario, which adheres closely to current law, revenues revenues and outlays would both grow steadily as a share of gross domestic product (GDP) in coming

D

discretionary spending—was assumed to remain at its 2010 share of GDP (minus (minus stimulus and related spending) under the alternative fiscal scenario. In this year’ss analysis, discretionary spending is assumed to year’ grow at the same rate as GDP through 2021 (but is adjusted for an assumed decrease in the number of U.S. military personnel deployed overseas), and mandatory spending is assumed to follow CBO’ CBO’ss baseline projections (declining as a share of GDP through

decades. As a result, debt would increase slowly as a percentage of GDP, GDP, although at higher levels than seen throughout most of U.S. history. The alternative fiscal scenario incorporates several changes to current law that are widely expected expect ed to occur or thattowould some provisions that might be difficult sustainmodify for a long period. Under that scenario, revenues as a share of GDP would remain close to their historical average, but outlays would grow steadily steadily.. Consequently, Consequently, as in last year’ss report, debt would increase sharply from its already year’ high level in coming years, reaching percentages of GDP unprecedented in the United States.

New Assumptions About Spending and Revenues

2021). After 2021, as in last year s report, other noninterest spending is assumed to remain constant relative to GDP (except ( except for Medicare’s Medicare’s offsetting receipts,  which are projected to increase over over time).  

 

 Although the conclusions of the long-term analysis are similar, CBO has updated several of its assumptions about spending and revenues since the 2010 report:  

In the alternative fiscal scenario, other noninterest spending is a lower percentage of GDP. In last year’ss report, most spending other than for Social year’ Social Security,, major mandatory health care programs, and Security interest—that is, other mandatory spending and all

1. See Congr Congressi essional onal Budget Budget O Office ffice,, The Long-Term Budget Outlook   (June 2010, revised August 2010).

In the alternative fiscal scenario, Medicare’s payment rates to doctors remain constant through 2021.  In the 2010 report, the rates that Medicare uses to pay physicians were assumed to grow with the Medicare economic index under the alternative fiscal scenario. In this year’s report, CBO assumes that those payment rates will remain fixed at their 2011 levels through 2021. In the extended-baseline scenario, outlays for Protection exchange subsidies are lower. The Patient Protection and Affordable Care Act of 2010 (Public Law 111148) creates insurance exchanges, starting in 2014, through which consumers can compare health plans and, if eligible, receive federal subsidies to help cover the cost of health insurance premiums. Last year, CBO assumed for both of its long-term scenarios that the percentage of people eligible for fo r exchange subsidies would be relatively stable over time and that the average subsidy would remain a constant share of plan premiums in the long run. This year, CBO uses the same assumptions for the alternative fiscal scenario. For the extended-baseline scenario, s cenario, however, however, CBO

CBO  

74

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

assumes that the percentage of people eligible for fo r subsidies will decline, because incomes are projected projected to increase more quickly than the eligibility thresholds. CBO also assumes that the subsidies will cover a decreasing share of plan premiums over the years. (For more information, see Ch Chap apte terr 3.)  

In the alternative fiscal scenario, a broader range of  tax provisions is is assumed to be extended. extended. Both this year and last year, the alternative fiscal scenario incorporated the assumption that tax provisions due to expire in the next few years would instead be extended through the 10-year period covered by CBO’s most recent baseline. In last year’s report, only tax provisions that formed the basis for “current-policy “current-policy”” adjustments specified in the Statutory Pay-As-You-Go Pay-As-You-Go Act of 2010 were were assumed to be be extended through that 2 period.  The extended provisions consisted of tax changes enacted since 2001 (for all but the highestincome taxpayers), relief from the alternative minimum tax (AMT), and the rates and exemption

causes. First, CBO has raised its long-term projection of immigration, which implies faster growth in the labor force. Second, CBO has increased its projection of how fast the capital stock will grow over the long run, because it now assumes that the prices of capital goods will grow more slowly than assumed in the 2010 report.  

Projections of the share of compensation that  workers receive as wages are higher. higher. The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010

(Public Law 111-152) establish an excise plans tax onwith certain employment-based health insurance premiums above a specified threshold, beginning in 2018. Some individuals and employers are likely to respond to that tax by shifting to less les s expensive plans, thereby reducing the share of total compensation that takes the form of health insurance premiums and boosting the share paid as cash wages. This year, CBO has raised its estimate of how many people will shift to

amounts for the estate tax in effect during 2009 (indexed for inflation in later years).3 For this report, by comparison, CBO assumes that in the alternative fiscal scenario, all tax provisions scheduled to expire in the next 10 years (except the temporary payroll tax reduction in effect for 2011) will be extended extended through 2021.

cheaper health insurance plans in response to the tax. That change in turn increases the amount of earnings subject to payroll taxes and—because Social Security benefits are based on taxable earnings—the amount of outlays for Social Security Security.. A further implication is that real wage growth growth is now projected to average average 1.4 percent over the long long run, up from 1.3 percent in the 2010 report.

New Projections of Economic Variables The economic projections that underpin the current long-term budget outlook are largely similar to those used last year, but CBO has updated its projections for the growth of output and the composition of employees’ employees’ compensation. (The new projections are explained in more detail in Chap Chapte terr 2.)  

Projections of GDP growth are slightly higher.  In this year’ss analysis, real (inflation-adjusted) GDP is proyear’  jected to grow at an average rate of 2.2 percent a year over the long term, compared with the 2.0 percent rate projected last year. year. That increase has two main

2. Inf Informa ormation tion abou aboutt the curre current-po nt-policy licy adjus adjustmen tments ts appear appearss in section 7 of title I of Public Public Law 111-139. 111-139. 3. Although the SStatutory tatutory Pay-As-Y Pay-As-You-Go ou-Go Act Act provided provided for the extension of the 2009 estate tax parameters and AMT relief only through 2011, CBO assumed that both of those policies would continue through 2020 under last year’s alternative fiscal scenario.

Changes in Projections Under the Extended-Baseline Scenario Compared with the previous long-term outlook, CBO’s current projections of primary (noninterest) spending under the extended-baseline scenario are slightly higher over the next few years and similar thereafter (see the top panel of Fi Figur guree A-1). A-1).4 The near-term difference stems mainly from higher projections of discretionary d iscretionary spending and of mandatory spending for programs p rograms other than major health care programs and Social Security. Security. Projected spending for Medicaid is slightly lower because of revisions to CBO’s 10-year baseline, and projected spending for exchange subsidies grows more slowly because of the change in assumptions discussed above. As a result, the current projection of mandatory federal spending on 4. Longer-t Longer-term erm ve version rsionss of some of the the figur figures es in this chapt chapter er are presented in Appendix in Appendix B.

CBO  

 APPENDIX A

CBO’S 2011 2011 LONG-T LONG-TERM ERM BUDGET OUTLOOK 

Figure A-1.

Comparison of CBO’s 2010 and 2011 Budget Projections Under the Extended-Baseline Scenario (Percentage of gross domestic product) Primary Spending and Revenues 30

30

25

25

20

20

Spending 15

Revenues

2010 Projection

2010 Projection

2011 Projection

2011 Projection 10

10

0

0 2011

15

2015

2019

2023

2027

2031

2035

75

Federal Debt Held by the Public

200

200

175

175

150

150

125

125 100

100

2011 Projection 75

75

2010 Projection

50

50 25

25

0

0 2011

Source Sou rce::

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The extended-baseline scenario adheres closely to current law, law, following CBO’s baseline budget projections for the first 10 years and then extending the baseline concept for for the rest of the long-term projection period. (For details, see Table Table 1-1 on page 4.)

health care is lower than last year’s year’s projection after 2017 (see Fi Figu gure re A-2). A-2). Total revenues are expected to be much lower over the next few years than CBO projected in 2010, largely because of the temporary extension of tax cuts enacted since 2001. After 2013, this year’s and last year’s

projections of total revenues revenues are nearly identical. Within that total, however, the outlook for various revenue sources has changed: As noted above, CBO assumes that a larger share of policyholders will choose lower-cost health insurance plans in response to the excise excise tax on certain employment-based plans, which will increase the share of compensation paid in wages. As a result, CBO

CBO  

76

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure A-2.

Comparison of CBO’s 2010 and 2011 Projections of Mandatory Federal Fede ral Spending on Health Care Under the Extended-Baseline Scenario (Percentage of gross domestic product) 10

10

9

9 8

8

2010 Projection 2011 Projection

7

7

6

6

5

5

4

4

0

0

2011

2015

2019

2023

2027

2031

2035

Source Sou rce::

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: The extended-baselin extended-baseline e scenario adheres closely to current current law, law, following CBO’s baseline budget projec projections tions for the first 10 y years ears and then extending the baseline concept for for the rest of the long-term projection period. (For details, see Table Table 1-1 on page 4.)

has raised its projections of revenues from income and

also lower than last year’s year’s projection, because payment

payroll taxessince and reduced projection of revenues from excise taxes last year’s year’sitsreport.

rates physicians are assumed to remain flat through 2021for instead of growing in line with the Medicare economic econ omic index.

Because of the larger deficits projected for fo r the next several years under the extended-baseline scenario, debt held by the public would grow to 75 percent of GDP by 2013, compared with the 66 percent previously projected for that year (see the bottom panel of Figure igure A-1). A-1). As in last year’ss report, debt year’ d ebt would grow very gradually as a share of GDP in the following decades.

Changes in Projections Under the  Alternative Fiscal Scenario Except for the next few years, primary spending as projected under the alternative alternative fiscal scenario scenario is lower in this year’s year’s report than projected last year; by 2035, it is 1.5 percent of GDP lower (see the top panel of Fi Figur guree A-3). A-3). Most of that decrease results from the differing assumptions about other noninterest spending discussed above. In addition, projected spending for Medicaid, the Children’s Health Insurance Program, and exchange subsidies is lower this year primarily because of lower projected Medicaid spending at the end of the current 10-year baseline. Projected outlays for Medicare are

Revenues under the alternative fiscal scenario are now projected to be lower throughout the long-term period than CBO projected in 2010. In the short term, the difference occurs because revenues are are estimated to be 2.1 percent of GDP lower lower in 2011 than projected last year,, for a variety of legislative and other reasons. In year later years, the difference stems from the assumption that a broader range of temporary tax provisions provisions will be extended through 2021. Starting in that year, projected revenues are 0.9 percent of GDP lower than in last year’s year’s report. Debt held by the public is now projected to grow even faster in the next decade under the alternative fiscal scenario than CBO projected last year (see the bottom panel of Figure A-3). By 2021, it would exceed exceed 100 percent of GDP, GDP, 10 percentage points higher than projected in 2010. In later years, debt would follow a path similar to  what CBO projected last year, year, reaching almost 190 percent of GDP in 2035, effectively the same level as projected projec ted previously previously..

CBO  

 APPENDIX A

CBO’S 2011 2011 LONG-T LONG-TERM ERM BUDGET OUTLOOK 

Figure A-3.

Comparison of CBO’s 2010 and 2011 Budget Projections Under the  Alternative Fiscal Scenario (Percentage of gross domestic product) 30

Primary Spending and Revenues

30

25

25

20

20

15

10 0

Spending

Revenues

2010 Projection

2010 Projection

2011 Projection

2011 Projection

15

10 0

77

2011

2015

2019

2023

2027

2031

2035

Federal Debt Held by the Public

200

200 175

175

150

150

2011 Projection

125

125 100

100

75

75

2010 Projection 50

50

25

25 0

0 2011

Source Sou rce::

2015

2019

2023

2027

2031

2035

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The alternative fiscal scenario incorporates incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult difficult to sustain for a long period. (For details, see T Table able 1-1 on page 4.)

CBO

 

 A P P E N D I X 

B Long-Term Projections Through 2085 T

his appendix presents longer-term versions of severall figures severa figures that appear in Chap Chapte terr 1 and Appendix  and Appendix A   of this report. The longer-term figures show the Congressional Budget Office’s Office’s projections of categories of primary (noninterest) spending, total revenues, and debt held by

the public through 2085 under the extended-baseline scenario and the alternative alternative fiscal scenario. scenario. The data underlying the figures are included in the supplementary data posted along with this report on CBO’s CBO’s Web site (  www.cbo.gov  www.cbo.gov ))..

CBO  

80

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure B-1.

Primary Spending and Revenues, by Category, Category, Under CBO’ C BO’ss Long-Term Budget Scenarios Scenarios Through Through 2085 (Percentage of gross domestic product) Extended-Baseline Scenario

35 30

Actua ctuall Total Primary Spending

35

Proje roject cte ed

30

Revenues 25

25 20

Other Noninterest Spending

15

15 10

20

Medicare, Medicaid, CHIP, and Exchange Subsidies

5

10 5

Social Security 0

0

1970

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

2080

Alternative Fiscal Scenario

35

Actua ctuall Total Primary Spending

30

35

Pro Proje ject cte ed 30

Revenues

25

25

Other Noninterest Spending

20

20

15

15

Medicare, Medicaid, CHIP, and Exchange Subsidies

10

10 5

5

Social Security 0

0 1970

Source Sou rce::

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

2080

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The extended-baseline scenario adheres closely to current law, law, following CBO’s 10-year baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table Table 1-1 on page 4.) CHIP = Children’s Health Insurance Program.

CBO  

 APPENDIX B

CBO’S 2011 2011 LONG-T LONG-TERM ERM BUDGET OUTLOOK 

Figure B-2.

Federal Debt Held by b y the Public Under CBO’s CBO’s Long-Term Budget Scenarios  Through 2085 (Percentage of gross domestic product) 200

200

Actu ctual

Proje roject cte ed 175

175 150

Alternative Alternati ve Fiscal Scenario

150

125

125

100

100

75

Extended-Baseline Scenario

75

50

50

25

25

0

0

81

1970

Source Sou rce::

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

2080

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Note: The extended-baselin extended-baseline e scenario adheres closely to current current law, law, following following CBO’s 10-year baseline baseline budget projections through 2021 and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal fiscal scenario incorporates several changes to current law that are widely widely expected to occur or that would modify some provisions that might be difficult t o sustain for a long period. (For details, see Table Table 1-1 on page 4.)

CBO  

82

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Figure B-3.

Comparison of CBO’s 2010 and 2011 Budget Projections Under the Extended-Baseline Scenario Through 2085 (Percentage of gross domestic product) 35

Primary Spending and Revenues

35

30

30

25

25

20

15

10

Spending

Revenues

2010 Projection

2010 Projection

2011 Projection

2011 Projection

20

15

10

0

0

2011

2021

2031

2041

2051

2061

2071

2081

Federal Debt Held by the Public

200

200

175

175

150

150

125

125 100

100

2011 Projection 75

75

2010 Projection

50

50 25

25

0

0 2011

Source Sou rce::

2021

2031

2041

2051

2061

2071

2081

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The extended-baseline scenario adheres closely to current law, law, following CBO’s baseline budget projections for the first 10 years and then extending the baseline concept for the rest of the long-term projection period. In the 2011 projection under this scenario, federal debt held by the public is lower as a percentage of GDP in the later decades of the projection period mainly because of lower projected spending on Medicaid and on insurance subsidies that will be provided through the exchanges created by the March 2010 health care legislation. As discussed in Appendix A, projected spending for Medicaid is lower because of revisions to CBO’s 10-year baseline, and projected spending for exchange subsidies grows more slowly because of changes in assumptions about the long-term evolution of eligibility for exchange subsidies and the size of the average subsidy. subsidy.

CBO  

 APPENDIX B

CBO’S 2011 2011 LONG-T LONG-TERM ERM BUDGET OUTLOOK 

Figure B-4.

Comparison of CBO’s 2010 and 2011 Budget Projections Under the  Alternative Fiscal Scenario Through 2085 (Percentage of gross domestic product) 35

Primary Spending and Revenues

35

30

30

25

25

20

20

15

15

Spending

Revenues

10

2010 Projection

2010 Projection

10

5

2011 Projection

2011 Projection

5

83

0

0

2011

2021

2031

2041

2051

2061

2071

2081

Federal Debt Held by the Public

200

200

175

175

150

150

125

125

2011 Projection

100

100

2010 Projection

75

75

50

50

25

25

0

0

2011

Source Sou rce::

2021

2031

2041

2051

2061

2071

2081

Con Congre gressi ssiona onall Budg Budget et Off Office ice..

Notes: Primary spending ref refers ers to all spending other than in interest terest payments on federal debt. The alternative fiscal scenario incorporates incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period. Reasons that CBO’s projections under that scenario changed between 2010 and 2011 are are discussed in Appe Appendix ndix A.

CBO

 

Glossary 

his glossary defines economic and budgetary terms as they apply to CBO’s 2011 Long-Term Budget Outlook; it Outlook; it also acts as a general reference for readers. In some cases, the entries sacrifice technical precision for the sake of brevity and clarity. clarity. Where appropriate, entries note the

T

boost aggregate demand in response to the recession that began at the end of calendar calendar year 2007. 2007. It provided provided appropriations for a variety of federal programs pro grams and increased or extended some benefits from Medicaid, unemployment compensation, and nutrition assistance

sources of data for economic variables as follows:  B

 B

BEA refers to the Bureau of Economic Analysis in the Department of Commerce, BLS refers to the Bureau of Labor Statistics in the Department of Labor,

 B

 B

CBO refers to the Congressional Budget Office, and NBER refers to the National Bureau of Economic Research (a private entity).

A

ggregate demand: Total purchases by consumers, businesses, governments, and foreigners of a country’s country’s output of final goods and services during a given period. (BEA) alternative minimum tax (AMT): A tax intended to limit the extent to which higher-income people can reduce their tax liability (the amount they owe) through the use of preferences in the tax code. Taxpayers Taxpayers subject to the AMT must recalculate their tax liability on the basis of a more limited set of exemptions, deductions, and tax credits than would normally apply. apply. The amount by which a taxpayer’s taxpayer’s AMT calculation exceeds his or her regular tax calculation is that person’s AMT liability.

 American Recovery Recovery and Reinvestment Act of 2009 (ARRA, Public Law 111-5): This law was intended to

programs, among others. ARRA also reduced individual and corporate income taxes and made other changes to tax law. appropriation act: A law or legislation under the jurisdiction of the House and Senate Committees on Appropriations that provides authority for federal programs or agencies to incur obligations and make payments from the Treasury. Each year, the Congress considers regular appropriation acts, which fund the operations of the federal government for the upcoming upcoming fiscal year. year. The Congress may also consider supplemental, deficiency deficiency,, or continuing appropriation acts (joint resolutions that provide budget authority for a fiscal year until the regular appropriation for that year is enacted). authorization act: A law or legislation under the jurisdiction of a committee other than the House and Senate Committees on Appropriations that establishes or continues the operation of a federal fed eral program or agency, agency, either indefinitely or for a specified period. An authorization act may suggest the budget authority needed to fund the program or agency, agency, which is then provided in a future appropriation act. However, However, for some programs, the authorization itself may provide the budget authority. authority. automatic stabilizers: Provisions in law that decrease revenues and increase expenditures when the economy goes into a recession (and vice versa when the economy expands) without requiring any new action on the part of the government. Stabilizers tend to reduce the depth of recessions and dampen expansions.

 

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

B

alanced Budget and Emergency Deficit Control Act of 1985 1985 (Public Law 99-177): Referred to in CBO’s CBO’s reports as the Deficit Control Act, it also has been known as Gramm-Rudman-Hollings. Gramm-Rudman-Hollings. Among other changes to the budget process, the law established rules that governed the calculation of CBO’s CBO’s baseline. In addition, it set specific deficit targets as well as procedures to reduce spending if those targets were exceeded. The law expired on September 30, 2006. However, CBO contin-

ues to follow the methodology methodolo gy prescribed in the law for establishing baselines. budget authority: Authority provided by law to incur financial obligations that will result in immediate or

following the peak), whereupon it starts to ri rise se again, defining a new cycle. Business cycles are irregular, varying in frequency, frequency, magnitude, and duration. (NBER)

C

apital: Tangible  Tangible and intangible resources that can be used or invested to produce a stream of benefits over time. Physical capital —also —also known as fixed as fixed capital  or  or the capital stock —consists —consists of land and the stock of products

set aside tobusiness supportinventories f uture production future andgoods  consumption, including and capital  (residen (residential and nonresidential structures and producers’ durable equipment). Human capital  is  is the education, training,  work experience, and other attributes that enhance enhance the ability of the labor force to produce goods and services.

future outlays of federal government funds. Budget authority may be provided in an appropriation act or authorization act and may take the form of a direct appropriation of funds from the Treasury Treasury,, borrowing authority, contract authority, entitlement authority, or authority to obligate and expend offsetting collections or receipts. Offsetting collections and receipts are classified as negative budget authority. authority. budget function: One of 20 general-subject categories into which budgetary resources are grouped so that all budget authority and outlays can be presented according to the national interests being addressed. There are 17 broad budget func functions, tions, including national defense, international affairs, energy, agriculture, health, income security,, and general government. Three other funcsecurity tions—net interest, allowances, and undistributed offsetting receipts—are included to complete the budget.

The capital  of  of a business is the sum advanced and put at risk by the business’s owners: For example, ex ample, bank capital   is the sum put at risk by the owners of a bank. In an an accounting sense, capital is a business’s business’s net worth wor th or equity—the difference between its assets and liabilities. Financial capital  is  is wealth held in the form of financial instruments (such as stocks, bonds, and mortgages) rather than held directly in the form of physical ph ysical capital. capital gains and losses:  The increase or decrease in the value of an asset that comes from f rom the increase or decrease in the asset’s asset’s market price after its purchase. A capital gain or loss is “realized” when the asset is sold. capital income: Income that is derived from capital, such as stock dividends, realized capital gains, an owner’s owner’s profits from a business, or the interest paid to holders of debt. Compare with labor income. income. 

budget year: See fiscal year. year. capital services: A measure of how much the stock of budgetary resources: All sources of authority provided to federal agencies that permit them to incur financial obligations, including new budget authority, unobligated balances, direct spending authority, and obligation limitations. business cycle: Fluctuations in overall business activity accompanied by swings in the unemployment rate, interest rates, and corporate profits. Over a business cycle, real activity rises to a peak (its highest level during the cycle) and then falls until it reaches a trough (its lowest level

physical capital contributes to the flow of production. compensation: All of the income due to an employee for his or her work during a given period. pe riod. In addition to  wages, salaries, bonuses, and stock options, compensation includes fringe benefits and the employer’s employer’s share of payp ayroll taxes for social insurance programs, such as Social Security. (BEA) conservatorship: The legal process by which an external entity (in the case of Fannie Fannie Mae and Freddie Mac, the

 

GLOSSARY

federal government) establishes control and oversight of a company to put it in a sound and solvent condition. constant dollar: A measure of spending or revenues in a given year that has been adjusted for differences in prices (such as inflation) between that year and a base year. Compare with current dollar and nominal nominal..  consumer price index (CPI): An index of the cost of living commonly used to measure inflation. The Bureau of

Labor publishes CPI-U, an index sumer Statistics prices based on the the typical market basketofofcongoo ds goods and services consumed by all urban consumers, and the CPI-W,, an index of consumer prices based on the typical CPI-W market basket of goods and services consumed by urban

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

cover. Such debt is held by outside investors, including cover. the Federal Reserve System. Other measures include debt held by government accounts  (debt  (debt issued for internal government transactions, to trust funds and other federal accounts, and not traded in capital markets), gross markets), gross federal debt  (the  (the sum of debt held by the public p ublic and debt held by government accounts), and debt subject to limit  (which  (which is subject to a statutory ceiling that applies to gross federal debt, with the exception of a small portion of the debt issued by the Treasury Treasury and the small amount of debt issued by other federal agencies, such as the Tennessee Tennessee Valley Authority and the Postal Service). Securities issued by Fannie Mae and Freddie Mac are not included in any of those measures of debt.

 

87

 wage earners and clerical workers. (BLS) consumption: In principle, the value of goods and services purchased and used up during a given period by households and governments. In practice, the Bureau of Economic Ana Analysis lysis counts purchases purchases of many longlasting goods (such as cars and clothes) as consumption even though the goods are not used up. Consumption by households alone is also called personal called personal consumption expenditures  or  or consumer spending.  spending.  cost-of-living adjustment: An annual increase in payments payme nts to reflect inflation. inflation. current dollar: A measure of spending or revenues in a given year that has not been adjusted for differences d ifferences in prices (such as inflation) between that year and a base year.. Compare with constant dollar and real year real.. 

debt service: Payment of scheduled interest obligations on outstanding debt. deficit: The amount by which the federal government’s total outlays exceed its total revenues in a given period, typically a fiscal year. year. Compare with surplus surplus..  Deficit Control Act: See Balanced Budget and Emergency Deficit Control Act of 1985.  direct spending: Synonymous with mandatory spending , direct spending is the budget authority provided by laws other than appropriation acts and the outlays that result from that budget authority. (As used in CBO’s 2011 Long-Term Budget Outlook , direct spending refers only to the outlays that result from budget authority provided in laws other than appropriation acts.) Compare with entitlement .

current year: The fiscal year in progress.

D

ebt: In the case of the federal government, the total value of outstanding bills, notes, bonds, and other debt instruments issued by the Treasury Treasury and other federal agencies. Debt held by the public  consists  consists primarily of securities that the Treasury Treasury issues to raise cash to fund f und the operations and pay off the maturing liabilities of the federal government that tax revenues are insufficient to

discount rate:ofThe interest rate used the present value future payments (suchtoascompute for pension plans). Alternatively, Alternatively, the discount rate is the interest rate that the Federal Reserve System charges on a loan it makes to a bank through its so-called discount d iscount window window.. Such loans, when allowed, enable a bank to meet its reserve requirements without reducing its lending. discretionary spending: The budget authority that is provided and controlled by appropriation acts and the outlays that result from that th at budget authority. authority.

 

88

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

E

conomic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, Public Law 107-16):  Legislation that significantly reduced tax liabilities (the amount of tax owed) between 2001 and 2010 by cutting individual income tax rates, increasing the child tax credit, repealing estate taxes, raising deductions for married couples who file joint returns, increasing tax benefits for pensions and individual retirement accounts, and creating additional tax benefits for education. EGTRRA

Labor’s Current Employment Statistics Survey), which Labor’s measures employment as the estimated number of nonfarm wage and salary jobs. (Thus, a person with more than one job may be counted more than once.) The other estimate comes from the so-called household survey (the Census Bureau’s Current Population Survey), which measures employment as the estimated number of people employed. (Thus, someone with more than one job is counted only once.) The establishment survey covers only people on the payrolls of nonagricultural establishments, whereas the broader household survey includes

phased in many of those changes, including some that  just became fully effective in 2010. Although Although initially slated to expire on or before December 31, 2010, many of the law’s provisions have been extended temporarily or made permanent. For legislation that modified

self-employed workers, agricultural workers, unpaid  workers in family-owned businesses, and employees employees of private households. However, the household survey is based on a smaller sample than the establishment survey is and therefore therefore yields a more volatile estimate

provisions of EGTRRA, see Jobs and Growth Tax Relief Reconciliation Act of 2003 and Tax Relief, Unemployment Insurance Reauthorization, and Job Creation  Act of 2010. economic stimulus: Federal fiscal or monetary policies aimed at promoting economic activity, activity, used primarily during recessions. Such policies include reductions in

taxes, increases federalfor in interest rates, and otherin support fospending, r financialreductions markets and institutions. effective tax rate: The ratio of taxes paid p aid to a given tax base. For individual income taxes, the effective tax rate is typically expressed as the ratio of taxes paid to adjusted gross income. For corporate income taxes, it is the ratio of taxes paid to domestic economic profits. For some purposes—such as calculating an overall tax rate on all income—an effective tax rate is computed on a base that includes the untaxed portion of Social Security benefits, interest on tax-exempt bonds, and similar items. It can

also bebycomputed on aincome base of o fand personal income as measured the national product accounts. The effective tax rate is a useful measure because the tax code’s code’s various exemptions, credits, deductions, and tax rates make actual ratios of taxes paid to income different from statutory tax rates. Compare with marginal tax rate and statutory tax rate. employment: Wo  Work rk performed or services s ervices rendered in exchange for compensation. Two estimates of employment are commonly used. One comes from the so-called establishment survey of employers (the Department of

of employment employment.. entitlement: A legal obligation of the federal government to make payments to a person, group of people, business, unit of government, or similar entity that meets the eligibility criteria set in law and for which the budget authority is not provided in advance in an appropriation act. Spending for entitlement programs is controlled through

those eligibility criteria andarebenefit or payments rules. programs’ The best-known entitlements the government’ major benefit programs, such as Social Security and Medicare. Compare with direct spending . estate and gift taxes: A linked set of federal taxes on estates, gifts, and generation-skipping transfers to tax t ax the transfer of wealth from one generation to the next and to limit the extent to which wealth can be given away during life to avoid taxation at death. excise tax: A tax levied on the purchase of a specific type of good or service, such such as tobacc tobaccoo products or air air

transportation services. expansion: A phase of the business cycle that begins  when gross domestic product exceeds its previous previous peak and extends until gross domestic product reaches its next peak. (NBER)

F

annie Mae (Federal National Mortgage  Association): A government-sponsored enterprise

 

GLOSSARY

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

founded during the Great Depression and federally chartered in 1968 as a shareholder-owned corporation that operates exclusively in the secondary market for resires idential mortgages (the market in which such mortgages are bought and sold). Fannie Fannie Mae provides liquidity to the mortgage market by purchasing qualifying mortgages from private lenders, pooling and securitizing them, and then selling them as mortgage-backed securities in the secondary market. The company also holds mortgagebacked securities and whole mortgages in its portfolio. po rtfolio. Since September 2008, Fannie Mae has been in federal

Freddie Mac (Federal Home Loan Mortgage Freddie Corporation): A government-sponsored enterprise founded in 1970 and federally chartered in 1989 as a shareholder-owned corporation that operates exclusively e xclusively in the secondary market for residential mortgages (the market in which such mortgages are bought and sold). Freddie Mac provides liquidity to the mortgage market by purchasing qualifying mortgages from private lenders, l enders, pooling and securitizing them, and then selling them as mortgage-backed securities in the secondary market. The company also holds mortgage-backed securities and

conservatorship.

 whole in itsin portfolio. Since September 2008, 2008, Freddiemortgages Mac has been federal conservatorship.

Federal Reserve System: The central bank of the United States. The Federal Reserve is responsible responsible for

 

89

setting the nations nation s monetary policy and overseeing creditt conditions. credi conditions. financing account: A nonbudgetary account required for a credit program (by the Federal Credit Reform Act of 1990) that reconciles subsidies calculated on an accrual basis with the cash flows associated with credit activities. The account tracks flows between the Treasury, the program account, and the public. The net cash flow in each financing account for a fiscal year is shown in the federal budget as an “other means of o f financing.” fiscal policy: The government’ g overnment’s tax and spending policies, which influence the amount and maturity of government debt as well as the level, composition, and distribution of national output and income. fiscal stimulus: Changes in tax rates or government spending intended to encourage economic activity activity.. Fiscal stimulus typically typically takes the form of temporary or permanent reduction reductionss in tax rates, or debt-financed debt-financed increases in the government’s government’s transfer payments p ayments or purchases of goods and services. fiscal year: A yearly accounting period. The federal government’ss fiscal year begins October 1 and ends Septemernment’ ber 30. Fiscal years are designated by the calendar years in  which they end—for example, fiscal year 2011 began began on October 1, 2010, and will end on September 30, 2011. The budget year  is  is the fiscal year for which the budget is being considered; in relation to a session of Congress, it is the fiscal year that starts on October 1 of the calendar year in which that session of Congress began.

G

eneral fund: One category of federal funds in the government’s government’s accounting structure. The general fund records all revenues and offsetting receipts not earmarked e armarked by law for a specific purpose and all spending financed by those revenues and receipts. government-sponsored enterprise: A financial institugovernment-sponsored tion created by federal law, law, generally through a federal charter,, to carry out activities such as increasing credit charter availability for borrowers, reducing borrowing costs, or enhancing liquidity in particular sectors of the economy, economy, notably agriculture and housing. grants: Transfer  Transfer payments from the federal government to state and local governments or other recipients to help fund projects or activities that do not involve substantial federal participation. gross debt: See debt .  gross domestic product (GDP):  The total market of goods and services produced domestically duringvalue a given period. That value is conceptually equal to gross domestic income, but measurement difficulties result in a statistical discrepancy between the two. The components of GDP are consumption (household and government), gross investment (private and government), and net exports. (BEA) gross national product (GNP): The total market value of goods and services ser vices produced during a given period by labor and capital supplied by residents of a country, country,

 

90

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

regardless of where the labor and capital are located. That value is conceptually equal to the total income accruing to residents of the country during d uring that period (national income). GNP differs from gross domestic product primarily by including the capital income that residents earn from investments abroad abroad and exc excluding luding the capital income that nonresidents earn earn from domestic investment.

capital  is  is spending on education, training, health services, and other activities that increase the productivity of the  workforce. Investment in human capital capital is not treated as investment by the national income and product accounts.

H

several tax reductions previously enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001.  JGTRRA also increased the exemption amount amount for the individual alternative minimum tax, reduced the tax

ealth Care and Education Reconciliation Act of 2010 (HCERA, Public Law 111-152): One of two laws enacted in March 2010 that made major changes to

J

obs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, Public Law 108-27): A law that reduced taxes by advancing to 2003 the effective date of

the U.S. health care and health insurance systems. HCERA amended many provisions that were created or amended by the Patient Protection and Affordable Care  Act, and it amended the Higher Education Act Act of 1965, replacing the federal program that provides guarantees for student loans with direct loans and increasing spending for the Pell Grant Grant program.

rates for income from dividends and capital capital gains, and expanded the portion of capital purchases that businesses could immediately deduct through 2004. The tax provisions were set to expire on various dates, and some of those provisions have been extended e xtended temporarily. (The law also provided roughly $20 billion for fiscal relief to sta states tes.) .)

nflation: Growth in a general measure of prices, usually expressed as an annual rate of change.

I

L

insurance exchange: Established in March 2010 by the Patient Protection Protection and Affordable Care Care Act and scheduled to begin operating in 2014. Each insurance exchange will serve as a marketplace in which consumers can compare premiums and benefits of health insurance plans available where they live. Each state’s exchange will verify eligibility for the program and help administer fedf ederal tax credits and subsidies that will reduce premiums

labor income: Income that is derived from employment,

abor force: The number of people age 16 or older in the civilian noninstitutionalized population who have jobs or who are available for work and are actively seeking jobs. (The civilian noninstitutionalized population excludes members of the armed forces on active duty and people in penal or mental institutions or in homes for the elderly or infirm.) The labor force participation rate is rate  is the labor force as a percentage of the civilian noninstitutionalized population age 16 or older ol der.. (BLS)

and cost-sharing requirements for certain individuals and families.

such as wages and salaries. Compare with capital income.

investment: Physical investment  is  is the current product set aside during a given period to be used for future production; an addition to the capital stock. As measured by the national income and product accounts, private accounts,  private domestic investment  consists  consists of investment in residential and nonresidential structures, producers’ durable equipment and software, and the change in business inventories. Financial investment  is  is the purchase of a financial security, security, such as a stock, bond, or mortgage. Investment in human

labor productivity: See productivity .  long-term interest rate: An interest rate associated with a security that matures in 10 or more years.

M

andatory spending: See direct spending . 

 

GLOSSARY

marginal tax rate: The tax rate that would apply to an additional dollar of a taxpayer’ taxpayer’ss income. Compare with effective tax rate and statutory tax rate.  means of financing: Means by which a budget deficit is financed or a surplus is used. Means of financing are not included in the budget totals. The primary means of of financing is borrowing from the public. In general, the cumulative amount borrowed from the public (debt held by the public) will increase if there there is a deficit and decrease if there is a surplus, although other factors can affect the amount that the government must borrow. borrow. Those factors, known as other means of financing , include reductions (or increases) in the government’s government’s cash balances, seigniorage, changes in outstanding checks,

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

income not consumed, publicly or privately, privately, during a given period. As measured by the Bureau of Economic  Analysis, national saving does not include unrealized unrealized capital capi tal gains or or losses. natural rate of unemployment: The rate of unemployment arising from all sources except fluctuations in aggregate demand. Those sources include frictional include frictional unemployment, which unemployment,  which is associated with normal turnover of jobs, and structural unemployment, which unemployment, which includes unemployment caused by mismatches between the skills of available workers and the skills necessary to fill vacant positions and unemployment caused when wages exceed their market-clearing levels because of institutional factors, such as legal minimum wages, the presence of

 

91

changes in accrued interest costs included in the budget but not yet paid, and cash flows reflected in credit financing financ ing accounts. accounts. monetary policy: The strategy of influencing the availability and cost of money and credit to affect output and inflation. An “easy” monetary policy attempts to reduce interest rates to increase aggregate demand, but it may lead to higher inflation. A “tight” monetary policy attempts to raise interest rates in the near term in order to reduce inflationary pressure pressure by lowering aggregate demand. The Federal Reserve System sets monetary policy in the United United States. States. monetary stimulus: An increase in the availability of (and hence a lower cost for) money and credit that is intended to encourage economic activity. activity. The Federal Reserve can lower short-term interest rates (and, to a more limited extent, long-term rates) by purchasing Treasury or other securities through its open-market operations. To To a more limited extent, it can provide stimulus by reducing the reserve ratio (the percentage

of assets that m member ember banks are are required to keep on deposit at the Federal Reserve) or by lowering discount rates (the rates at which it lends money to member banks).

N

ational saving: Total saving by all sectors of the economy: personal saving, business saving (corporate after-tax profits not paid as dividends), and government saving (budget surpluses). National saving represents all

unions, social conventions, or employers’ wage-setting practices intended to increase workers’ morale and effort. net interest: In the federal budget, net interest comprises the government’s government’s interest payments on debt held by the public (as recorded in budget function 900), offset by interest income that the government receives on loans and cash balances and by earnings of the National Railroad Retirement Investment Trust. nominal: A measure based on current-dollar value. Nominal  income  and  and spending  are  are measured in current dollars. The nominal interest rate  on  on debt is the promised dollar return, without an adjustment for inflation. The nominal exchange rate  is  is the rate at which a unit of one currency trades for a unit of another currency. currency. Compare  with constant dollar and real real.. 

O

ff-budget: Spending or revenues sometimes

excludedoffrom the budget totals bytrust law. funds The revenues and outlays the two Social Security (the Old Age and Survivors Insurance Trust Trust Fund and the Disability Insurance Trust Trust Fund) and the t he transactions of the Postal Service are off-budget (but are included in the total budget). offsetting collections and offsetting receipts:  Funds collected by government agencies from other o ther government accounts or from the public in businesslike or marketoriented transactions that are credited to an expenditure account (in the case of offsetting collections) or to a

 

92

CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

receipt account (in the case of offsetting receipts). Both types of collections are treated for budgetary purposes as negative budget authority and outlays. Collections that result from the government’s government’s exercise of its sovereign or governmental powers are ordinarily classified as revenues, although they are classified as offsetting collections or or offsetting receipts when a law requires it. other means of financing: See means of financing .  outlays: to payincurred a federalinobligation. Outlays may pay Spending for obligations a prior fiscal year or in the current year; hence, they flow partly from unexpended balances of prior-year budget authority and partly

able to some nonelderly people with modified adjusted gross income income between between 138 percent percent and 400 percent percent of the federal poverty level. People who have offers of coverage from their employer generally will not be eligible. present value: A single number that expresses a flow f low of current and future income (or payments) in terms of an equivalent lump sum received (or paid) today. The present value depends on the rate of interest (known as the discount rate) that is used to translate future cash flows

into current Forinterest example, $100 is invested on  January 1 at dollars. an annual annual rateif of 5 percent, it will grow to $105 by January 1 of the next year. Hence, at an annual 5 percent interest rate, the present value of $105

from budget authority provided for the current year. year. For most categories of spending, outlays o utlays are recorded on a cash accounting basis. However, However, outlays for interest on debt held by the public are recorded on an accrual accounting basis, and outlays for direct loans and loan guarantees reflect estimated subsidy costs instead of cash transacti transactions. ons. out-year: A fiscal year following the budget year.

P

atient Protection and Affordable Care Act (PPACA, Public Law 111-148): One of two laws enacted in March 2010 that made major changes to the U.S. health care and health insurance systems. Among its provisions, PPACA PPACA establishes a mandate for most legal residents to obtain health insurance, provides subsidies for health insurance, and expands Medicaid. It offset those costs with increased taxes and other revenues and reduced Medicare spending. The law also included several private health insurance market reforms and measures designed to enhance delivery and quality of care.

potential gross domestic product: The level of real gross domestic product that corresponds to a high level of resource (labor and capital) use. (Procedures for calculating potential GDP are described in CBO’s Method for Estimating Potential Output: An Update ,  August August 2001.) premium assistance credit: Beginning in 2014, a refundable tax credit for the purchase of health insurance through an insurance exchange. The credit will be avail-

payable a year from today is $100. primary deficit or surplus: The total budget deficit or surplus excluding net interest. productivity: Average real output per unit of input. Labor productivity  is  is average real output per hour of labor. The growth of labor productivity is defined as the growth of real output that is not explained by the growth of labor

input alone. Total factor productivity  is  is average real output per unit of combined labor and capital services. The growth of total factor productivity is defined as the growth of real output that is not explained by the growth of labor and capital. Labor productivity and total factor productivity differ in that increases in capital per worker raise labor productivity but not total factor productivity. (BLS)

R

eal: Adjusted to remove the effects of inflation. Real output  represents  represents the quantity, quantity, rather than the th e dollar value, of goods and services produced. Real income  repre represents the power to purchase real output. A real interest rate   is a nominal interest rate adjusted for expected inflation; it is often approximated by subtracting an estimate es timate of the expected inflation rate from the nominal interest rate. Compare with current dollar and nominal nominal.. recession: A significant decline in economic activity spread across the economy, lasting more than a few fe w months, and normally visible in production, employment, real income, and other indicators. A recession

 

GLOSSARY

begins just after the economy reaches a peak of activity and ends when the economy reaches its trough. (NBER) recovery: A significant, broad-based increase in economic activity that begins just after the economy reaches a trough of activity and ends when the economy reaches the level of its previous peak. revenues: Funds collected from the public that arise from the government’s government’s exercise of its sovereign or governmental

powers. Federal revenues come from a variety of sources, including individual and corporate income taxes, excise taxes, customs duties, estate and gift taxes, fees and fines, f ines,

CBO’S 2011 LONG-TERM BUDGET OUTLOOK

sustainable growth rate (SGR): The formula that determines updates to payment rates for physicians under the Medicare program. The SGR sets annual and cumulative spending targets for those payments. If total spending exceeds the targets, an across-the-board reduction is supposed to be made in future fees to bring spending back into line (both annually and cumulatively). Since 2003, however, however, the Congress and the President have overridden such reductions.

T

ax Relief, Unemployment Unemployment Insurance Reauthori-

 

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payroll taxes for social insurance programs, and miscellaneous receipts (such as earnings of the Federal Reserve System, donations, and bequests). Federal revenues are also known as federal as federal governmental receipts  receipts . risk premium: The additional return (over the risk-free rate) that investors require to hold assets whose returns are risky. risky. The risk premium is often associated as sociated with market or aggregate risk—risks that cannot be eliminated

by diversifying a portfolio.

S

hort-term interest rate: The interest rate earned by a debt instrument (such as a Treasury Treasury bill) that will mature within one year. year.

zation, and Job Creation Act of 2010 (2010 tax act, Public Law 111-312): This law temporarily extended through 2012 provisions set to expire in 2010 that were initially enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and the American Recovery and Reinvestment Act of 2009. Those extensions affected individual income tax rates, credits, and deductions. The law also increased the exemption

amount for the alternative reduced the employee’ s contribution forminimum the Socialtax, Security payroll tax, modified other tax provisions, and extended benefits for long-term unemployed workers. total factor productivity: See productivity .  transfer payments: Payments made to a person or organization for which no current or future goods or services ser vices are required in return. Federal transfer payments include Social Security and unemployment benefits. (BEA)

statutory tax rate: A tax rate specified by law. In some cases, such as with individual and corporate income taxes, the statutory tax rate varies with the amount of taxable income. (For example, under the federal corporate income tax, the statutory tax rate for companies with taxable income below $50,000 is 15 percent, whereas the rate for corporations with taxable income greater than $18.3 million is 35 percent.) In other cases, the statutory tax rate is uniform. (For instance, the statutory federal tax rate on gasoline is 18.4 cents per gallon for all taxpayers.) Compare with effective tax rate and marginal tax rate.

Treasury bond: A fixed-rate, f ixed-rate, interest-bearing security issued by the Treasury Treasury with an original maturity of more than 10 years.

surplus: The amount by which the federal government’s government’s total revenues exceed its total outlays in a given period, typically a fiscal year. Compare with deficit . 

Treasury note: A fixed-rate, interest-bearing security issued by the Treasury Treasury with an original maturity of more than a year but not more than 10 years.

Treasury bill: A security issued by the Treasury Treasury with an original maturity of no more than one year. Interest on a Treasury bill is i s the difference di fference between the purchase p urchase price and the value paid at redemption.

 

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CBO’S 2011 LONG-TERM BUDGET OUTLOOK 

Troubled Asset Relief Program (TARP): A program that permits the Secretary of the Treasury Treasury to purchase or insure troubled financial assets. Authority Authority for the the program was initially set by the Emergency Economic Stabilization Act of 2008 at $700 billion in assets outstanding at any one time; the authority to make new investments has expired. The TARP’s activities have included the purchase of preferred stock from financial institutions, support to automakers and related businesses, a program to avert housing foreclosures, and partnerships with the private sector.

earmarked for the purpose of the fund, as well as budget authority and outlays of the fund that are financed by those revenues or receipts. The federal government has more than 200 trust funds. The largest and best known finance major benefit programs (including Social Security and Medicare) and infrastructure spending (such as the Highway Trust Fund and the Airport and Airway Trust Fund).

trust fund: In the federal accounting structure, an account designated by law as a trust fund (regardless of

nemployment rate: A measure of the number of  jobless people who are available for work and are actively actively

U