The United States clearly does not have a short-term federal budget deficit problem—unless that problem is that it is closing too quickly to support rapid recovery. To the degree we do have a fiscal challenge requiring some sacrifice, it is in long-term projections of federal debt. The primary sources of the long-term projected problem are simply insufficient revenues and excessive national health expenditures. Under the “extended baseline” projection included in CBO’s last long-term budget outlook, federal outlays relative to GDP increase by 5.4 percentage points between 2013 and 2038, while federal revenues relative to GDP increase by only 2.7 percentage points; outlays and revenues are projected to diverge thereafter. Revenues have not been keeping up with spending and are not likely to keep up as far as the eye can see.
Most of the growth in outlays is due to increased spending on health care programs, primarily Medicare and Medicaid. However, what is happening with Medicare and Medicaid is just a symptom of what is happening to total national health care expenditures—the growth in Medicare and Medicaid outlays just reflect this growth in health care spending. These total expenditures rose extraordinarily fast over most of the past three decades, and this has led CBO to project they will rise significantly faster than overall economic growth for the foreseeable future. As a matter of fact, spending on Medicare and Medicaid has increased at a slower rate than private health care expenditures over the past 40 years.
None of this is news to anybody closely following budget policy. What was news is that in CBO’s most recent (and now-infamous) Budget and Economic Outlook, released last week, there was an increase in the projected accumulated deficits over the next decade. It’s worth examining the reason for this deterioration in a little detail, since too many will reflexively interpret it as a failure to contain spending. But in fact, it’s really a failure to lay the conditions for economic growth, and a resulting hemorrhaging of projected tax revenues.
Sometime between May 2013 and February 2014, CBO became much more pessimistic about economic growth over the next 10 years. The reasons are described in the recently released Budget and Economic Outlook and are dominated by the scarring effects of the Great Recession and failure to spur a rapid recovery. This pessimism is reflected in their baseline budget projections. Comparing CBO’s May 2013 budget update with their February 2014 projection, accumulated deficits are now projected to be $1 trillion larger between 2014 and 2023. This increase is due to $1.6 trillion in less revenue offset by $600 billion in reduced spending. So, this is clearly not a failure to contain spending, rather it’s that projected revenue has declined by $1.6 trillion in just seven months!
This table shows the sources of the changes in CBO’s projections of federal revenues. About half of the change is due to the individual income tax and the other half is from the corporate income tax and social insurance taxes. CBO notes that tax bases will be lower than their 2013 projection because of projected higher unemployment and lower GDP growth. Lower inflation and interest rates—further symptoms of a still-weak recovery—also contribute to this reduction in projected revenue.
So the bad news is that economic weakness has significantly reduced estimates of tax collections in coming years. And this economic weakness is indeed bad news (though its effect on tax collections is just one—and far from the most important—reason why). But there is good news—CBO reduced its estimate of projected spending on Medicare and Medicaid by $203 billion over the next 10 years. This accounts for one third of the reduction in spending projections. This change reflects changes in national health care spending due to lower inflation and greater productivity in the health care sector. This deceleration of health care spending growth is huge news for budget wonks, as, again, future spending growth is utterly dominated by health care cost trends. Much of this deceleration occurred before the Affordable Care Act was passed, but the health reform law contained many cost-containment provisions that make continuing this trend very possible in coming years.
Overall, the projected ten-year debt problem has gotten worse, and insufficient tax revenues are the main reason. CBO does note that there are reasons that their projections could be off, especially toward the end of the 10-year budget window. Nonetheless, the budget projections suggest that a large part of getting to sustainable budget deficits within the next 10 years will be increasing federal revenues. But if health care costs continue to decelerate, our long-term budget challenge has gotten much less daunting.