LegiStorm

Summary:

The federal budget deficit was the largest it has been since World War II as a percentage of GDP from 2009 to 2012, peaking at 10.1% of GDP. This occurred because spending reached its highest share of GDP since 1945 and revenues reached their lowest share of GDP since 1950. Since then, the deficit has declined to a projected 2.8% of GDP in 2014, which is still above the 1946 to 2008 average. Over the next 25 years, deficits are projected to become very large again under current law. The recent decline in the deficit is partly due to improvements in the economy, the expiration of temporary measures taken in response to the recession, and spending cuts (mainly to discretionary spending). Spending was cut by the Budget Control Act of 2011 (BCA; P.L. 112-25) and the reduction in overseas contingency operations (OCO), primarily in Iraq and Afghanistan. Since September 2008, legislative changes to spending have added a cumulative $1.12 trillion to deficits and legislative changes to revenues, mainly the extension of expiring tax provisions, have added $1.75 trillion to deficits, excluding resulting interest costs. Looking forward, several uncertainties are inherent in the baseline that may lead to different outcomes than projected. There have been large errors to budget projections historically, in part because economic forecasting is subject to large errors. The budget has also proven to be highly sensitive to recessions, and CBO does not project a recession in its 10-year projection. Budget projections also do not assume any significant changes in spending on future wars or disasters. The baseline projection follows current law, assuming that the "doc fix" and tax "extenders" will expire as scheduled. If Congress temporarily extends either, as it has done regularly in the past, the deficit will be larger than projected. In the long run, legislative changes will be needed to reduce spending or increase taxes to keep the debt on a sustainable path. Postponing action requires larger changes to be made in the long run, and limits the ability to phase in changes gradually. Economists view the debt as currently unsustainable because it is projected to grow faster than gross domestic product (GDP) indefinitely under current policy, causing an ever growing share of national income to be devoted to servicing the debt. The main source of long-term fiscal unsustainability is the growth in elderly entitlement spending. In particular, spending on major health programs, such as Medicare and Medicaid, is assumed to continue to grow faster than GDP, as it has historically. Overall, mandatory spending has grown as a share of GDP, rising from 4.7% of GDP, when data were first compiled in 1962, to a projected 12.3% of GDP in 2014, and is projected to continue rising. By contrast, discretionary spending has fallen from 12.3% of GDP in 1962 to a projected 6.8% of GDP in 2014, and under the baseline it is projected to decline to its lowest share of GDP ever, primarily because of the BCA's statutory caps. Revenues are projected to stay near their historical average over the next 10 years. Economic theory predicts that deficits have a stimulative effect on the economy during recessions, but harm economic growth by resulting in an increase in interest rates or the trade deficit during economic booms. Thus, the state of the economy is a consideration for the timing of deficit reduction. Options for deficit reduction on the spending side are constrained by the fact that Social Security, Medicare, net interest, and defense discretionary spending make up almost two-thirds of total spending. On the revenue side, 80% of revenue is raised by income and payroll taxes.