Friday, July 3, 2009

The Congressional Budget Office is warning the White House and Congress that U.S. budget policy is heading toward an “explosive fiscal situation” unless major changes are made.

In its latest “Long-Term Budget Outlook” report, the nonpartisan CBO declared that current policies involving taxes and entitlements, including Medicare, Medicaid and Social Security, would eventually wreak havoc with the economy and American living standards.

“Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States,” the report concluded. “Over time, the accumulation of debt would seriously harm the economy.”

If current laws do not change, federal spending on Medicare and Medicaid combined will increase from about 5 percent of GDP today to nearly 10 percent in 2035 and to more than 17 percent by 2080, the report estimates.

“Slowing the growth rate of outlays for Medicare and Medicaid is the central long-term challenge for federal fiscal policy,” the report concludes.

“CBO’s long-term budget projections make clear that doing nothing is not an option,” said CBO Director Douglas Elmendorf. “Legislation must ultimately be adopted that raises revenue or reduces spending or both.”

The biggest long-term factor is not the aging population, whose impact will subside significantly after 2035, the end of what CBO calls the intermediate period. During the 75-year period covered by the report, Social Security plays a relatively small role in the evolving fiscal crisis, CBO said.

Rather, CBO argues, the most important long-term factor is the unsustainable rapid growth of health care costs. From 1975 through 2007, for example, annual health care spending for an average American grew nearly 2 percent faster than per capita GDP.

Over the final 65 years of its 75-year scenario, CBO assumes this growth-rate differential will be just 0.8 percent. But even that reduction does little to forestall the “explosive fiscal situation” that CBO expects to develop.

Under CBO’s “alternative fiscal scenario,” which makes policy assumptions consistent with current practices and is the more likely fiscal path many experts expect the nation will follow, publicly held debt would reach 83 percent of GDP by 2019. That is virtually indistinguishable from the 82 percent level that CBO expects President Obama’s 10-year budget plan to achieve by 2019.

Federal debt in the alternative fiscal scenario would surpass 100 percent of GDP in 2023 and would reach 200 percent of GDP in 2038. For perspective, publicly held federal debt peaked at 109 percent of GDP shortly after World War II. It was 41 percent of GDP at the end of fiscal 2008.

Annual budget deficits would skyrocket from 7.4 percent of GDP in 2020 to 15 percent in 2035, 22 percent in 2050 and 43 percent in 2080. By 2080, publicly held debt would exceed 700 percent of GDP, and annual interest payments on the federal debt would top 30 percent of GDP, compared with 1.2 percent today.

In fact, CBO doesn’t expect this fiscal path to be sustainable long enough to generate such bleak numbers. “Over time, the accumulation of debt would seriously harm the economy,” CBO declared.

Rising federal debt would reduce the capital stock by more than 35 percent and GDP by about 16 percent by 2045, the report said. Under this scenario, CBO’s growth model implodes in the 2060s and is unable to calculate the effects of the soaring deficits and debt.

“For years, we’ve been warning that the budget was out of balance over the long term and we should act while there is still time,” said Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. “Well, guess what? Time is quickly running out. We’re drowning in unprecedented levels of red ink, and there is no plan to fix the situation.”

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