New CBO Report Details Fiscal Challenges

As talks on a possible fiscal plan that would reduce the deficit and lift the ceiling on the national debt struggle and perhaps stall, the Congressional Budget Office (CBO) published a troubling long-term budget forecast.

The CBO report provides a forecast of the federal government’s finances over the next few decades, and the outlook is disconcerting. For home builders, remodelers,  homeowners, and other stakeholders in the housing sector, the health of the nation’s public finances is tightly connected to the future of housing.

Large federal deficits raise the possibility of tax increases for homebuyers and homeowners (via curtailment of the mortgage interest deduction), as well as small businesses (in the form of higher tax rates). Such deficits, if unaddressed, would also increase interest rates over the long-run, which would choke off credit to buyers and builders.

The CBO uses two baselines for its forecast: (1) a present-law baseline that is more optimistic, but contains unrealistic policy assumptions, particularly tax increases that neither political party seems inclined to support; and (2) an “alternative fiscal scenario” baseline that is for the most part an extension of present policy and represents a realistic economic and political forecast. It assumes, for example, that the 2001 and 2003 tax cuts, the AMT patch, the so-called “doc fix” for Medicare reimbursement, and current spending levels are kept in place.

The fiscal challenge for the government is enormous under the present policy baseline. For tax collections, the CBO assumes taxes collected by the federal government remain near their historical average of 18 to 19% of GDP. However, over the 2011 to 2021 period, the average annual budget deficit is estimated to be 6.8% of GDP. This represents a gap of $1 trillion each year between revenues collected and money spent.

How did we get here? Partisans will point to recent policies that contributed to the budget challenge. But the primary reason is demographic. As the country ages, health-related government spending is growing rapidly.

Under present policies, Medicare’s share of the national economy will approximately double from a little more than 3% to about 6% of GDP.  This large growth rate exceeds even the increase in Social Security, which over the same period will grow from 4.8% to 6.1% of GDP, a significant increase but not comparable to the growth of Medicare.

The budget deficit will cause the national debt to grow. In fact, under the more realistic alternative fiscal scenario baseline, the debt-to-GDP ratio will reach 90% in 2018. The 90% threshold is commonly cited by economists as a level at which the prospects of fiscal crisis become quite real.

Clearly, the current path is unsustainable. Nonetheless, given the current weak state of the economy, it would also be a mistake over the short-run to enact contractionary fiscal policy, particularly in the form of tax increases. The economy, and the housing market, needs jobs and household balance sheet repair. In the meantime, government officials should understand the sources of the budget gap and focus policymaking in those areas.