Budget Deficits: An Explanation of How Policy Affects Budget Balance
Congressional research reportMar 16, 2009
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Budget Deficits: An Explanation of How
Policy Affects Budget Balance
name redacted
Analyst in Public Finance
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Specialist in Macroeconomic Policy
March 16, 2009
Congressional Research Service
7-....
www.crs.gov
R40435
CRS Report for Congress
Prepared for Members and Committees of Congress
Budget Deficits: An Explanation of How Policy Affects Budget Balance
Summary
In fiscal year (FY) 2008, the nation’s budget deficit reached $455 billion or 3.2% of gross
domestic product (GDP), up from $161 billion or 1.2% of GDP in FY2007. New deficit
projections provide a picture of what the United States faces over the next decade. In February
2009, the Congressional Budget Office (CBO) projected that the deficit in FY2009 will reach
more than $1.4 trillion. Between FY2010 and FY2019, cumulative deficits could reach as high as
$10 trillion. CBO projects deficits in each fiscal year of this period. These deficits are largely a
result of enacted federal financial intervention and fiscal stimulus legislation designed to alleviate
the credit crunch and to bolster the economy. Current economic conditions have also led to
increases in outlays for certain government social programs and declines in revenue collection,
leading to further deterioration in the budget balance.
Several significant federal financial interventions were enacted in 2008 in an effort to relieve the
credit crisis and mitigate the economic effects of the recession on Americans. These include the
enactment of economic stimulus in early 2008, the Housing and Economic Recovery Act in July
2008, the Troubled Assets Relief Program (TARP) and its components in October 2008, the
extension of unemployment benefits in November 2008, and the American Recovery and
Reinvestment Act (ARRA) in February 2009. Other actions have involved the purchase of assets
largely utilizing existing or expanded authority.
Deficits can serve as a powerful instrument of fiscal policy and are not necessarily problematic.
Governments use deficit spending to smooth outlays and taxes so that taxpayers and program
beneficiaries are shielded from abrupt economic shocks and to mitigate the size of those shocks.
However, persistent deficits lead to growing accumulations of federal debt that may lead to higher
interest payments, tax increases, or spending cuts.
Over time, deviations from baseline deficit projections can be attributed to three broad causes:
legislative, economic, and technical changes. Projected fiscal balances can differ significantly
from actual outcomes. Changes in legislative policy between January 2008 and January 2009 are
likely to more than double the FY2009 deficit according to revisions to the CBO baseline over
that period. Further, technical changes, largely attributed to the government placing Fannie Mae
and Freddie Mac into conservatorship, will add hundreds of billions of dollars to the FY2009
deficit. Other factors will also contribute to a larger deficit in FY2009.
In his budget proposal, President Obama also outlined specific policies he hopes to implement,
which include significant new agendas with regard to energy, health care, and education. If all of
these provisions are enacted, the President’s budget proposal would result in a FY2009 deficit of
$1.752 trillion or 12.3% of GDP.
When the economy recovers from the current downturn, Congress may choose to focus more
effort on balancing the budget and reining in debt by spending less, increasing taxes, or a
combination of these things. Over the long-term, balancing the budget is further complicated by
significant issues regarding entitlement spending, especially as it relates to rising health care
costs. CBO has concluded that “under any plausible scenario, the federal budget is on an
unsustainable path.”
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Contents
What are Deficits?.......................................................................................................................1
Understanding Deficit Projections in the CBO Baseline ........................................................2
Current Conditions......................................................................................................................2
Recent Policies and Their Effects on the Deficit ....................................................................3
Economic Stimulus Act of 2008 ......................................................................................4
Housing and Economic Recovery....................................................................................4
CBO’s Baseline Deficit Projections .......................................................................................7
Current Policies Not Included in the CBO Baseline.........................................................8
The Deficit in President Obama’s Budget Outline..................................................................9
Future Expectations .................................................................................................................. 10
Tables
Table 1. Legislative, Economic, and Technical Changes to the CBO Baseline Deficit
Projections Between January 2008 and January 2009 ...............................................................7
Table 2. Deficit Estimates Under President Obama’s Current Policy Scenarios ............................9
Table A-1. Differences Between 2001 Baseline Projections and the Actual Budget
Balance, FY2001-FY2008...................................................................................................... 12
Appendixes
Appendix. An Analysis of Deficit Movements over the Last Decade.......................................... 11
Contacts
Author Contact Information ...................................................................................................... 14
Congressional Research Service
Budget Deficits: An Explanation of How Policy Affects Budget Balance
T
he nation’s budget situation is challenging. In fiscal year (FY) 2008, the budget deficit
reached $455 billion or 3.2% of gross domestic product (GDP), up from $161 billion or
1.2% of GDP in FY2007. New deficit projections provide a picture of what the United
States faces over the next decade. In February 2009, the Congressional Budget Office (CBO)
projected that the deficit in FY2009 will reach more than $1.4 trillion, which includes the deficit
impact of the American Recovery and Reinvestment Act (ARRA; H.R. 1, P.L. 111-5). Between
FY2010 and FY2019, cumulative deficits could reach as high as $10 trillion. CBO projects
deficits in each fiscal year of this period. 1
These deficits are largely a result of federal financial intervention and fiscal stimulus legislation
designed to alleviate the credit crunch and to bolster the economy. Current economic conditions
have also led to increases in outlays for certain government social programs and declines in
revenue collections, leading to further deterioration in the budget balance.
Economists generally agree that when an economy is in recession, running deficits by increasing
government spending or cutting taxes can stimulate growth. However, once growth returns, they
advise paying down debt. Though the economy is currently in recession and running deficits may
be appropriate, the accumulated deficits will increase federal debt held by the public and will
generally increase the portion of the budget devoted to future interest payments. Larger deficits
today and in the future would add additional pressure to the long-term budget outlook, hampering
the ability of Congress and the President to address other priorities like healthcare and entitlement
reform.
This report will define deficits and will explain the appropriate way to measure them. It will also
describe how current economic conditions and federal financial interventions have increased the
deficit over time.
What are Deficits?
Deficits can serve as a powerful instrument of fiscal policy. Differences between revenues and
outlays determine whether or not the budget is in surplus or deficit, which often serves as a
measure of the federal government’s fiscal health. Annual budget deficits or surpluses determine,
over time, the level of federal debt and affect the amount of annual interest paid to finance the
debt. Occasional deficits, in and of themselves, are not necessarily problematic. Deficit spending
allows governments to smooth outlays and taxes to shield taxpayers and program beneficiaries
from abrupt economic shocks. Persistent deficits, on the other hand, lead to growing
accumulations of federal debt that may lead to higher interest payments, tax increases, or
spending cuts.
Changes in economic conditions can cause movements in outlays (spending) or revenues and can
lead to changes in the budgetary outlook. These can occur simultaneously or as a result of each
other. Economic growth can stimulate employment and individual income, generally reducing
certain types of spending and increasing revenue levels. During a recession reductions in
consumption and increased reliance on government programs have the opposite effect. For
example, in a strong economy, new jobs are often created. If the unemployed become employed
1
U.S. Congress, Congressional Budget Office, Estimated Impact on the Deficit of Three Alternative Policy Scenarios
Specified by Speaker Pelosi and Chairman Spratt, February 23, 2009.
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
and earn higher incomes, additional tax revenue would be generated. In contrast, in a weak
economy, people may lose their jobs, which could lower tax revenue and increase government
expenditures on programs such as unemployment insurance and food stamps. Economists refer to
these changes as automatic stabilizers.2 Policy changes by the federal government to change
spending or revenue levels (i.e., through the creation of new programs or through tax cuts) would
also affect the size of the deficit.
The dollar value of the budget deficit (or surplus), however, may give a partial and potentially
misleading picture of the government’s true fiscal condition. Deficits and debt levels are often
measured as a percentage of GDP, rather than in dollar amounts. Measurement of deficits and
debt as a percentage of GDP provides adjustments for inflation and relates the size of the deficit
or debt to the size of the economy.
Understanding Deficit Projections in the CBO Baseline
The CBO baseline is an estimate of federal spending and receipts and resulting levels of surplus
or deficit during a fiscal year, under existing law. Congress set forth specific rules for calculating
direct spending, receipts, and discretionary spending baselines in Section 257 of the Balanced
Budget and Emergency Deficit Control Act of 1985 (Title II of P.L. 99-177), as amended. 3 A
baseline provides a benchmark for comparing proposed budget policy changes to existing policies
and indicating changes that may be necessary to meet certain budgetary goals. Therefore, the
calculation of a baseline can be instrumental to the evaluation of budget policies.
However, there are numerous uncertainties surrounding the baseline projections, especially in the
out-years, and they cannot be thought of as absolute certainty of the government’s fiscal
condition. According to CBO, “[t]he baseline is intended to provide a neutral, nonjudgmental
foundation for assessing policy options. It is not ‘realistic,’ because tax and spending policies will
change over time. Neither is it intended to be a forecast of future budgetary outcomes.”4 The
proper way to use a baseline is as a rule-of-thumb estimate for the budgetary ramifications of
current policy. This offers the policymaker a means to measure the relative effects of proposed
legislation in the context of the overall budget.5
Current Conditions
The deficit in FY2008 was $455 billion, or 3.2% of GDP, sharply higher than the FY2007 deficit
of $162 billion (1.2% of GDP). In January 2009, CBO projected that the deficit would reach
nearly $1.2 trillion (8.3% of GDP) in FY2009, which did not include the effects of the American
2
See CRS Report RL31235, The Economics of the Federal Budget Deficit, by (name redacted).
Until the expiration of this section at the end of FY2006, CBO was required to follow the provisions of Section 257 in
producing its baseline projections. CBO has indicated that it will follow these practices until directed otherwise by
Congress. For more information, see CRS Report 98-560, Baselines and Scorekeeping in the Federal Budget Process,
by (name redacted)
4
U.S. Congress, Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2002-2012, January
2001, p. 7.
5
For more information, see CRS Report RL31414, Baseline Budget Projections: A Discussion of Issues, by (name
redacted).
3
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Recovery and Reinvestment Act of 2009 (ARRA).6 At the request of Speaker of the House Nancy
Pelosi and House Budget Committee Chairman Spratt, CBO released three alternative budget
scenarios in February 2009. Under all of the scenarios, CBO projected a deficit of $1.4 trillion in
FY2009, with the majority of the deficit increase from the January to February projections
occurring as a result of ARRA. 7 CBO also projected the continuation of deficits well into the
future. This budgetary outlook is largely attributed to the effects of the economy as well as the
significant federal financial interventions and stimulus legislation already passed by Congress.
Additional actions may increase the deficit further.
CBO also projects that the recession, probably the longest and deepest since World War II
(WWII), will likely last well into 2009.8 The current condition of the economy will likely result in
increases in outlays for mandatory programs, such as food stamps and unemployment benefits,
also known as “automatic stabilizers,” and increases in the deficit. Revenue collection is also
projected to be lower largely due to declines in personal incomes and corporate profits. The
deficit impact of these increases in outlays and decreases in revenues is accounted for in the CBO
baseline.
The projected deficit for FY2009 is high relative to historic standards. The deficit reached its
peak in 1943 at 30.3% of GDP. After WWII, deficits remained relatively low until the mid-1980s.
In FY1985, the deficit reached 6.0% of GDP.9 If the deficit in FY2009 reaches the projected level,
it will likely be the highest deficit as a percentage of GDP since FY1946.
Recent Policies and Their Effects on the Deficit
Several significant federal financial interventions were enacted in 2008 and early 2009 in an
effort to relieve the credit crisis and mitigate the economic affects of the recession on Americans.
These include the enactment of economic stimulus in early 2008, the Housing and Economic
Recovery Act (HERA) in July 2008, the Troubled Assets Relief Program (TARP) and its
components in October 2008, the extension of unemployment benefits in November 2008, and
the American Recovery and Reinvestment Act (ARRA) in February 2009. Other actions, such as
interventions by the Federal Reserve (Fed) and the Federal Deposit Insurance Corporation
(FDIC), have largely utilized existing or expanded authority. The long-term impact of these
programs on the budget deficit is somewhat uncertain.
The size, variety, and complexity of federal responses to financial and economic turmoil present
many challenges to budget analysis. The ultimate costs of these responses will depend on how the
economy recovers, how well firms receiving federal assistance weather future financial shocks,
and whether or not the government receives positive returns on its asset purchases. Estimating
6
These estimates are based on current law under a specific set of assumptions. As will be discussed later, changes in
policy or use of different assumptions would change these estimates. U.S. Congress, Congressional Budget Office, The
Budget and Economic Outlook: Fiscal Years 2009 to 2019, January 2009.
7
U.S. Congress, Congressional Budget Office, Estimated Impact on the Deficit of Three Alternative Policy Scenarios
Specified by Speaker Pelosi and Chairman Spratt, February 23, 2009.
8
Ibid.
9
For more information about historical movements in federal debt and deficit levels, see CRS Report RL34712, Ebbs
and Flows of Federal Debt, by (name redacted).
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how much these responses will cost the federal government is difficult, both for conceptual and
operational reasons.10
Economic Stimulus Act of 2008
In February 2008, Congress enacted the Economic Stimulus Act of 2008 (P.L. 110-185) aimed at
promoting consumption and investment by sending rebates to taxpayers and allowing firms to
depreciate new capital investments more quickly. The costs of these provisions increased the
deficit by $152 billion in FY2008 and by an estimated $16 billion in FY2009.11
Housing and Economic Recovery
The Housing and Economic Recovery Act (HERA, P.L. 110-289) provided new authority to
address issues in the mortgage markets by allowing banks to write down the balance of existing
loans so that borrowers can refinance and avoid foreclosure. The act also contained other
provisions to help local communities acquire and redevelop vacant and foreclosed properties and
created a new regulator for the government-sponsored enterprises (GSEs), Fannie Mae, Freddie
Mac, and the Federal Home Loan Banks. The act gave Treasury the temporary authority to
purchase debt and equity securities of the GSEs.12 The provisions of HERA increased the deficit
by $1.4 billion in FY2008 and are expected to increase the deficit by $36.7 billion in FY2009 and
$3.6 billion in FY2010. 13
CBO’s deficit estimate for FY2009 includes the addition of Fannie Mae and Freddie Mac,
previously not accounted for in the budget. They have been included by CBO in their budget
baseline because they were placed under direct control of the federal government on September 6,
2008. This action added $238 billion to the deficit in FY2009, an amount which represents CBO’s
estimate of the net present value of the current outstanding obligations and securities of the GSEs.
These transactions are being recorded by CBO on a net present value basis rather than a cash
basis. The net present value reflects the asset purchase price, less the present value of future asset
income, plus an adjustment for market risk. 14 In subsequent years, the effect on the budget is
projected to be much smaller, $66 billion between FY2010 and FY2019, because the subsidy cost
would only relate to the net present value of new business. Even if Fannie Mae and Freddie Mac
are excluded from the FY2009 deficit calculation, the FY2009 deficit would still reach a postWWII high.15
10
For more information, see CRS Report R40088, The Federal Budget: Current and Upcoming Issues, by (name red
acted) and (name redacted).
11
Joint Committee on Taxation, Report Number JCX-17-08, available at http://www.house.gov/jct/x-17-08.pdf. Over
the FY2010 to FY2018 period, some of the bonus depreciation costs will be recovered.
12
For more information, see CRS Report RL34623, Housing and Economic Recovery Act of 2008, coordinated by (na
me redacted).
13
U.S. Congress, Congressional Budget Office, Cost Estimate for H.R. 3221 Housing and Economic Recovery Act of
2008, available at http://www.cbo.gov/ftpdocs/95xx/doc9597/hr3221.pdf.
14
Market risk is the cost resulting from the potential of future declines in the value of the asset due to market
conditions.
15
U.S. Congress, Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2009 to 2019,
January 2009.
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Troubled Assets Relief Program
On October 3, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA; P.L.
110-343), which, among other provisions, authorized the Treasury Secretary to use $700 billion
(subject to certain Congressional restrictions and notifications) to intervene in financial markets.
While former Treasury Secretary Henry Paulson first proposed using TARP funds to buy
mortgage-related securities, those plans were later dropped. Instead, the Treasury Department
used TARP funds to recapitalize banks and financial institutions by acquiring preferred shares. On
November 12, Paulson announced that a portion of TARP would fund a new Federal Reserve
collateralized lending program, the Term Asset-Backed Securities Loan Facility (TALF), which
would take in securities based on “newly and recently originated” loans, such as for education,
automobiles, and credit cards. In addition, TARP funds were also loaned to automakers and used
to purchase equity in and guarantee assets of numerous financial institutions. As of December 31,
2008, the Treasury Secretary had disbursed or committed $350 billion in TARP money. The
release of the remaining $350 billion was made available after certification in January.16
CBO estimates a deficit increase as a result of TARP outlays of approximately $180 billion in
FY2009 and $5 billion in FY2010. This amount differs from actual TARP outlays due to the 1990
Federal Credit Reform Act and due to provisions of EESA, which require these transactions to be
recorded by CBO on a net present value basis with an adjustment for market risk rather than on a
cash basis.17 CBO projects a cost of $180 billion based on assumption of a 25% average subsidy
rate for these purchases (i.e., the rate used to calculate the net present value).18 If these asset
purchases were accounted for in the budget estimates solely based on the purchase price, the
estimated deficit would be substantially higher in the near term. These costs would be recovered
for budgetary purposes when the assets are sold in the future, essentially creating negative outlays
at that time. Though CBO estimates the budgetary impact to be much lower than the purchase
price, the Treasury Department must still raise enough money by selling debt to make the
purchases in the first place.
Extension of Unemployment Benefits
On November 21, 2008, President Bush signed the Unemployment Compensation Extension Act
of 2008 (P.L. 110-449) into law, which expanded the potential duration of unemployment benefits
up to a maximum of an additional 20 weeks. It also created a second tier of benefits for workers
in states with high unemployment of up to a maximum of an additional 13 weeks. This additional
coverage helps those workers who have exhausted the traditional 26 week benefit period. CBO
estimated the impact on the deficit of these provisions at $9 billion for FY2009.19
16
The final $350 billion in authority was exercised upon transmission of a written report by the President detailing the
plan for the exercise of this authority. Congress had 15 calendar days to pass a joint resolution under “fast track” rules,
to deny the authority to use the final $350 billion. The second half of the TARP funds were released after the Senate
failed to block the release (S.J.Res. 5), though the House subsequently voted to block their release (H.J.Res. 3).
17
The Bush Administration recorded these amounts on a cash basis rather than a discounted present value basis, which
reflects greater outlays in the current time period to be offset by future gains when the asset is sold. The Obama
Administration may record these assets purchases differently.
18
U.S. Congress, Congressional Budget Office, The Troubled Asset Relief Program: Report on Transactions Through
December 31, 2008, January 2009.
19
U.S. Congress, Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2009 to 2019,
January 2009, Table 8.
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American Recovery and Reinvestment Act of 2009
On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of
2009 (ARRA; H.R. 1, P.L. 111-5), which included $501 billion in new outlays and $286 billion in
net tax cuts for a variety of activities in an attempt to stimulate the economy. Provisions include
Medicaid funding assistance for states, funding for infrastructure projects, tax incentives for small
businesses, and expanded tax credits for individuals and families.20 CBO estimates that this
economic stimulus legislation will increase the deficit by $185 billion in FY2009, $399 billion in
FY2010, $134 billion in FY2011, and $787 billion over the FY2009 through FY2019 period.21
Other Actions
The Federal Reserve (Fed) has also played a major role throughout the economic downturn in
limiting systemic risk. Through its various programs, the Fed has provided direct financial
assistance of $1 trillion to borrowers. Though the activities of the Fed do not directly impact the
federal budget, its profits are remitted to Treasury and recorded as revenues in the budget. Over
the longer term, these actions may alter the level of remittances to the Treasury, thereby
increasing or decreasing federal revenues.
Unlike all other institutions, currency (Federal Reserve notes) is the Fed’s primary liability. Along
with its holdings of Treasury securities, its assets are the loans it makes and the private assets it
holds. Its loans and asset purchases are financed by increasing its liabilities (Federal Reserve
notes), and does not inherently impose any cost to the Treasury. Indeed, if the loans are repaid,
they would increase the profits of the Fed, which in turn would increase the Fed’s remittances to
the Treasury.22 Even if the loans are not repaid, they are fully collateralized (in some cases, overcollateralized), so the Fed would not suffer losses unless the collateral loses value. In addition,
some of the loans are made with recourse, which means that the firms are liable if the collateral
loses value. 23
The Treasury Department has made large cash deposits at the Fed to try to offset some of the
potential inflationary effects of the Fed’s actions through a new program called the Treasury
Supplementary Financing Program. To finance these deposits, the Treasury has significantly
increased the national debt. According to CBO, the Treasury Supplementary Financing Program
increased the national debt by $296 billion in 2008.24 Eventually, it is expected that these funds
will no longer be needed and the additional debt will be paid off. CBO projects that the additional
debt will be paid off in 2009, although that is unlikely to occur until the Fed withdraws its
emergency assistance to the financial sector, which has not occurred to date. This program is not
20
For more information, see CRS Report R40104, Economic Stimulus: Issues and Policies, by (name redacted),
(name redacted), and (name redacted).
21
U.S. Congress, Congressional Budget Office, Cost Estimate for H.R. 1 Conference Agreement, February 13, 2009,
Table 1.
22
Assuming that the interest rate on the loans exceeded the rate of return on the Treasuries that the Fed would have
purchased if the loans had not occurred.
23
For more information on the Federal Reserve’s financial intervention activities, see CRS Report RL34427, Financial
Turmoil: Federal Reserve Policy Responses, by (name redacted).
24
For more information, see CRS Report RL34427, Financial Turmoil: Federal Reserve Policy Responses, by (name
redacted).
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counted toward the deficit since it does not affect government outlays or revenues; as a result,
2008 was a rare occasion when changes in the debt did not mirror the budget deficit.
The FDIC has also taken a number of actions aimed at supporting the housing and financial
markets. These actions include a temporary increase to deposit insurance for individual accounts
from $100,000 to $250,000, the creation of a Temporary Liquidity Guarantee Program (TLGP),
and efforts to reduce foreclosures. The TLGP is intended to strengthen confidence and encourage
liquidity in the banking system by guaranteeing newly issued senior unsecured debt of banks,
thrifts, and certain bank holding companies. The FDIC has also sought buyers for distressed
banks. However, since the FDIC has increased its guarantees to individuals and banks, the
pressure on its deposit insurance fund has grown. If financial distress causes these guarantees to
be called upon, the FDIC may require additional funds from the Treasury to meet FDIC
obligations, thereby increasing the budget deficit.
CBO’s Baseline Deficit Projections
Table 1 illustrates how the programs described above have and are expected to alter the deficit
situation over the next 10 years. The legislation included in this table has been enacted since
CBO’s January 2008 baseline estimates. As Table 1 shows, legislative activity will have the
greatest impact on increasing the deficit in FY2009. As a result of the TARP legislation, the
deficit is estimated to increase by $184 billion, on a net present value basis, in FY2009 and $5
billion between FY2010 and FY2018. In addition, ARRA will add $185 billion to the deficit in
FY2009 and $603 billion between FY2010 and FY2018. In subsequent years, legislative,
economic, and technical changes will contribute nearly the same amounts towards increasing the
deficit. With the passage of the stimulus legislation, legislative changes will contribute even more
to the increases in the deficit, particularly in FY2010 and FY2011.
The Appendix to this report details how the baseline changed from projected surpluses to deficits
as a result of legislative policy and other conditions between January 2001 and January 2009.
Table 1. Legislative, Economic, and Technical Changes to the CBO Baseline Deficit
Projections Between January 2008 and January 2009
(billions of dollars)
2008
2009
2010-2018
Baseline Budget Deficit (-)/ Surplus (+)
Projection in Jan. 2008
-219
-198
472
Total Legislative
-192
-601
-1,340
ARRA
0
-185
-603
HERAa
-1
-17
17
TARPb
0
-184
-5
Other Discretionary Spending
-31
-51
-78
Other Mandatory Spending
-45
-37
-62
Revenue
-115
-116
74
0
-10
-681
-29
-110
-1,887
Debt Service
Economic
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2008
2009
2010-2018
Technical
-17
-464
-1,040
GSEs
0
-238
-66
-455
-1,372
-3,795
Projected Budget Surplus(+)/Deficit(-)
Source: CRS calculations based on CBO data.
Notes: Years are fiscal years. Figures for 2008 are actual. Columns may not be additive due to rounding.
a.
GSE costs are accounted for in technical changes.
b.
The Administration estimates the net present value of TARP purchases at $247 billion for FY2009.
After legislative changes and the estimated effects of the economy are accounted for, the
remaining difference between the original projection and actual result is classified as a technical
change. These changes occur because CBO’s projections of revenues and mandatory spending are
also based on other technical assumptions unrelated to the state of the economy, creating
differences between the actual results and original assumptions. For example, mandatory
spending levels depend on actual program participation rates rather than the projected
participation rates, which may be different. Similarly, tax revenues will depend not only on the
growth in income, but how quickly tax liability rises as income rises and how income growth is
distributed across taxpayers. Most technical changes tend to be on the revenue side rather than the
spending side of the budget.
Technical changes in FY2009 largely stem from the decision to include the net present value of
Fannie Mae and Freddie Mac’s existing assets and liabilities, as discussed earlier. Second,
economic conditions have led to downward revisions in revenue projections due to lower
projections of nominal GDP and the components of taxable income. Some of these declines have
been offset by lower interest payments on the federal debt due to lower interest rates on current
borrowing. Over the longer term, the deficit estimates may change depending on the actual pace
of economic recovery and whether or not additional legislation affecting outlays or revenues in
response to the economic slowdown is enacted.
Current Policies Not Included in the CBO Baseline
Under the baseline, deficits continue to fall over the next ten years. This pattern occurs due to the
traditional practices employed by CBO with regard to baseline budget estimation and projection,
which assume the continuation of current policy. Therefore, if certain tax or spending provisions
are scheduled to expire (although widely expected to be extended), the costs of these provisions
are not included in the CBO baseline. Their inclusion would likely lead to further increases in the
deficit. Policies currently being excluded from the baseline but which some believe are likely to
be continued in some form include extension of the alternative minimum tax “patch” to adjust for
inflation, additional war financing costs, and increases in discretionary spending over and above
the current baseline estimates. The baseline also assumes that the 2001 and 2003 Bush tax cuts
will expire at the end of FY2010, resulting in an increase in revenues. According to President
Obama’s budget outline, he proposes to extend some of these tax cuts. Actual effects on spending
and revenues as a result of these issues could vary depending on numerous factors.
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The Deficit in President Obama’s Budget Outline
On February 25, 2009, President Obama released his budget proposal, which “accounts for items
that under the old rules could have been left out ... ” Below, Table 2 illustrates how the costs
accounted for under the Obama Administration’s baseline budget will affect the deficit over the
next ten years. Between FY2009 and FY2019, cumulative deficits are expected to reach over
$10.7 trillion. The most costly provisions include extending the 2001 and 2003 tax cuts as well as
including the full year cost of financing overseas operations. Previous budgets had assumed that
the tax cuts would expire at the end of FY2010, which would result in revenue increases starting
in FY2011 and did not include the costs of financing the wars in Iraq and Afghanistan, which
were usually funded through annual supplemental appropriations. The Administration also
includes a placeholder line item for an additional $250 billion in future financial market
stabilization efforts.
Table 2. Deficit Estimates Under President Obama’s Current Policy Scenarios
(billions of dollars)
2009
2010-2019
-1,212
-1,614
Index to Inflation the 2009 parameters
of the AMT as enacted in ARRA
0
-576
Extension of 2001 and 2003 Tax Cuts
0
-2,681
ARRA
-202
-591
Adjustments to reflect costs of
overseas contingency operations and
disasters
-81
-1,496
Placeholder for potential additional
financial stabilization efforts
-250
0
Other Adjustmentsb
-14
-2,025
-1,759
-8,983
BEA Baseline Deficit (-)/ Surplus (+)
Projectiona
Deficit under Current Policy Baseline
Source: OMB
Notes: Columns may not be additive due to rounding.
a.
Though CBO and the Administration use the provisions of the BEA to create their baseline estimates,
economic or technical assumptions may cause slight differences in the baseline estimates from the two
sources.
b.
Includes debt service.
In his budget proposal, President Obama also outlined specific policies he hopes to implement,
which include significant new agendas with regard to energy, health care, and education. If all of
these provisions are enacted, the President’s budget proposal would result in an FY2009 deficit of
$1.8 trillion or 12.3% of GDP. Over the longer term, the Administration’s proposal projects a
deficit of $570 billion (3.1% of GDP) in FY2014 and $712 billion (3.1% of GDP) in FY2019.25
25
Office of Management and Budget, “A New Era of Responsibility: Renewing America’s Promise,” February 2009,
Table S-1.
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Future Expectations
Deficits that exceed growth in the economy are not sustainable in the long-run. To eventually
reduce the deficit would require less spending, increased taxes, faster than average economic
growth, or a combination of these things. Over the long-term, entitlement spending, especially as
it relates to rising health care costs, is projected to increase rapidly. The nation’s aging population,
combined with rising health care costs per beneficiary, seems likely to keep federal health costs
rising faster than per capita GDP. CBO has concluded that “under any plausible scenario, the
federal budget is on an unsustainable path,” over the long run.26 The Government Accountability
Office and the Office of Management and Budget reach similar conclusions.
According to CBO projections, keeping future federal outlays at 20% of GDP, approximately its
current share, and leaving fiscal policies unchanged would require drastic reductions in all
spending other than that for Medicare, Social Security, and Medicaid. A former CBO Acting
Director stated that, “by 2030 ... spending for those programs [Medicare, Social Security, and
Medicaid] is projected to reach roughly 15 percent of GDP.... If that increase happened ..., the rest
of the budget would have to be cut by more than half” to keep overall spending close to its
current level. The Administration indicated similar concerns about the outlook for the budget over
the long term in the President’s FY2009 budget.
26
U.S. Congress, Congressional Budget Office, Long Term Budget Outlook, December 2007, p. 1.
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Appendix. An Analysis of Deficit Movements over
the Last Decade
In January 2001, CBO projected budget surpluses through FY2011, the entire 10-year projection
window. However, in each fiscal year completed since that time, federal spending has accounted
for approximately a fifth of the economy (as measured by gross domestic product—GDP) and
federal revenues have ranged between just under a sixth and just over a fifth of GDP, resulting in
budget deficits. Table A-1 shows the differences between the 2001 baseline CBO projections and
the actual budget balance between FY2001 and FY2008 by attributing the deficit increases to the
legislative, economic, and technical categories.
In addition to the direct effect of new legislation on the budget, some determinants of spending
and revenues are not directly controlled by Congress. As discussed earlier, changing economic
conditions can affect spending and revenue levels through automatic stabilizers as well as shifting
the size of the tax base.
After legislative changes and the estimated effects of the economy are accounted for, the
remaining difference between the original projection and actual results is classified as a technical
change. As explained previously, these changes occur because CBO’s projections of revenues and
mandatory spending are also based on other technical assumptions unrelated to the state of the
economy, creating differences between the actual results and original assumptions. Some
technical changes are the result of legislative changes. The cost of the legislative changes are ex
ante projections of their cost (as scored by CBO and the Joint Committee on Taxation) made at
the time the policy was enacted. If policies turned out to be more (less) expensive than the official
score, this would appear in the table as a negative (positive) technical change.
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Table A-1. Differences Between 2001 Baseline Projections and the Actual Budget
Balance, FY2001-FY2008
(billions of dollars)
2001
2002
2003
2004
2005
2006
2007
2008
Baseline Surplus Projection in Jan. 2001
281
313
359
397
433
505
573
635
Legislative Changes
-81
-150
-363
-519
-543
-632
-721
-1005
Revenue (Tax Cut)
-74
-81
-186
-272
-218
-199
-233
-381
Non-Defense Discretionary
Spending
0
-12
-35
-49
-65
-93
-83
-89
Defense Spending
0
-38
-84
-122
-155
-177
-205
-245
Mandatory Spending
-7
-14
-43
-41
-41
-72
-72
-118
Debt Service
0
-5
-15
-37
-60
-93
-131
-175
Economic Changes
-37
-121
-113
-59
2
15
20
1
Technical Changes
-35
-201
-259
-231
-206
-137
-34
-86
Total Changes
-153
-471
-737
-810
-751
-753
-736
-1090
Actual Budget Surplus(+)/Deficit(-)
128
-158
-378
-413
-319
-248
-163
-455
Source: CBO, Budget and Economic Outlook, January 2002 to October 2008; An Analysis of the President’s
Budgetary Proposals, March 2002 to March 2007.
Notes: Years are fiscal years. Debt service refers to additional interest payments made on the national debt
resulting from all legislative changes to revenues or outlays. Columns may not be additive due to rounding. In the
January baseline, CBO does not report changes to the previous year budget deficit that occurred since the
August baseline. Therefore, any changes between the actual deficit and the baseline deficit reported in August
have been apportioned evenly between economic and technical changes.
CBO projected an FY2008 budget surplus of $635 billion under the policies in place in January
2001. The actual budget deficit was $455 billion, a difference of more than $1 trillion between the
projection and the actual outcome. The FY2008 deficit marked the greatest difference to date
between the surplus projections and the actual result.
Deficit Responses to Legislative Changes
Legislative changes have resulted in lower revenues and increased spending because, as expected,
policy has changed since CBO made its projection in 2001. Overall, legislative changes
accounted for almost three-quarters of the cumulative shift from surplus to deficit over the past
eight years. The legislative changes that increased the deficit the most were the tax cuts (the
largest of which were P.L. 107-16 and P.L. 108-27), the increase in military and related spending
in Iraq and Afghanistan, and the recent economic stimulus and recovery legislation (P.L. 110-185,
P.L. 110-289, and P.L. 110-185).27 Tax cuts accounted for nearly half of all legislative changes
and military spending accounted for about 30%, with the remaining being caused by higher
mandatory and non-military discretionary spending (including the 2008 stimulus) for the total
increase in the deficit between 2001 and 2008.28
27
The cost of revenue changes has declined since 2004 because of the expiration of certain tax provisions, most notably
accelerated depreciation for corporate investment.
28
Debt service is excluded from this calculation since the debt service shown in the table is the direct result of other
(continued...)
Congressional Research Service
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
Comparing legislative changes to the baseline surplus projection made in 2001 demonstrates that,
even if there had been no economic downturn or any other projection error, legislative changes
alone would still have caused a budget deficit in each year from 2003 to 2008. The contribution
of legislative changes to deficit has grown each year since 2001. Because economic and technical
changes became smaller, the overall deficit declined between 2004 and 2007. The deficit rose in
2008 primarily due to legislative changes, which were responsible for 92% of the increase in the
deficit in that year.
These legislative changes helped move federal revenues as a share of gross domestic product
(GDP) from a 50-year high in 2000 to a 45-year low in 2004. The subsequent rise in revenues
brought revenues slightly above the 50-year average share of GDP in 2007. Meanwhile, federal
spending as a share of GDP rose from its lowest level in 35 years in 2000 to a level about equal to
the 50-year average in 2004, where it remained in 2007. In 2008, as a share of GDP, revenues fell
to their lowest levels since 2005, while spending reached its highest level since 1994. Legislation
enacted in 2008, including TARP and investments in other economic recovery programs, are
projected to cause increases in the deficit in future fiscal years.
Of course, an estimate of how much higher spending contributed to the shift to deficit depends on
one’s baseline definition of spending under current policy. Because discretionary spending is
largely determined on an annual basis and not bound by previous year law, there is no obvious
definition of current policy for discretionary spending. CBO’s mandated definition of current
policy is that discretionary spending grows at the same rate as inflation. Many analysts have
criticized this definition as being too low because it would have consistently under-predicted
spending historically. If a higher rate of spending growth (i.e., a rate equal to GDP growth) was
assumed to represent current policy, then CBO’s original estimates of future surpluses in 2001
would have been smaller, and higher spending would have subsequently accounted for a smaller
proportion of the shift to deficit.
Deficit Responses to Economic Conditions
Economic conditions also affected revenues and spending, contributing to changes in the deficit
since CBO’s 2001 projection through “automatic stabilizers,” higher than expected inflation, and
lower than expected interest rates. These are shown as economic changes in the table. The
economic recession of 2001 was an important cause of the deficit in 2002 and 2003. Beginning in
2004, economic conditions had little effect on the shift to deficit. Towards the end of 2008,
deteriorating economic conditions began affecting the deficit once again, however the full
magnitude will likely be felt in later years. Between 2002 and 2008, economic changes accounted
for about 4% of the shift to deficit.
Deficit Responses to Technical Changes
Technical changes peaked as a cause of the shift to deficit at $259 billion in 2003, and have
declined somewhat since then. For the last eight years overall, technical changes accounted for
just over one-fifth of the shift from surplus to deficit. Large economic and technical changes point
(...continued)
legislative changes that increased government borrowing. (Debt service also increased because of economic and
technical changes, but that is not broken out separately in the table.)
Congressional Research Service
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Budget Deficits: An Explanation of How Policy Affects Budget Balance
to the significant uncertainty behind budget projections, even over short periods of time. For
example, holding policy constant, the 2001 surplus was $72 billion smaller ($37 billion due to
economic changes, $35 billion due to technical changes) than CBO’s projection made only nine
months earlier.
Some technical changes are the result of legislative changes. There has been recent discussion of
whether the 2007 deficit was smaller than anticipated because the tax cuts partly “paid for
themselves” through higher economic growth, an effect that was not included in their original
score. Table A-1 suggests otherwise—although the 2007 deficit was smaller than anticipated in
projections made in 2004 and 2005, when CBO was extremely pessimistic about future revenues,
the deficit was much larger than anticipated in projections made before 2004. The 2001 projection
of the state of the economy in 2007—made before the tax cuts were enacted—turned out to be
extremely close to the actual state of the economy in 2007. In other words, the actual performance
of the economy after the tax cuts was almost identical to how CBO expected the economy to
perform had there been no tax cuts. For example, CBO projected in 2001 that economic growth
(without tax cuts) would average 3.1% between 2003 and 2008 (on a fiscal year basis); actual
growth in those years equaled 3.0%. Furthermore, there were extremely large technical revisions
from 2002 to 2006, mostly because tax revenue turned out to be lower than expected (after taking
the tax cuts into account) each year. If anything, this would suggest that tax cuts cost more in
reality than the original score had anticipated, rather than less.29
Author Contact Information
(name redacted)
Analyst in Public Finance
[redacted]@crs.loc.gov, 7-....
(name redacted)
Specialist in Macroeconomic Policy
[redacted]@crs.loc.gov, 7-....
29
See also CRS Report RL32502, What Effects Did the 2001 to 2003 Tax Cuts Have on the Economy?, by (name
redacted); and CRS Report RL33672,Revenue Feedback from the 2001-2004 Tax Cuts, by (name redacted).
Congressional Research Service
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