CBO’s long-term budget outlook: details and analysis

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As the reality of a second quarter of negative economic growth sets in in Washington, the Congressional Budget Office (CBO) published its own sobering report on the government’s long-term finances. The CBO’s long-term fiscal outlook report shows deficits will widen over the next three decades as federal spending and tax revenues are expected to exceed historic levels, with spending growth far outpacing modest revenue growth tax. Indeed, the Congressional Budget Office (CBO) expects federal spending to reach 30% of GDP by 2052, a level most often associated with European nations.

These projections should give lawmakers pause as they consider creating costly new programs to subsidize the semiconductor industry, expand health care benefits and fund new programs to fight climate change. The CBO expects that even with much of the Tax Cuts and Jobs Act (TCJA) expiring in 2026 and significant new revenue being generated from actual tranche drift, the gap between tax revenue and expenditure will reach more than 10% of GDP by 2052.

Meanwhile, the $280 billion in new spending and tax subsidies Congress just authorized in the Flea and Science Act will nearly negate the $300 billion in deficit reduction that supporters say will be secured. by the Inflation Reduction Act. And that doesn’t take into account the harm that tax increases will do to the economy in recession. Therefore, the combination of the two pieces of legislation will further worsen the long-term fiscal situation.

Observation #1: The gap between spending and taxes is widening, although both are expected to exceed historical averages. Expenses are the problem.

As the chart below illustrates, over the past 50 years or so, from 1972 to 2021, the gap between federal spending and tax revenue has averaged 3.5% of GDP. Expenditure averaged 20.8% of GDP, while revenue averaged 17.3%. Currently, the gap stands at 3.9% of GDP, with spending well above historical averages at 23.5% of GDP and revenues at a near-record high of 19.6% of GDP.

While the CBO forecasts modest tax revenue growth at best over the next three decades, it forecasts nearly linear growth in spending to reach 30% of GDP by 2052. The three main drivers: net interest payments on the national debt, major health care programs such as Medicare and Social Security.

Currently, interest payments on the national debt amount to 1.6% of GDP. But the CBO predicts that these payments will more than triple to 7.2% of GDP by 2052. So debt interest payments would eventually make up a larger share of GDP than health insurance or social Security. The CBO’s estimate could be conservative if long-term interest rates are higher than currently expected.

Federal health care programs are a major driver of future deficit spending. Today, these costs represent 5.8% of GDP (more than social security), but are expected to reach 8.8% by 2052. Social security, which currently represents 4.9% of GDP, is expected to reach 6 .4% over the next 30 years.

In contrast, discretionary spending – from national defense to transportation to education funding – is expected to total 6.0% of GDP. Thus, by 2052, the primary functions of the federal government will be providing health care and retirement benefits to Americans, and paying past debts, not essential functions like national security.

Observation #2: The drift in real tranches and the expiration of the TCJA will slightly increase revenue as a percentage of GDP, but not enough to keep up with rampant spending.

One of the biggest surprises given the current state of the economy is that federal tax revenues are at a near-record high of 19.6% of GDP. The only other year in which revenues took a bigger chunk of the nation’s income was 2000, the year of the tech bubble in financial markets. Despite today’s increase in tax revenue, the CBO expects tax revenue to return to its historical average level in 2025 (17.6%) – just ahead of the scheduled expiration of major components of the Tax Cuts and Jobs Act (TCJA) – then gradually climb again to reach 19.1% of GDP in 2052.

The revenue generated by the TCJA expiration – which primarily impacts the individual components of the plan – is an important factor in maintaining future revenue levels above historical norms. Indeed, the CBO estimates that the expiration of the TCJA is equivalent to a tax increase of about 0.8% of GDP through 2052.

Interestingly, a bigger factor contributing to future tax revenue increases, according to the CBO, is actual bracket slippage. While much of the tax code, including tax brackets, is pegged to the rate of price inflation, history shows that wages and salaries are rising faster than prices. So while the CBO projects that real incomes per worker will grow by about 1% per year for the next 30 years, that’s enough to drive up tax revenue as a share of the economy. The effect is gradual, starting at 0.3% of GDP, but reaches 1.6% by 2052.

Actual tranche slippage and TCJA expirations won't keep pace with federal spending CBO's long-term fiscal outlook federal deficit

The table below illustrates how actual bracket shifting can increase the amount of income taxed at higher rates while reducing the amount taxed at lower rates. For example, the CBO estimates that in 2032, approximately 9% of taxable income will be taxed at the top marginal tax rate of 39.6% (the highest rate after the TCJA expires). However, due to actual bracket drift, they project that 11% of income will be taxed at the highest rate 20 years later.

Similarly, a significant number of low- to middle-income taxpayers will pay higher taxes due to true bracket creep. We find that the share of income taxed in the zero bracket and the share taxed in the 10-15% brackets both decrease between 2032 and 2052 while the share taxed in the 20-35% brackets increases. This illustrates how real wage growth can push taxpayers into higher brackets, quietly swelling federal coffers.

Shares of income taxed at different rates under the personal income tax system
Income tax rate
0 10 to 15% 20 to 35% 39.6%
2032 26% 37% 29% 9%
2052 23% 33% 33% 11%

Source: Congressional Budget Office, “The 2022 Long-Term Budget Outlook,” Figure 2-8.

Observation #3: Congress seems to be making the deficit picture worse with the Chips and Science Act and the Inflation Reduction Act.

Meanwhile, Congress has just passed the Chips and Science Act which authorizes some $280 billion in new direct subsidies and tax credits for the semiconductor industry and related programs. Of this amount, some $79 billion is for grants and tax credits between 2023 and 2027. The remaining $200 billion is authorized primarily for research purposes between 2022 and 2031.

Although touted as bolstering domestic production of computer chips and increasing national security, the bill creates a new “chip” bureaucracy and a new vested interest dependent on taxpayer subsidies.

Although the bill’s $79 billion in grants and tax credits are authorized through 2027, Congress is inclined to extend the grassroots measures, which could likely double the cost of these initiatives over 10 years.

Next, the Senate is about to debate the Cut Inflation Act, which contains some $433 billion in new spending over the next decade: $369 billion for “energy security and climate change.” and $64 billion for the extension of Affordable Care Act (ACA) grants to three years.

These new spending measures would be offset by $739 billion in new revenue: $313 billion by enacting a new minimum tax of 15% on accounting corporate income; $288 billion by allowing Medicare to negotiate prescription drug prices; $124 billion by giving the IRS more money to audit high-income taxpayers; and $14 billion by closing the so-called carried interest loophole.

These are, however, static estimates that have not been adjusted for their potential impact on slowing economic growth, likely exceeding the amount the bill will rise in new revenue.

Still, if the new revenues materialize as announced, the bill aims to reduce the deficit by $300 billion over the next decade. But almost all of this deficit reduction will be offset by the $280 billion that has just been authorized for the Chips and Science Act. The net effect on future deficits will be immaterial at best. However, if we assume that the ACA subsidies are also extended for 10 years, the combined legislation will surely worsen the fiscal situation in the long run.

Conclusion

The CBO’s latest long-term budget outlook paints a troubling picture of fiscal irresponsibility. Even assuming that tax revenues remain above historical norms over the next three decades, future deficits are expected to rise rapidly due to the uncontrolled growth of health care programs, social security and payments on the explosion of the national debt. Rather than stopping this spending spree, Congress is actively adding programs that will exacerbate these long-term trends. What we need is a serious dose of fiscal restraint, not another spending spree.

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