Download 2017 Long-Term

April 19, 2017
Economics Group
Special Commentary
John E. Silvia, Chief Economist
john.silvia@wellsfargo.com ● (704) 410-3275
Michael A. Brown, Economist
michael.a.brown@wellsfargo.com ● (704) 410-3278
Michael Pugliese, Economic Analyst
michael.d.pugliese@wellsfargo.com ● (704) 410-3156
2017 Long-Term Budget Outlook:
Fiscal Challenges Facing Policymakers
Executive Summary
With the release of the Congressional Budget Office’s (CBO) latest Long-Term Budget Outlook,
the ongoing fiscal policy story of increasing federal deficits and a large and growing stock of
federal debt continues.1 Against this backdrop, Congress and the new administration also have
ambitious plans to provide fiscal stimulus in the form of tax cuts and perhaps greater federal
spending on defense and infrastructure projects. We begin with an overview of the CBO’s latest
long-term budget baseline, which describes the future fiscal policy path under current law. We
then turn the discussion of what the fiscal outlook would look like if Congress and the
administration were to agree upon roughly $2 trillion in additional fiscal stimulus over the next
10 years.
The CBO projects that deficits are expected to rise from 2.9 percent of GDP today to 9.8 percent of
GDP by 2047 if current law remains unchanged. The result of these increasing deficits is the debtto-GDP ratio rising from 77 percent today to 150 percent of GDP by 2047. Should additional fiscal
stimulus, primarily in the form of tax cuts, be enacted, the result would be a 202 percent debt-toGDP ratio by 2047. As the CBO points out, such a large stock of debt as a share of the economy
would result in crowding out of private investment and interest costs squeezing other forms of
government spending, among other adverse long-run effects.
At the end of the day, there is no free lunch, and tough decisions will need to be made on both the
tax and spending fronts in the years ahead. While the desire to support stronger GDP growth
through expansionary fiscal policy appears noble on the surface, the unchecked costs of some
programs in the years ahead create a very challenging environment for this generation of fiscal
policymakers and private markets as well.
The Outlook According to CBO
In the CBO’s annual Long-Term Budget Outlook, federal budget deficits are expected to rise from
2.9 percent of GDP today to 9.8 percent of GDP by 2047. The result of these increasing deficits is
the debt-to-GDP ratio climbing from 77 percent today to 150 percent of GDP by 2047 under
current law. The projected deficits and resulting debt level under the CBO’s current law baseline
by 2047 would mark an unprecedented level of debt as a share of GDP at any point in the history
of the U.S. (Figure 1).
The three largest categories of spending contributing to annual deficits and by extension the
higher debt levels are Social Security, Medicare and interest on government debt. In fact, by 2047,
under current law, federal spending for people age 65 or older who receive benefits from Social
Security, Medicare and Medicaid would account for roughly half of all federal noninterest
spending, compared with roughly two-fifths today (Figure 2). This sizable shift in federal fiscal
resources over the next several years will begin to raise questions of intergenerational inequality
1
Congressional Budget Office. (2017). The 2017 Long-Term Budget Outlook.
This report is available on wellsfargo.com/economics and on Bloomberg WFRE.
The unchecked
costs of some
programs in the
years ahead
create a very
challenging
environment for
this generation
of fiscal
policymakers.
Fiscal Challenges Facing Policymakers
April 19, 2017
WELLS FARGO SECURITIES
ECONOMICS GROUP
as older Americans expect their promised federal benefits, while the pool of younger, working
Americans will be responsible for paying for the vast majority of federal spending.
We look at two
scenarios, one
which would
stabilize federal
debt at its
current level of
77 percent of
GDP and one in
which the debt is
reduced to the
50-year average
of 40 percent of
GDP.
In light of CBO’s fiscal outlook, the next logical question is what would need to be done in order to
stabilize or reduce the debt-to-GDP ratio. We look at two scenarios presented by CBO, one which
would stabilize federal debt at its current level of 77 percent of GDP and one in which the debt is
reduced to the 50-year average of 40 percent of GDP. In both cases, we explore the magnitude of
the tax increase per household and the size of the cuts to Social Security benefits that would be
required if one of these options, either complete tax increases or complete budget cuts, were
enacted to reach these debt-to-GDP ratio goals.2
In the case of stabilizing the debt-to-GDP ratio at its current level of 77 percent of GDP by 2047,
for each year from now until 2047 federal revenues would need to increase 10 percent per year,
budget cuts to noninterest spending would need to amount to 9 percent, or some combination of
these two actions would need to be taken. If policymakers decided to enact tax increases for all
types of revenue to obtain the goal of stabilizing the debt, it would require taxes for the
households in the middle fifth of the income distribution to rise by $1,300, to $13,700 per year
from the $12,400 per year in the CBO’s baseline estimate beginning in 2018.3 Conversely, if
policymakers decided to enact cuts to all types of noninterest spending, average Social Security
benefits for households in the middle fifth of the lifetime earnings distribution who were born in
the 1950s and claim benefits at age 65 would see a reduction in their Social Security check of
$1,700 per year, reducing their annual benefit from $19,200 to $17,500 per person.
Figure 1
Figure 2
U.S. Debt Held by the Public
160%
CBO Extended Baseline Projections, Percent of GDP
Federal Spending Breakdown
160%
16%
CBO Extended Baseline Scenario Projections, Percent of GDP
Federal Debt Held by the Public: 2047 @ 150.0%
140%
120%
Social Security: 2047 @ 6.3%
Major Health Care Programs: 2047 @ 9.2%
Other Noninterest Spending: 2047 @ 7.6%
Net Interest: 2047 @ 6.2%
16%
140%
14%
14%
120%
12%
12%
100%
10%
10%
WW II
100%
80%
80%
8%
8%
60%
60%
6%
6%
40%
4%
4%
20%
2%
2%
0%
0%
0%
2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048
40%
Civil War
WW I
20%
0%
1790 1814 1838 1862 1886 1910 1934 1958 1982 2006 2030
Source: Congressional Budget Office and Wells Fargo Securities
In the case of reducing the current debt-to-GDP ratio to its 50-year average of 40 percent of GDP
by 2047, for each year from now until 2047 federal revenues would need to increase 17 percent
per year, budget cuts to noninterest spending would need to amount to 15 percent per year, or
some combination of these two actions would need to be taken. If policymakers decided to enact
tax increases for all types of revenue achieve this goal, it would require taxes for the households in
the middle fifth of the income distribution to rise by $2,100, to $14,500 per year from the
$12,400 per year in the CBO’s baseline estimate beginning in 2018. Conversely, if policymakers
decided to enact cuts to all types of noninterest spending, average Social Security benefits for
households in the middle fifth of the lifetime earnings distribution who were born in the 1950s
and claim benefits at age 65 would see a reduction in their Social Security check of $2,800 per
year, reducing their annual benefit from $19,200 to $16,400 per person.
Congressional Budget Office. (2017). The 2017 Long-Term Budget Outlook. 23.
While we are pointing out the effect on households for the purposes of this discussion, all types of taxes
would increase under this scenario, including corporate taxes.
2
3
2
Fiscal Challenges Facing Policymakers
April 19, 2017
WELLS FARGO SECURITIES
ECONOMICS GROUP
As can be seen, both of these scenarios already require sizable tax increases, benefit cuts or some
combination of the two in order to stabilize/reduce the current debt level. The challenge becomes
even larger should policymakers wait longer to enact changes. Should policymakers wait until
2028 to enact changes, revenues would need to increase or noninterest spending would need to
decline by 2.9 percent of GDP to stabilize the debt-to-GDP ratio, compared to 1.9 percent of GDP
if changes are enacted in 2018. In order to reduce the debt-to-GDP ratio to 40 percent, these tax
hikes and/or noninterest budget cuts would need to increase/decrease by 4.6 percent of GDP
compared to 3.1 percent of GDP if changes are enacted in 2018.
The Outlook with Fiscal Expansion Effects
With a new administration and an ambitious task list facing the 115 th Congress, the backdrop of
the current challenging fiscal outlook creates a difficult operating environment in which to
attempt to enact fiscal policy changes. In laying out our baseline fiscal policy assumptions in
February, we assumed a combination of corporate tax cuts and individual tax cuts totaling a little
over $2 trillion over the next 10 years and further assumed that these cuts were not paid for. 4 In
other words, we did not assume deficit neutrality for any of the fiscal policy changes Congress and
the administration may enact. Given that the CBO has provided a baseline fiscal outlook that
assumes that current law remains unchanged, we wanted to simulate what would happen to the
CBO’s outlook should Congress and administration agree to non-deficit neutral tax cuts and/or
additional fiscal stimulus over the next 10 years.
The backdrop of
the challenging
fiscal outlook
creates a
difficult
environment in
which to
attempt to enact
fiscal policy
changes.
In the Long-Term Budget Outlook, the CBO presented a scenario that included $2 trillion in
additional deficit spending over the next 10 years and how such an increase in the deficit would
affect the long-run fiscal outlook. With a cumulative increase in the federal budget deficit over the
next 10 years of $2 trillion, excluding interest payments and macroeconomic feedback effects, the
net result would be an increase in federal debt to 202 percent of GDP by 2047 compared to
150 percent of GDP in 2047 in the CBO’s baseline, current law estimates (Figure 3).
Figure 3
Figure 4
Federal Net Interest Spending
Fed. Budget Deficit: Alternative Assumptions
225%
CBO's Extended Baseline and Illustrative Paths
225%
200%
200%
175%
175%
150%
150%
125%
125%
100%
100%
75%
75%
50%
50%
25%
Extended Baseline
8%
CBO Extended Baseline Scenario Projections, Percent of GDP
8%
Net Interest: 2047 @ 6.2%
6%
6%
4%
4%
2%
2%
25%
10-Year Deficit Increased by $2 Trillion
0%
2022
0%
2026
2030
2034
2038
2042
2046
0%
0%
2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048
Source: Congressional Budget Office and Wells Fargo Securities
It should be noted that our fiscal policy assumptions total roughly $2.6 trillion over the next
10 years, so technically the debt-to-GDP ratio in 2047 would be larger than 202 percent should
our fiscal policy assumptions become reality. Such large debt-to-GDP ratios, as the CBO has
repeatedly cited in the past, would crowd out other forms of private and public investment,
increase the federal government’s net interest costs, putting more pressure on other parts of the
federal budget (Figure 4), limit lawmaker’s ability to respond to unforeseen events and increase
the likelihood of a financial crisis. With federal debt rising at a rapid rate, investors may demand
higher interest rates in return, further squeezing the federal budget and creating additional
challenges. In our view, the long-run costs of non-deficit neutral tax cuts at the projected levels of
4
Silvia, J.E. and Brown, M.A. (2017). Fiscal Policy & Our Economic Outlook. Wells Fargo Economics.
3
Fiscal Challenges Facing Policymakers
April 19, 2017
WELLS FARGO SECURITIES
ECONOMICS GROUP
federal debt would outweigh the short-run benefits provided by the tax cuts. This is particularly
true in the current economic environment, where the economy is close to full employment and
near potential GDP growth, which historically has the net effect of increasing inflation pressures
more than real GDP growth.5 Alternatively, should Congress find a deficit neutral path to reduce
taxes, which does not reduce public investment spending, the potential exists for a boost to both
short and long-run GDP growth. That said, finding a deficit neutral path with the current fiscal
outlook would require some form of entitlement program reforms, as most other cuts to
discretionary federal programs would have the net effect of reducing public investment in order to
provide a tax cut. Such a policy change would have nearly offsetting economic effects in the longrun.
Conclusion: There Is No Free Lunch
The fiscal
challenges
facing future
generations
continue to
grow.
As the CBO’s latest long-term budget outlook shows, the fiscal challenges facing future
generations continue to grow. The longer policymakers wait to enact reforms that will put the U.S.
on a fiscally sustainable path, the more difficult these challenges will become. While the idea of
providing short-run fiscal stimulus appears to be an attractive way to support economic activity in
the short run, the way in which such policies are enacted matters a great deal. Deficit increasing
tax cuts in the current environment, with the economy near full employment and with a minimal
output gap, would result in greater deficits in the long-run and could create more inflation
pressures rather than simulate real economic growth in the short-run. Finding a path to deficit
neutral cuts would require reforms to entitlement programs, which many policymakers have a
desire to avoid. While policymakers’ goals today of providing expansionary fiscal policy to support
greater GDP growth are a noble cause, there is no free lunch. The costs of such programs as a
result of prior generations of policymakers neglecting fiscal reforms during expansionary phases
of past business cycles have created a very challenging environment for this generation of
policymakers wishing to enact fiscal changes.
Auerbach, A. and Gorodnichenko, Y. (2012). Measuring the Output Responses to Fiscal Policy.
American Economic Journal: Economic Policy, 4(2), 1-27.
Taylor, J.B. (2000). Reassessing Discretionary Fiscal Policy. Journal of Economic Perspectives, 14(3),
21-36.
5
4
Wells Fargo Securities Economics Group
Diane Schumaker-Krieg
Global Head of Research,
Economics & Strategy
(704) 410-1801
(212) 214-5070
diane.schumaker@wellsfargo.com
John E. Silvia, Ph.D.
Chief Economist
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john.silvia@wellsfargo.com
Mark Vitner
Senior Economist
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Jay H. Bryson, Ph.D.
Global Economist
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Senior Economist
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