Econ Intel Brief #2

CBO's new projections; the magic number to know; and the impending fiscal cliff.

Feb 07, 2024

CBO’s New Projections
The Magic Number to Know
The Mother of All Fiscal Cliffs?
Stuff to Read While Waiting for Votes
Upcoming Data Releases

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CBO’s New Projections

At 2pm, CBO released its Budget and Economic Outlook for FY24 to FY34. Overall, the numbers look dire, but slightly less dire than CBO’s prior Outlook because of the Fiscal Responsibility Act. Here are some numbers that immediately stick out to me.

(FY = fiscal year, CY = calendar year)

Budget Outlook

As a share of GDP, revenue remain around its historical average level. By FY34, revenue (17.9% of GDP) will rise above its historical average (17.3% of GDP).
As a share of GDP, spending remains above its historical average level. By FY34, spending (24.1%) will have continued to rise above its historical average (21.0%).
Rising spending is primarily driven by three categories: Social Security, Medicare, and net interest. By FY34, these categories alone will total $5.8 trillion per year.
Net interest spending will exceed defense spending in FY24 and beyond. In FY34, the U.S. will spend $1.6 trillion on net interest vs. $1.0 trillion on defense.
In FY25, spending on mandatory programs and net interest ($5.0 trillion) will exceed incoming revenues ($4.9 trillion). Every dime of discretionary spending is borrowed.

Economic Outlook

CBO projects a “soft landing” this year. While CBO sees a slowing of the economic expansion because of tight monetary policy, it does not project a recession.

Real GDP growth will slow to 1.5% in CY24, slower than in recent quarters. In the long run, real GDP will grow by 1.9% per year, about half its post-WWII historical average.
The unemployment rate will rise to 4.2% in CY24, higher than recent levels. It will continue to rise over time to a long-run level of 4.5%.
Payroll employment will rise by an average of 84k per month in CY24, slower than last year. It will rebound next year before slowing to a long-run rate of 51k per month.
The effective federal funds rate will remain at 5.1% in CY24, and decline over time towards a long-run level of 2.9%. (That’s slightly higher than the Fed projects.)
The 10-year Treasury yield will rise to 4.6% in CY24 (retracing some of its decline during Q4 2023). It will settle around 4.1% in the long run.

Caveats

Importantly, CBO’s projections assume that current law generally remains unchanged, including the expiration of TCJA, but assumes that the government continues to make scheduled Social Security and Medicare Part A payments after trust fund insolvency. (This assumption is required by law.)

The Magic Number to Know

If you need a know a single number from CBO’s report, then it’s $7.6 trillion. That number represents the projected primary deficit from FY25 to FY34. (The primary deficit is non-interest spending less revenues.) Essentially, to prevent debt-to-GDP from growing over the 10-year window, Congress needs to find enough savings to reduce the primary deficit to zero. (The debt would continue to grow because of new borrowing for interest payments, but GDP would grow at about the same rate, so debt would remain around 100% of GDP.)

I call this the “magic number” because it is crucial to the debate over fiscal reform. If someone proposes a simple solution to fix the budget, then the first question you should ask is “Does it produce a 10-year savings of at least 7.6 trillion?” If the answer is “no,” then the math doesn’t add up. The proposal might still be worthwhile—every dollar of savings helps, and Congress should take incremental wins—but it is not sufficient to close the gap.

For illustration, suppose someone proposes dramatically raising taxes on “the rich.” Even under a static score (i.e., ignoring the negative effect of much higher tax rates on economic growth), Brian Riedl estimates that common plans would only raise about $7 trillion over the 10-year window. This example is useful because it underscores that unless Congress addresses its spending problem, the only way to fix the budget is by hiking taxes on the middle class. (For example, see this recent proposal to hike taxes on retirement savings.)

Middle class taxes are already set to rise because of the expiration of popular TCJA provisions in 2025. If Congress were to fully extend TCJA, then (using CRFB’s estimate as a guide) then the magic number would rise to nearly $11 trillion.

The Mother of All Fiscal Cliffs?

The debt limit suspension expires on January 2, 2025. At that time, the debt limit will be automatically raised to accommodate all debt issued during the suspension period (June 3, 2023 to January 1, 2025). Treasury will use cash on hand and “extraordinary measures” to continue to finance the government’s deficit spending, but will eventually run out. That puts Congress on the clock to raise or re-suspend the debt limit before the “X Date.” (If you need a refresher, I’ve written a lot about the debt limit.)

As Congress negotiates over the debt limit, it will also be negotiating over appropriations. The appropriations negotiations will be particularly high stakes because of expiring provisions.

At the end of Sep 2025, the statutory discretionary spending caps expire. (These were enacted under the FRA which only set “targets” not backed by sequestration through FY29.)
At the end of Dec 2025, the increased and expanded ACA subsidies expire. (These were set to expire previously but were extended by the IRA.)
At the end of Dec 2025, a whole host of TCJA provisions expire. E.g., marginal rates on personal income will rise, the standard deduction would fall, the credit for other dependents would expire, a slew of deductions would change, and the alternative minimum tax would revert to pre-TCJA levels. That’s just on the personal tax side. A number of business provisions (e.g., pass-through deduction) will also expire.
Assuming the House-passed CTC and R&D bill becomes law, I believe those provisions would also expire by the end of 2025.

(CRFB has a nice page outlining the impending fiscal deadlines.)