The Budget Outlook

The Congressional Budget Office (CBO) projects that if current laws and policies remained unchanged, the federal budget would show a deficit of $219 billion for 2008 (see Table 1-1). That deficit would amount to 1.5 percent of gross domestic product (GDP), slightly larger than the shortfall of 1.2 percent of GDP ($163 billion) posted in 2007.

														Total,	Total,
		Actual												2009-	2009-
		2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018	2013	2018


On-Budget Deficit		-344	-414	-396	-450	-343	-151	-184	-154	-136	-160	-102	-27	-1,525	-2,104
Off-Budget Surplus^a		181	195	198	210	226	238	244	251	254	254	253	249	1,117	2,378

	Total Deficit (-) or Surplus	-163	-219	-198	-241	-117	87	61	96	117	95	151	223	-408	274

Memorandum:
Social Security Surplus		187	197	199	210	226	238	244	250	253	254	253	249	1,118	2,378
Postal Service Outlays		5	2	2	1	*	*	*	*	*	*	*	*	2	*

Total Deficit (-) or Surplus as a Percentage of GDP		-1.2	-1.5	-1.3	-1.5	-0.7	0.5	0.3	0.5	0.6	0.5	0.7	1.0	-0.5	0.1


Debt Held by the Public as a Percentage of GDP^b		36.8	36.8	36.7	36.5	35.4	33.3	31.6	29.8	28.0	26.4	24.6	22.6	n.a.	n.a.


Probability of a Budget Deficit (Percent)		n.a.	97	83	79	62	42	45	c	c	c	c	c	n.a.	n.a.

Note: GDP = gross domestic product; n.a. = not applicable; * = between -$500 million and zero.

That increase in the deficit in 2008 would come after three consecutive years of declining deficits. Without changes in law, revenues would increase by only 3.4 percent, but outlays would grow by 5.2 percent. Those estimates—along with the other projections that make up the agency’s budget baseline—reflect an assumption that no further legislation affecting the budget will be enacted. Accordingly, the current deficit projection excludes the effects of potential policy changes to spending or revenues, including any steps lawmakers may take to bolster a weakening economy through fiscal stimulus.¹

In addition, so far this year funding has been provided for only a portion of the anticipated costs for operations in Iraq and Afghanistan and the war on terrorism.² Supplemental appropriations for such purposes could increase outlays by about $30 billion this year.

Beyond 2008, deficits under baseline projections continue each year until 2012, when they yield to modest surpluses through 2018. Under the assumptions that govern those projections, the deficit falls from $219 billion in 2008 (1.5 percent of GDP) to $198 billion in 2009 (1.3 percent of GDP) and $117 billion (0.7 percent of GDP) in 2011 and then changes to small surpluses in 2012 and later years (see Figure 1-1). By 2018, the surplus reaches 1.0 percent of GDP.

CBO’s budget baseline, however, is not intended as a forecast of future outcomes, but rather as a benchmark that encompasses current laws and policies. It is predicated on two key projections that stem from long-standing statutory procedures, one affecting revenues and one affecting discretionary outlays.

It is likely that appropriations will differ from those assumed in the baseline and that lawmakers will enact changes in spending and tax policies. Although CBO’s baseline projections do not incorporate such potential changes in policy, this chapter shows the implications that some alternative policy assumptions would have for the budget over the next 10 years. For example, CBO has constructed two possible scenarios for future spending related to military operations in Iraq and Afghanistan and other activities associated with the war on terrorism. Those scenarios incorporate different assumptions about how rapidly troop levels might be reduced over the next several years—and have different effects on the path of spending projections.

Alternative assumptions about tax policy also would change CBO’s projections. If all of the tax provisions that are set to expire over the next 10 years were extended and the AMT was indexed for inflation, the budget outlook for 2018 would change from a surplus of $223 billion to a deficit of $617 billion. In addition, debt held by the public at the end of 2018 would nearly double from 22.6 percent of GDP to 44.4 percent, and the 10-year, or cumulative, bottom line would change from a surplus of $0.3 trillion to a deficit of $4.6 trillion.

Over the long term, the nation faces substantial fiscal difficulties, which are already becoming apparent in CBO’s baseline. Throughout the coming decade, spending for the government’s health care programs and spending on the nation’s elderly population will increasingly strain the federal budget. In CBO’s projections, outlays for Medicare grow at an average rate of almost 7 percent per year between 2010 and 2018. Projected federal spending for Medicaid increases even more rapidly. Also, beginning this year, the first baby boomers become eligible for Social Security retirement benefits, and increasing numbers of beneficiaries will help boost the annual rate of growth of spending for Social Security from about 5.1 percent this year to 6.4 percent in 2018.

Beyond 2018, those trends will accelerate. Health care costs are likely to continue growing faster than GDP—as they have for the past 40 years. Indeed, the rate at which health care costs grow relative to national income will be the most important determinant of future federal spending. In addition, as the percentage of the population age 65 or older continues to increase, spending for Medicare, Medicaid, and Social Security will, under current law, exert such pressure on the federal budget as to make the current path of fiscal policy unsustainable.³ Substantial changes in federal spending and tax policies will be necessary to maintain fiscal stability.

The budget deficit fell in 2007 for the third year in a row, dropping from $318 billion in 2005 to $248 billion in 2006 and to $163 billion in 2007. As a percentage of GDP, the deficit declinefrom 2.6 percent in 2005 to 1.2 percent in 2007.

Revenues in 2007 totaled $2.6 trillion (or 18.8 percent of GDP), an increase of 6.7 percent from the amount the previous year. They were buoyed by a rise of 11.5 percent ($120 billion) in individual income tax receipts (see Table 1-2). In contrast, such tax receipts grew by 4.7 percent annually from 1997 to 2006. Revenues from other sources grew more slowly than they have in recent years.

		Actual		Estimated	Projected^a
		1997-2006	2007	2008	2009	2010-2018


				Revenues

Individual Income Taxes		4.7	11.5	4.1	10.6	6.9
Corporate Income Taxes		7.5	4.6	-1.7	-2.2	1.0
Social Insurance Taxes		5.1	3.8	4.6	4.1	4.5
Other^b		4.0	-4.2	3.1	3.0	6.6

	Total Revenues	5.2	6.7	3.4	6.1	5.5

				Outlays

Mandatory		6.0	2.7	6.9	6.7	5.6
Discretionary		6.7	2.6	4.5	2.9	2.2
Net Interest		-0.6	5.0	-1.6	3.1	0.8

	Total Outlays	5.5	2.9	5.2	4.9	4.1

Memorandum:
Consumer Price Index		2.6	2.3	3.2	2.3	2.2
Nominal GDP		5.4	4.6	3.9	4.3	4.7

Note: The growth rates in this table do not account for shifts in the timing of certain payments or receipts.

Corporate income tax receipts grew by 4.6 percent ($16 billion) last year, compared with 7.5 percent annually over the preceding decade (which included a particularly rapid average annual growth rate of nearly 40 percent between 2003 and 2006). Social insurance tax revenues (including payroll tax receipts for Social Security and Medicare) grew by 3.8 percent ($32 billion) in 2007, lower than the 5.1 percent average annual growth over the 1997–2006 period.

Revenues from all other sources, including excise, estate, and gift taxes as well as customs duties, dropped by 4.2 percent ($7 billion) in 2007, in part as a result of the abolition of certain telephone tax payments and the refund of some previous payments of those taxes. Those revenues had increased at an average rate of 4 percent per year in the previous 10 years.

Outlays totaled $2.7 trillion in 2007, or 20.0 percent of GDP. Federal spending grew modestly last year, by 2.9 percent (if adjusted for shifts in the timing of certain payments, the rate of increase was slightly less—2.6 percent). In recent years, the growth of spending was much higher, averaging 5.5 percent from 1997 to 2006. Both mandatory and discretionary spending grew more slowly in 2007 than they did over the past 10 years.

Mandatory spending rose by 2.7 percent (to $1.45 trillion) in 2007, compared with 6.0 percent average annual growth from 1997 to 2006.⁴ Growth in Medicare spending, which rose by 16.7 percent in 2007, was well above the average annual rate for that program of 6.9 percent over the previous 10 years. That percentage difference from 2006 outlays, however, overstates the growth in Medicare spending because it reflects shifts in the timing of certain payments. After adjusting for payments that were shifted from 2006 to 2007, CBO estimates that outlays for Medicare grew by 12.8 percent in 2007 and by 7.1 percent, on average, from 1997 to 2006. That substantial increase in 2007 occurred in part because 2007 was the first full fiscal year in which the new prescription drug program (Part D of Medicare) was in effect and because of rapid growth in the Medicare Advantage component of the program (under which beneficiaries may enroll in private health insurance plans).

Outlays for Social Security grew at a faster pace than in recent history—6.9 percent in 2007 versus 4.6 percent, on average, over the past decade. (Outlays for Social Security were held down in 2006 because the Treasury adjusted both Social Security outlays and revenues down by $6.2 billion to correct for previous accounting errors related to taxes withheld from Social Security benefits. With that accounting change excluded, the growth rate was 6.0 percent in 2007, and the adjusted rate over the 1997–2006 period was 4.7 percent.) Growth in Medicaid was below average, with outlays 5.5 percent above the 2006 level, compared with average annual growth of about 7 percent over the preceding decade. (See Chapter 3 for a more detailed discussion of these and other spending programs.)

All other mandatory spending experienced a sharp drop in growth compared with that in the past 10 years, returning to more typical levels. In recent years, this component of mandatory spending (with Medicare, Medicaid, and Social Security excluded) had increased markedly because of a variety of factors, including increases in the amounts and refundable portions of the earned income tax credit (EITC) and child tax credit, higher spending on agricultural subsidies, and large outlays for flood insurance payments following Hurricane Katrina.

Discretionary spending also grew more slowly than it had in the past—by 2.6 percent in 2007 (reaching $1.0 trillion), compared with 6.7 percent, on average, over the previous 10 years. That slower growth happened in part because, in 2007, many federal agencies were operating under a continuing resolution, which stipulated funding levels at or below the amounts they received in 2006. Within the category of discretionary spending, outlays for defense increased by 5.5 percent, whereas nondefense spending contracted slightly, dropping by 0.6 percent in 2007.⁵ In contrast, from 1997 through 2006, defense spending grew by 6.9 percent annually, and nondefense spending increased by 6.4 percent.

Funding for U.S. operations in Iraq and Afghanistan and other activities in the war on terrorism expanded significantly in 2007. Budget authority for those purposes totaled $171 billion in that year, compared with $120 billion in 2006. (Funding for those operations and activities is discussed in greater detail in Box 1-1.) CBO estimates that outlays for those purposes totaled about $120 billion in 2007.

Untitled Document

Box 1-1.

Funding for Activities in Iraq and Afghanistan and for the War on Terrorism

Since September 2001, the Congress and the President have provided a total of $691 billion in budget authority for military and diplomatic operations in Iraq, Afghanistan, and other regions in support of the war on terrorism and for related veterans’ benefits and services (see the table). Appropriations specifically designated for those activities, which averaged about $93 billion a year from 2003 through 2005, rose to $120 billion in 2006 and $171 billion in 2007. The Administration has requested $193 billion for war-related purposes in 2008, of which $88 billion has been appropriated thus far.

Estimated Appropriations Provided for Activities in
Iraq and Afghanistan and for the War on Terrorism, 2001 to 2008

(Billions of dollars)


				2001	2002	2003	2004	2005	2006	2007	2008	Total, 2001-2008

Military Operations and Other Defense Activities
	Iraq^a			0	0	46	68	53	89	113	71	440
	Other^b			14	18	34	21	18	22	39	13	178
		Subtotal		14	18	80	88	70	111	152	84	618

Indigenous Security Forces^c
	Iraq			0	0	0	5	6	3	6	2	21
	Afghanistan			0	0	0	0	1	2	7	1	12
		Subtotal		0	0	0	5	7	5	13	3	33

Diplomatic Operations and Foreign Aid
	Iraq			0	0	3	15	1	3	3	1	26
	Other			*	2	5	2	2	1	2	1	15
		Subtotal		*	2	8	17	3	4	5	1	40

Veterans' Benefits and Services^d
	Iraq			0	0	0	0	0	0	1	0	1
	Other			0	0	0	0	0	0	*	0	*
		Subtotal		0	0	0	0	0	0	1	0	1
			Total^e	14	19	88	111	81	120	171	88	691

Source: Congressional Budget Office.

Note: * = between zero and $500 million.

a. CBO estimated how much money has been provided for Operation Iraqi Freedom by allocating funds on the basis of obligations reported by the Department of Defense (DoD). For more information about funding for that operation, see Congressional Budget Office, Estimated Costs of U.S. Operations in Iraq Under Two Specified Scenarios (July 13, 2006).

b. Includes Operation Enduring Freedom (in and around Afghanistan), Operation Noble Eagle (homeland security missions, such as combat air patrols, in the United States), the restructuring of Army and Marine Corps units, classified activities other than those funded by appropriations for the Iraq Freedom Fund, and other operations. (For 2005 through 2008, funding for Operation Noble Eagle has been intermingled with regular appropriations for the Department of Defense. That funding is not included in this table because it cannot be separately identified.)

c. Funding for indigenous security forces—which went to accounts for diplomatic operations and foreign aid (budget function 150) in 2004 and, since 2005, has gone to defense accounts (budget function 050)—is used to train and equip local military and police units in Iraq and Afghanistan.

d. Excludes almost $2 billion in spending for medical care, disability compensation, and survivors’ benefits for veterans of operations in Iraq and Afghanistan and the war on terrorism. Those amounts are based on CBO’s estimates of spending from regular appropriations for the Department of Veterans Affairs and were not explicitly appropriated for war-related expenses.

e. At the current rate of military operations, the funding provided to date for 2008 will not be sufficient to pay for all of the costs that will be incurred this year.

Funding to date for military operations and other defense activities related to the war totals $618 billion, most of which has gone to the Department of Defense (DoD). Lawmakers also provided $33 billion to train and equip indigenous security forces in Iraq and Afghanistan.¹ A total of $651 billion has thus been appropriated since September 2001 for defense operations in Iraq and Afghanistan and for the war on terrorism.

In addition, $40 billion has been provided for diplomatic operations and foreign aid to Iraq, Afghanistan, and other countries that are assisting the United States in the war on terrorism. Of that amount, $16 billion was appropriated for the Iraq Relief and Reconstruction Fund.

DoD reports that it obligated an average of about $11 billion per month in 2007 for operations in Iraq and Afghanistan and for other activities related to the war on terrorism—an increase of about $3 billion compared with average monthly obligations in 2006. Operation Iraqi Freedom accounted for approximately 85 percent of all reported obligations; Operation Enduring Freedom (which refers mainly to operations in and around Afghanistan) accounted for another 15 percent. Additional security missions that have taken place in the United States since the terrorist attacks of September 11, 2001—such as combat air patrols over Washington, D.C., and New York City (known as Operation Noble Eagle)—accounted for less than 1 percent.

Because most appropriations for operations in Iraq and Afghanistan and for other activities related to the war on terrorism appear in the same budget accounts that record appropriations for DoD’s other functions, determining how much has actually been spent for those activities is difficult. However, CBO estimates that appropriations for defense operations in Iraq and Afghanistan and for the war on terrorism resulted in outlays of about $430 billion through fiscal year 2007 (with about $115 billion occurring in 2007). Of the funds appropriated for international affairs related to the war, about $30 billion was spent through 2007, CBO estimates. In total, by the agency’s estimate, outlays for operations in Iraq and Afghanistan amounted to about $120 billion last year. The President has requested another $105 billion for the war in 2008, in addition to the $88 billion that has been appropriated for that year. If that amount is provided, outlays in 2008 (which also include outlays from prior years’ appropriations) would total about $145 billion, CBO estimates.

1. The $33 billion includes $5 billion provided for Iraqi security forces in 2004 in an appropriation for the Department of State’s Iraq Relief and Reconstruction Fund.

Outlays for net interest rose by 5.0 percent in 2007 after a decade in which they declined, on average, by 0.6 percent per year. That increase in net interest payments reflects an uptick in short-term interest rates and a larger amount of federal debt. In 2007, short-term interest rates were nearly 30 basis points higher than in 2006, and the debt increased by about $200 billion.⁶

The projections that make up CBO’s baseline are not intended to be predictions of future budgetary outcomes—rather, they represent CBO’s best judgment of how the economy and other factors would affect federal spending and revenues if current laws and policies remained in place. CBO constructs its baseline in accordance with provisions set forth in the Balanced Budget and Emergency Deficit Control Act of 1985 and the Congressional Budget and Impoundment Control Act of 1974. (Although the relevant provisions in the Deficit Control Act expired at the end of September 2006, CBO continues to follow that law’s specifications in preparing its projections.) In general, those provisions spell out how the agency should project federal spending and revenues under current laws and policies. The resulting baseline can then be used as a benchmark against which to measure the effects of proposed changes in spending and tax laws and policies.

For discretionary spending, the Deficit Control Act specified that the baseline should be derived by assuming that the most recent year’s budget authority, including any supplemental appropriations, is provided in each future year, with adjustments to reflect projected inflation (as measured in specified indexes) and certain other factors (such as the annual cost-of-living adjustments to federal benefits).

For revenues and mandatory spending, the Deficit Control Act required that baseline projections assume that present laws continue unchanged.⁷ In many cases, the laws that govern revenues and mandatory spending are permanent. Thus, CBO’s baseline projections for those programs reflect anticipated changes in the economy, demographics, and other relevant factors that affect the implementation of those laws.

Under CBO’s assumptions for its baseline, the federal budget will show a deficit in 2008 of around 1.5 percent of GDP—though that figure could be higher if economic stimulus is provided or if additional appropriations are made for operations in Iraq and Afghanistan. In the baseline, deficits of about the same magnitude remain through 2011, at which point they give way to surpluses as a result of the rise in projected revenues when certain tax provisions expire. By 2018, the surplus equals about 1.0 percent of GDP (see Table 1-3).