U.S. Fiscal Policy

April 23, 2010

This afternoon I participated in a panel discussion about “Fiscal Strategies after the Global Crisis” at the International Monetary Fund. My short presentation focused on some familiar themes:

Given current law and certain possible changes to that law that are generally supported by the Administration and many Members of Congress, the budget deficit and debt are on a worrisome path—unsustainable in the long run and posing growing risks even during the next several years.

The following picture shows CBO’s March projections of debt relative to gross domestic product (GDP) under current law (the budget “baseline”) and under an alternative scenario in which the 2001 and 2003 tax cuts are extended and the alternative minimum tax (AMT) is indexed for inflation. The President’s budget would extend most of the 2001 and 2003 tax cuts, index the AMT for inflation, and make a variety of other changes in law. CBO’s projection of the debt under that budget is quite similar to our projection under the alternative scenario shown below. If that debt indeed rises toward 90 percent of GDP, it would be entering territory that is unfamiliar to us and to most developed countries in recent years.

Debt Held by the Public as a Percentage of GDP

 Putting U.S. fiscal policy on a safe path would probably require significant changes in spending, revenue, or both. In thinking about changes that might be made, it’s important to understand where most of the revenue will be coming from and where most of the spending will be going.

CBO’s March projection under current law shows that, in 2020, about one-half of federal revenue will come from individual income taxes, about one-third will be from payroll taxes, and the rest will be from corporate profits taxes and other sources. The same projection shows that roughly three-quarters of spending will go to just five areas—Social Security, Medicare, Medicaid, defense, and net interest—with the remaining one-quarter of spending covering all other federal programs. The following chart provides more details:

Shares of Federal Spending Projected for 2020 in CBO’s March Baseline

Changes of the magnitude required to put U.S. fiscal policy on a safe path could have important economic and social effects. Given the political and substantive difficulties in making significant policy changes, determining what those changes will be is an urgent task for policymakers.