The Challenge of Deficit Reduction

November 8, 2012

In fiscal year 2012, the federal budget deficit surpassed $1 trillion for the fourth year in a row. If lawmakers maintained current policies by preventing most of the tax increases and spending cuts that are scheduled to occur in January, deficits would total almost $10 trillion over the next decade. Federal debt held by the public would increase from nearly 73 percent of gross domestic product (GDP) at the end of 2012 to 90 percent of GDP 10 years from now.

What factors underlie the nation’s budgetary imbalance? What options are available to bring spending and taxes into closer alignment? And what factors might lawmakers and the public weigh when evaluating different approaches to deficit reduction?

Today CBO released a report, Choices for Deficit Reduction, that addresses those questions.

It notes that the aging of the baby-boom generation and growing per capita spending on health care will put increasing pressure on the budget in the coming decade and beyond. Moreover, increases in federal debt lead to higher interest payments for the government, reduce national saving, limit lawmakers’ ability to use tax and spending policies to respond to unexpected challenges, and increase the likelihood of a fiscal crisis.

To avoid those consequences, lawmakers will have to adopt policies that make major reductions in the benefits that people receive when they get older, substantially decrease other activities of the federal government (relative to the size of the economy), raise revenues significantly above the historical average percentage of GDP, or involve some combination of those approaches. The report lists a number of options, mostly taken from previous CBO publications, that illustrate how challenging it would be to shrink the deficit by as much as $500 billion, $750 billion, or $1 trillion in 2020 relative to the shortfalls projected under current policies.

Very few of the policy changes that CBO has examined in the past are large enough, by themselves, to achieve a sizable portion of the deficit reduction necessary to put the budget on a more sustainable path. In addition, many options that would have a substantial budgetary impact would require large numbers of people to pay more in taxes or receive less in government benefits or services; others would shift significant costs to state and local governments.

It is possible to keep tax revenues at their historical average share of GDP—but only by making substantial cuts, relative to current policies, in the large benefit programs that aid a broad group of people at some point in their lives. Alternatively, it is possible to keep the policies for those large benefit programs unchanged—but only by raising taxes substantially, relative to current policies, for a broad segment of the population. Changes in other federal programs can affect the size of the changes needed in taxes or large benefit programs, but they cannot eliminate the basic trade-off between those two parts of the budget.

This report was prepared by Leigh Angres, Christi Hawley Anthony, Barry Blom, and Janet Holtzblatt.