Answers to Questions for the Record Following a Hearing on The Budget and Economic Outlook: 2022 to 2032

On May 26, 2022, the House Committee on the Budget convened a hearing at which Phillip L. Swagel, the Congressional Budget Office’s Director, testified about the agency’s report The Budget and Economic Outlook: 2022 to 2032.1 After the hearing, Congressman Burgess submitted questions for the record. This document provides CBO’s answers. It is available at www.cbo.gov/publication/58223.

Question. Mr. Swagel, we require banks to undergo stress testing. Does any of CBO’s modeling undergo stress testing to determine what is happening to the economy, particularly with the excessive spending in the last year? When do you anticipate being able to provide to Congress updated information on the fiscal effect of higher inflation and higher interest rates?

Answer. CBO continually evaluates and updates its models to understand the effects of changes in the economy.2 CBO expects to release updated budget and economic projections in January 2023. Those projections, like the ones in The Budget and Economic Outlook: 2022 to 2032, which was released on May 25 and discussed at the hearing, will provide information about the effects of higher inflation and interest rates on the budget.

In response to interest from lawmakers, CBO is developing the capacity to provide additional information about those topics. For example, to illustrate how recent changes in economic conditions might affect its baseline budget projections, the agency examined an economic scenario based on information from the May 2022 Survey of Professional Forecasters (SPF). That survey, which reflects economic developments that occurred after CBO completed its latest economic projections on March 2, 2022, shows that, on average, forecasters expect inflation and interest rates to be higher than the agency currently projects, particularly over the next three years. To construct the SPF-based scenario, CBO began by setting values of economic variables—including several measures of real growth (that is, growth adjusted to remove the effects of inflation), inflation, and interest rates—equal to the average values published in the SPF. Then, to specify values for additional variables needed to project budgetary outcomes, the agency used a statistical model that draws on historical correlations between macroeconomic variables.3 To estimate the budgetary implications of the SPF-based scenario, CBO used approaches based on its budgetary feedback model and its baseline net interest outlays model.4

As a percentage of gross domestic product (GDP), projected deficits under the scenario that incorporates information from the SPF are larger than deficits in CBO’s baseline projections. As a result, debt as a percentage of GDP in 2032 is slightly higher under the SPF-based scenario than it is in CBO’s baseline projections, even though GDP is greater in the SPF-based scenario. Net outlays for interest, which are 1.6 percent of GDP in CBO’s baseline projections, are 1.7 percent of GDP under the SPF-based scenario in 2022, primarily because of that scenario’s higher interest rates. In 2032, net outlays for interest are the same in both sets of projections—3.3 percent of GDP. From 2022 to 2032, nominal federal debt held by the public grows by 66.4 percent in CBO’s baseline projections and by 69.4 percent under the SPF-based scenario. Nominal GDP grows by 48.5 percent over that period in CBO’s baseline projections and by 51.4 percent under the SPF-based scenario. As a result, by the end of 2032, debt is 109.6 percent of GDP in CBO’s baseline projections and 110.1 percent of GDP in the agency’s projections for the SPF-based scenario.

CBO has also recently published an updated edition of a recurring report about how changes in economic conditions might affect the federal budget, as well as the accompanying interactive workbook that allows users to analyze the budgetary implications of alternative economic scenarios by specifying differences in the values of four economic variables—productivity growth, labor force growth, interest rates, and inflation.5 In CBO’s analysis, if inflation was higher than it is in the agency’s forecast, the increase in revenues would roughly offset the increase in noninterest spending. But inflation can also affect net interest costs through its effects on nominal interest rates. Interest rates higher than those in CBO’s baseline projections would boost net interest outlays, deficits, and debt. The workbook can be used to assess the magnitude of such possible changes.

Question. Mr. Swagel, the Tax Cuts and Jobs Act was decried as a handout to the rich. According to Internal Revenue Service data analyzed by the Tax Foundation for the 2019 tax year, the top 50% of taxpayers paid 97% of all individual income taxes, and the bottom 50% paid only 3% of all individual income taxes. According to the new CBO baseline released yesterday, tax receipts are up by 39%—borne mostly by the rich. And yet, our deficit is projected to reach $1 trillion in FY 2022. Why does our budget deficit continue to grow despite record tax receipts and an inflated economy?

Answer. Although in CBO’s projections deficits initially shrink as a percentage of GDP in 2022 and 2023, they remain large by historical standards and generally increase over the next decade.6 From 2023 to 2032, the annual shortfall averages $1.6 trillion. The more than $2 trillion deficit projected for 2032 would equal 6.1 percent of GDP, significantly larger than the 3.5 percent of GDP that deficits have averaged over the past 50 years.

In CBO’s projections for 2022, revenues and outlays measured in relation to GDP are higher than their historical averages, but the deficit is large by historical standards because outlays are up by more than revenues. Revenues reach 19.6 percent of GDP this year—the largest that receipts, measured as a share of the economy, have been in more than two decades. Excluding shifts in the timing of some outlays, total federal outlays in 2022 equal 23.5 percent of GDP—above the 50-year average of 20.6 percent. Spending exceeds its historical average because of increases in mandatory spending due in part to legislation enacted in response to the coronavirus pandemic. As a share of GDP, the other major components of federal spending are estimated to be below their 50-year averages.

Over the next 10 years, outlays—which average 23.2 percent of GDP—grow faster than revenues in CBO’s projections, so deficits increase. Rising interest rates and accumulating debt cause net interest costs to double as a percentage of GDP from 2022 to 2032. The aging population and the rising cost of health care drive up outlays for Social Security and health care programs. Meanwhile, revenues decline over the next few years but average 18.1 percent of GDP over the 2023–2032 period—above their 50-year average of 17.3 percent of GDP. Although revenues remain high by historical standards, they are exceeded by outlays throughout the projection period.

Question. Mr. Swagel, according to the Congressional Budget Office’s monthly budget review for April 2022, net outlays for interest on the debt increased by $54 billion, or 25%, largely due to higher inflation this year. The Federal Reserve has now raised interest rates to try and get this inflation under control. The CBO baseline shows that spending for interest payments on the debt will increase from 1.6% of GDP to 3.3% of GDP. Is it possible that payments for interest on the debt will continue to increase beyond this projected level? What factors could lead to this outcome?

Answer. Even if federal laws remained unchanged for the next decade, actual budgetary outcomes, including interest costs, would differ from CBO’s baseline projections because of unanticipated changes in economic conditions and in a host of other factors that affect federal spending and revenues. Moreover, outcomes will also depend on future legislative action: New laws that significantly altered federal taxes and spending could be enacted.

A number of factors could lead to interest rates, and thus interest costs, that are higher or lower than CBO projects. Monetary policy—the federal funds rate set by the Federal Reserve and the pace at which the Federal Reserve reduces the size of its balance sheet—could differ from CBO’s projections. Another source of long-term uncertainty is the global economy’s longer-term response to the substantial increases in budget deficits and debt that occurred as governments spent significant amounts in an attempt to mitigate the impact of the pandemic and the economic downturn it caused. A significant increase in the extent to which national governments, financial institutions, and other entities hold other nations’ debt could raise the risk that financial stress in one country would affect the financial stability of other countries. In addition, changes in foreign demand for U.S. assets or the international role of the dollar would affect interest rates. Factors such as increased foreign and domestic saving, slower growth in total factor productivity, and lower labor force participation have contributed to the downward trend in interest rates over the past several decades. How much those factors will continue to weigh on interest rates over the next several years remains uncertain. In addition, the extent and timing of upward pressure on interest rates stemming from increased federal borrowing are highly uncertain.

To show how variations in economic conditions could affect its budget projections, CBO analyzed how the budget might change if values of key economic variables differed from those in the agency’s forecast.7 For example, if all interest rates—including both the rate on 3-month Treasury bills and the rate on 10-year Treasury notes—were 0.1 percentage point higher each year than they are in CBO’s economic forecast, deficits would increase progressively over the projection period by amounts that would rise to $41 billion in 2032, all else being equal. The cumulative deficit for 2023 to 2032 would thus be $285 billion larger than it is in the agency’s baseline projections.