CBO Sees Increasing 'Risk of a Fiscal Crisis'

September 17, 2013 - 12:35 PM

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U.S. Treasury Department (AP Photo)

(CNSNews.com) - The Congressional Budget Office released its 2013 long-term budget outlook on Tuesday, stating that "a large and continually growing federal debt ...would increase the probability of a fiscal crisis for the United States."

The report says under current laws and policies, the federal debt could reach 100 percent of Gross Domestic Product in 2038.

It also projects that the federal government's health care spending "will grow considerably in 2014 because of changes made by the Affordable Care Act."

CBO says federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product. "That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007," the report said.

If current laws stay generally the same, CBO expects federal debt held by the public to decline slightly relative to GDP over the next several years, but after that, deficits would grow again, partly because of the the government’s major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies to be provided through the new Obamacare health insurance exchanges).

"CBO projects that the federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy," the report said.

The word "crisis" appears numerous times in the report, as the CBO explains the negative consequences of burdensome debt.

At some point, the report says, investors would begin to doubt the government’s willingness or ability to pay U.S. debt obligations, making it more difficult or more expensive for the government to borrow money.

Even before that happens, the high and rising amount of debt "would have significant negative consequences" for both the economy and the federal budget.

-- The risk of a fiscal crisis—-in which investors demanded very high interest rates to finance the government’s borrowing needs-—would increase.

-- The government would have less flexibility to use tax and spending policies to respond to unexpected challenges, such as economic downturns or wars.

-- Federal spending on interest payments would rise, thus requiring larger changes in tax and spending policies;

-- Increased borrowing by the federal government would eventually reduce private investment, because the portion of total savings used to buy government securities would not be available to finance private investment.

The larger the debt, the larger the risk

According to CBO, a large and continually growing federal debt would "would increase the probability of a fiscal crisis for the United States."

The report says:

In such a crisis, investors become unwilling to  finance all of a government’s borrowing needs unless they are compensated with very high interest rates; as a result, the interest rates on government debt rise suddenly and sharply relative to rates of return on other assets. That increase in interest rates reduces the market value of outstanding government bonds, causing losses for investors who hold them. Such a decline can precipitate a broader financial crisis by creating losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt—losses that may be large enough to cause some financial institutions to fail.

Unfortunately, there is no way to predict with any confidence whether or when such a fiscal crisis might occur in the United States. In particular, there is no identifiable tipping point of debt relative to GDP that indicates that a crisis is likely or imminent. All else being equal, however, the larger a government’s debt, the greater the risk of a fiscal crisis.

The report say reducing the amount of federal debt would give future policymakers more flexibility in responding to extraordinary events.

Spending on health care

CBO says the future growth of federal spending on health care is a "significant source of budgetary uncertainty."

It notes that the federal government (taxpayers) pay for health care through Medicare, Medicaid, and other programs, and through various tax credits and tax breaks.

"The federal government’s health care spending will grow considerably in 2014 because of changes made by the Affordable Care Act: More low-income people will become eligible for Medicaid, and others will become eligible for subsidies for health insurance purchased through exchanges," CBO says.

Federal spending and revenues

By 2038, CBO projects, federal spending could increase to 26 percent of GDP, compared with 22 percent in 2012 and an average of 20.5 percent over the past 40 years.

Specifically, if current laws generally remain in place:

-- Federal spending for the major health care programs and Social Security would increase to a total of 14 percent of GDP by 2038, twice the 7 percent average of the past 40 years.

-- In contrast, total spending on everything other than the major health care programs, Social Security, and net interest payments would decline to 7 percent of GDP, well below the 11 percent average of the past 40 years and a smaller share of the economy than at any time since the late 1930s.

-- The federal government’s net interest payments would grow to 5 percent of GDP, compared with an average of 2 percent over the past 40 years, mainly because federal debt would be much larger.

CBO projects that federal revenues would equal 19.5 percent of GDP by 2038 under current law, compared with an average of 17.5 percent over the past four decades.

CBO said revenues are projected to rise from 15 percent of GDP last year to 17.5 percent in 2014, "spurred by the ongoing economic recovery and changes in provisions of tax law (including the expiration of lower income tax rates for high-income people, the expiration of a temporary cut in the Social Security payroll tax, and the imposition of new taxes).

After 2014, CBO projects that revenues would increase gradually relative to GDP, largely because growth in income beyond that attributable to inflation would push taxpayers into higher income tax brackets over time.