Meet the Author

David E. Altig |

Vice President

David Altig was formerly vice president and associate director of research at the Federal Reserve Bank of Cleveland. Dr. Altig’s research is primarily focused on monetary and fiscal policy issues.

Meet the Author

Brent Meyer |

Economist

Brent Meyer

Brent Meyer is a former economist of the Federal Reserve Bank of Cleveland.

02.09.07

Economic Trends

The Budget and Economic Outlook

David E. Altig and Brent Meyer

This week President Bush released his proposal for government spending, taxation, and borrowing for fiscal years 2008-2017. Congress will now have its say, and the final fate of those proposals awaits the outcome of the political push and pull that defines our democracy. As part of that process, the Congressional Budget Office (CBO) will eventually provide projections of the budgetary impact of the president’s proposals, as well as the budget resolutions that eventually clear Congress. But we can get some preliminary hints by looking at some of the CBO’s baseline estimates, released on January 24, of what things look like under current law.

“Current law,” of course, is not a completely unambiguous concept. Certain expenditures—classified as “discretionary,” and accounting for roughly 40 percent of all federal spending—must be approved annually, so the CBO has to make some assumption about how spending in that category will grow. Because discretionary spending includes defense and security-related outlays, this is particularly difficult in the current environment. Following past practice (which was previously mandated by law), the CBO’s baseline projections assume that discretionary spending grows at the rate of inflation after the current fiscal year (2007):

In fact, the president’s budget proposal calls for an average annual growth rate in total discretionary spending of just over 3 percent from 2007 through 2012, versus the 1.8 percent annual inflation rate assumed by the CBO (measured by the chain-weighted gross domestic product price index).

To get an idea of what difference this makes, we can look to the CBO’s projections of the government’s surplus under the alternative assumptions that discretionary spending is frozen at 2007 levels or that discretionary spending grows at the rate of nominal gross domestic product (GDP):

Mandatory spending—which includes Social Security, Medicare, and Medicaid expenditures—is, of course, the bigger part of the spending picture. And it is getting bigger:

The president’s budget proposal includes several suggested reforms to mandatory spending programs, but they are designed to have most of their impact beyond the ten-year horizon of the CBO analysis: According to the Office of Management and Budget (OMB), outlays on entitlement programs will be, under baseline assumptions, about 12 percent of GDP if the president’s proposals are enacted, and 12.3 percent if they are not. The effects are, of course, much bigger in later decades, when imbalances between expenditures and funding for these programs become more pronounced. (See, for example, part II of the OMB’s Analytical Perspectives, Budget of the United States Government, Fiscal Year 2008.)

The final piece of the puzzle is on the revenue side, and here the story gets a little trickier. The CBO’s “current law” assumption includes the expiration of tax cuts that were enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). In addition, it does not assume relief for the increasing number of taxpayers that are affected by the Alternative Minimum Tax (AMT). There is fairly broad support for reforming the AMT provisions, and the president’s proposals would extend the major provisions of his major earlier tax legislation. How much difference does would that make? Again, the CBO provides a glimpse:

These changes in the baseline tax assumptions would, according the CBO’s analysis, eventually convert a surplus of about 1.2 percent of GDP to a deficit of about 0.8 percent of GDP. We will leave it to you to decide whether that is a big deal, or not.