CBO recently released new budget projections that incorporate the 2017 tax act and the 2018 spending deals. In a new paper with Alan J. Auerbach, we show that the fiscal situation is even worse than it looks.

Over the past year, the 2017 tax cut, the 2018 spending deal, and higher projected interest rates have raised projected deficits and debt, while expectations of a stronger economy (in part attributable to the fiscal stimulus from those policy changes) and lower health care spending worked in the opposite direction. The net effect is that CBO now projects the federal debt will be 94.5 percent of Gross Domestic Product in 2027 under current law, compared to its projection of 91.2 percent last June.  

But a realistic picture is more troubling, for three reasons.    

First, in an odd twist, CBO’s projection of a strong economy makes its forecast of large future deficits more worrisome. CBO projects that the economy will, on average, be at full employment over the next decade. If (or more likely when) the economy slows, the medium-term fiscal outlook is likely to look significantly worse.

Second, under more realistic assumptions about tax and spending policy, deficits will be considerably higher, as CBO acknowledges.  CBO is required to make assumptions about spending that are not realistic and assume that Congress will let temporary tax cuts expire. 

Those assumptions likely overestimate tax revenues and underestimate spending.  Under current law, CBO projects a debt-GDP ratio of 96.2 percent by 2028.  On the other hand, if Congress continues current policy by extending tax cuts and increasing spending, we project the debt-GDP ratio will rise to 106.5 percent in a decade, the highest ratio in U.S. history. (CBO’s projections under their alternative fiscal scenario are slightly different.)

Third, the situation only gets worse after 2028. The “fiscal gap” measures the tax and spending changes needed to bring the debt-GDP ratio to a specified level in a given year. For example, Congress would have to immediately enact permanent spending cuts and/or tax increases totaling 4.0 percent of GDP just to maintain today’s debt-GDP ratio 30 years from now.

This represents about a 21 percent cut in non-interest spending or a 24 percent increase in tax revenues relative to current levels. To put this in perspective, the 2017 tax cuts and 2018 spending deal will raise the deficit by slightly more than 2 percent of GDP in 2019.  Thus, the required adjustments to keep debt at its current levels relative to the size of the economy in 2048 are about twice as large and in the opposite direction as recent policy moves. And the longer policymakers wait to institute changes, the larger those adjustments would have to be.

Sustained federal deficits and rising debt that are used to finance consumption or transfer payments will crowd out future investment and reduce prospects for economic growth.  Rising debt levels also make it more difficult to conduct routine policy, address major new priorities, or deal with the next recession or emergencies. And they impose substantial burdens on future generations.

 The nation’s debt-GDP ratio rose by about 35 percentage points during the most recent recession.  It is hard to believe that policymakers or financial markets would look kindly on a similar increase in US borrowing when the next recession hits.  While we don’t really know how much debt the US can accumulate without precipitating a crisis, a rising debt-GDP ratio can’t go on forever.