Following up on its scoring of the fiscal effects of the President’s 2013 budget, CBO today released a separate macroeconomic analysis of the policies in that budget. CBO finds that the President’s budget would shrink the economy over the longer-term, relative to current law, by as much as 2.2 percent. This reduction in economic output would, in turn, exacerbate the already large projected deficits under the President’s budget. CBO also finds that when these macroeconomic effects are taken into account, the ratio of debt to GDP under the President’s budget increases in the latter years of the 10-year window, in contrast to the stabilization of this ratio when these macro effects are not considered. It notes that if that upward trend continued after the budget window, the budget path would accelerate the damage to the economy and would ultimately be unsustainable.
CBO analyzed the economic effects of the President’s budget over the short-term (2013-2017) and longer-term (2018-2022) using a variety of different economic models in order to provide a range of possible economic impacts.
CBO finds that the President’s budget could increase economic output (real gross national product, or GNP) by as much as 1.4 percent over the 2013-2017 period. However, using another set of assumption within its models (in which the boost to aggregate demand from the President’s policies is smaller and the reduction of investment from higher deficits is larger), CBO finds that the budget could also reduce economic output by 0.2 percent over this period.
Over the longer-term, CBO finds that the entire range of possible economic effects is negative. Their analysis finds that the President’s budget would reduce economic output by 0.5 percent to as much as 2.2 percent from 2018-2022, relative to current law.
Taking this macroeconomic feedback into account, CBO finds that cumulative budget deficits under the President’s budget could be as much as $400 billion higher than its static projection for the 2018-2022 period.
The negative economic drag over this period would occur because high budget deficits would lower national saving, which would lead to a lower level of the nation’s capital stock. The supply of labor, another important ingredient in economic growth, is also lower under the President’s budget over this timeframe, partly due to increases in transfer payments as well as a reduction in wages from a smaller capital stock and lower productivity. Both effects tend to lower people’s incentives to work.
The President’s policy of increasing taxes on capital income (for instance, the new 3.8 percent surtax on capital income as part of the health care legislation) would accentuate the shrinkage of the capital stock relative to current law. CBO finds that the effective marginal tax rate on capital income under the President’s budget would be 0.8 percentage points higher in the latter part of the decade.
Importantly, CBO finds that the negative economic effects at the end of the decade would lead to an increase in the debt to GDP ratio under the President’s budget. In CBO’s static score of the budget, this ratio was relatively stable at the end of the budget window. CBO cautions that if this ratio continued to rise after 2022, “the budgetary effects on economic output would become increasingly negative as rising debt crowded out growing amounts of productive capital. Moreover, interest rates would continue to rise, increasing interest payments and therefore deficits and accelerating the erosion of economic output.” Ultimately, CBO warns, this dynamic would not be sustainable.