Is War Between Generations Inevitable?

Studies | Social Security

No. 246
Friday, November 30, 2001
by Jagadeesh Gokhale and Laurence J. Kotlikoff

The CBO's Fiscal Fantasy

In January of this year, the CBO released projections of 10-year cumulative federal surpluses equaling $5.6 trillion. In August they revised this projection to $3.4 trillion in light of the slowing economy and the 2001 tax cut. That's a huge drop for currency traders and others who were finding solace in our budget surplus. Assuming the decline in the surplus is accurately calculated, can we count on the remaining $3.4 trillion actually materializing? Unfortunately not, because the original $5.6 trillion estimate was unrealistic. The main reason why is the CBO assumption, embedded in both its January and August forecasts, that federal discretionary spending on everything from missile defense to cigars for the president will remain constant, adjusted for inflation, over the next 10 years. While the CBO is up front in its small print about making this assumption, and claims as its rationale the Deficit Control Act of 1985, the assumption is hardly common knowledge. Indeed, most members of Congress may not understand that the CBO is making no adjustment whatsoever in projected federal spending for either population or productivity growth and is envisioning a 20 percent decline by 2011 in the size of government relative to the economy.

As incredible as this may seem, it's actually an improvement over the CBO's past practice of assuming fixed nominal spending on the part of the federal government.3 Even the CBO now admits that practice was "unreasonable" and not "a viable guideline" for projecting spending into the future. But having convinced the nation that the times are flush and the surpluses huge, our elected officials are spending more and taxing less. And since the terrorist attack on September 11, 2001, things have gotten much worse.

"The CBO surplus projections assume federal discretionary spending will not increase over the next 10 years."

The historical record provides some perspective on the likelihood that the federal government could shrink so dramatically over the next 10 years. Federal purchases as a share of GDP are currently lower than at any time in the past 40 years. In the early 1960s, federal purchases were roughly 12 percent of national output. Today, they are 6 percent. In the early 1960s, defense spending was 9 percent of GDP. Today, it is 3 percent. Spending on international aid as a share of GDP is also very low by historical standards. So is the third category of spending - domestic, non-defense discretionary spending.

Domestic, non-defense discretionary spending is currently 3 percent of GDP. Not since the early 1960s has such a small share of GDP been spent by the feds on domestic affairs. In 1980, for example, that spending totaled 4.7 percent of GDP.

The fact that federal spending has already declined so dramatically relative to the economy makes a further decline unlikely. Indeed, if defense spending grows with the economy, which appears highly likely given our war against terrorism, real non-defense spending would have to fall by one-third over the next 10 years to satisfy the CBO's forecast! What if the CBO is wrong and discretionary spending grows with GDP? What happens to the 10-year surplus? It falls by roughly $1 trillion, almost a third of its current projected level.

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