Effects of Recession and Growth on the Budget
January 14, 2002
What is the impact of slower than anticipated economic growth on the federal budget?
The U.S. economy and the federal budget are so large that very tiny changes in assumptions can create multi-billion dollar errors.
- Since gross domestic product (GDP)is about $10 trillion, every tenth of one percent of growth is worth $10 billion.
- Since the federal government takes about 20 percent of GDP, 0.1 percent higher growth adds $2 billion to the Treasury.
This impact rises over time and estimates of cumulative surpluses or deficits can rise and fall by huge amounts from small changes in economic assumptions. As tables in last year's budget show:
- If real GDP growth was 1 percent less than expected in 2001, federal revenues would be reduced $9.6 billion; government spending would be $2.1 billion higher for things such as unemployment compensation; and the surplus would be $11.7 billion lower.
- By 2011, one percent lower growth in 2001 would cause revenues to be $35.9 billion lower and spending to be $29.7 billion higher, and over the entire period, the cumulative budget surplus will be reduced $475 billion (see figure).
- With growth being about 2.5 percent less last year than originally estimated, revenues will be $52 billion lower and spending $18 billion higher this year.
- Over 10 years, the recession will lower combined surpluses by at least $1.2 trillion.
The most important variable in estimating long-term growth is productivity -- output per man-hour. From the mid-1980s until the mid-1990s, productivity only grew about 1 percent per year. But since 1995, productivity has spurted to about 2.5 percent per year. Projecting and compounding this increase explains almost all of the budgetary improvement we have observed lately.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, January 14, 2002.
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