Untying Uncle Sam’s Gordian Budget Knot

When analyzing the latest federal budget projections from the Congressional Budget Office, it quickly becomes apparent that the budget forecast relies heavily on questionable expectations: higher tax revenue (due to the recent tax hikes) and lower discretionary spending (due to the Budget Control Act of 2011 a.k.a. the sequester) to achieve a short-lived drop in the federal deficit.

Chart 1 shows projected tax revenues as a percent of Gross Domestic Product (GDP). Uncle Sam is banking on very strong revenue growth, especially from the individual income tax which will grow by 35 percent to 9.8 percent of GDP in 2023 from 7.3 percent in 2012. In dollar terms, individual income tax collections will more than double to $2.548 trillion in 2023 from $1.132 trillion in 2012.

Chart Showing Federal Revenues as a Percent of GDP 2012 to 2023

This is a remarkable projected rate of growth given that one of the weaknesses in the CBO forecast is that they show smooth economic sailing over the next decade–no recessions are in sight. Given the recent tax hikes, looming health insurance costs from Obamacare, and growing federal regulations it seems more than likely that the U.S. economy will have another recession within the next decade and sooner rather than later.

Chart 2 shows projected federal spending as a percent of GDP. Discretionary spending (defense, transportation, education, etc.) is the only category that goes down dropping by 34 percent to 5.5 percent of GDP in 2023 from 8.3 percent in 2012. CBO is using current law which means that they are assuming the sequester (which reduces discretionary spending) will take effect.

Chart Showing Federal Spending as a Percent of GDP 2012 to 2023

In contrast, mandatory spending (social security, medicaid, medicare, etc.) grows by 8 percent to 14.1 percent of GDP in 2023 from 13.1 percent in 2012. Note that by 2023, mandatory spending will be 157 percent larger than discretionary spending up from being 58 percent larger in 2012.

On a percentage basis, the fastest growing spending category is projected to be interest payments which will increase by 131 percent to 3.3 percent of GDP in 2023 from 1.4 percent in 2012.  As I explained in my previous blog post, “Uncle Sam’s Interest Payment Time Bomb,” CBO’s forecast could be a major understatement if interest rates rise faster or higher than expected.

Chart 3 summarizes the projected impact of higher revenue and lower discretionary spending on the federal budget deficit. When measured as a percent of GDP or in dollars, the deficit is projected to shrink through 2015 before growing again.

Chart Showing Federal Deficit as a Percent of GDP and Dollar Amount

Overall, these charts reveal the true underlying culprit driving Uncle Sam’s credit card spending binge over the next decade–mandatory, or entitlement, spending. The good news is that if reforms are enacted by 2015, the projected drop in the deficit could be pushed all the way to zero in just a few more years. The bad news is that President Obama has already ruled out any changes to entitlements.

Despite recent improvements in the deficit, CBO’s long-term projections paint a bleak picture in terms of permanently reducing the budget deficit. Entitlements and interest payments are already projected to eat the budget growing to 76 percent of the budget in 2023 from 64 percent in 2012. Controlling their growth will only become harder and harder with each passing day as America continues to age and the amount of debt grows higher.

Some may call for higher taxes, but CBO’s projections show that they have already gotten their wish with tax collections growing significantly faster than GDP. Additional tax hikes would only heighten the risks for an economic recession which would reduce revenues, boost entitlement spending and further increase the deficit.

Entitlement reform is the only way to untie Uncle Sam’s Gordian budget knot.