The U.S. government risks a fiscal crisis unless it makes significant changes in tax and spending policies, the Congressional Budget Office said.
The nonpartisan agency said today that without policy changes, the national debt within 15 years will top the historical peak set after World War II. In 1946, government debt amounted to 109 percent of the economy.
This year, it’s projected to reach 70 percent of the gross domestic product, up from 40 percent in 2008, according to CBO.
By 2037, the debt would be almost twice the size of the economy, the agency said. That would mean higher interest rates, slower economic growth and far more painful choices for lawmakers than they face today.
The growing debt “would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget,” the agency said in its annual report on the long-term outlook for the federal budget. “Such a crisis would confront policy makers with extremely difficult choices. To restore investors’ confidence, policy makers would need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.”
The gap between projected taxes and spending is so large, the report said, that if lawmakers merely wanted to prevent the debt-to-GDP ratio from increasing over the next 25 years, they’d have to immediately and permanently cut $700 billion from the $3.6 trillion U.S. budget.
A so-called fiscal cliff is coming at the end of 2012 when a number of major tax-and-spending changes will take effect unless Congress acts. The George W. Bush-era income tax cuts will expire as will a temporary cut in the Social Security payroll tax. About $1 trillion in automatic spending cuts will be poised to start, expanded jobless benefits will expire and the government will approach the legal limit on federal borrowing.
Lawmakers are waiting for the outcome of the November election before deciding what to do about the fiscal changes, in hopes that voters will give them a stronger hand in negotiations.
“CBO’s report is a warning that we must get our fiscal house in order,” said Representative Steny Hoyer of Maryland, the second-ranking House Democrat. “However, Republican leaders’ insistence on finding savings only from cuts to essential services for the most vulnerable Americans will not get us any closer to the real, comprehensive deficit reduction solution we need.”
House Budget Committee Chairman Paul Ryan said the report “underscores the obvious: the president’s policies are not working.” Republicans passed a budget “that responsibly averts the looming debt crisis” and will “advance solutions that foster a better environment for economic growth and job creation,” said Ryan of Wisconsin.
Lawmakers will face difficult tradeoffs in deciding how to phase in any deficit reduction, CBO said, in part because of the still-weak economy.
“Abruptly implementing spending cuts or tax increases would give families, businesses and state and local governments little time to plan and adjust,” according to the agency. “Immediate spending cuts or tax increases would represent an added drag on the weak economic expansion.”
Yet “cutting spending or increasing taxes slowly would lead to a greater accumulation of government debt and might raise doubts about whether longer-term deficit reduction would ultimately take effect,” CBO said.
For now, the financial markets are giving lawmakers time to sort out the fiscal issues. Low interest rates have allowed President Barack Obama’s administration to finance almost four years of a budget deficit topping $1 trillion without igniting price increases. While the amount of marketable Treasuries outstanding has more than doubled to $10.4 trillion from $4.4 trillion in mid-2007, debt expenses equaled 3 percent of the economy in 2001, less than when the U.S. ran a surplus in 1999.
Still, CBO said interest costs will climb dramatically without cuts. It projected they will reach 10 percent of GDP by 2037.
As debt mounts, interest costs will be a growing share of government spending, making it harder for policy makers to respond to unanticipated expenses such as wars or financial crises, CBO said.
“To keep deficits and debt from climbing to unsustainable levels,” policy makers will need to increase revenue substantially, cut spending significantly, or “adopt some combination of those two approaches,” CBO said. “The aging of the U.S. population and the rising costs of health care mean that the combination of budget policies that worked in the past cannot be maintained in the future.”