This blog post was co-created by Keith Davis, CFA.
On Wednesday, the Congressional Budget Office released updated projections for federal government deficits and debt over the next ten years. Some people may have been excited by what they read. The CBO essentially halved its estimate for cumulative budget deficits over the next 10 years. The ratio of total debt held by the public to GDP is now expected to be just 61% by 2021 compared to the prior estimate of 77%. Sounds great, right?
These projections need to be taken with a LARGE grain of salt. They are based on unrealistic assumptions about the future course of spending and fiscal policy. But before I get into that, let me summarize the report's findings. The following statistics are based on the CBO's baseline projections:
Obviously, the halving of projected cumulative deficits over the next ten years to $3.5 trillion from $6.7 trillion is a positive development. According to the CBO, about two-thirds of the reduction is the result of the recent passage of the Budget Control Act. This hard-fought piece of legislation, which came at the last minute and averted a potential financial crisis, sets caps on future discretionary spending and creates a process for adopting additional deficit reduction measures.
The remaining one-third of the reduction in cumulative deficits is the result of "changes in the economic outlook and technical revisions to CBO's projections."
Based on my comparison between the CBO's March and August projections for the 2012-2021 time frame, there are three major changes that account for the approximately $3.2 trillion decrease in cumulative deficit.
First, the CBO now expects $1.2 trillion in mandatory cuts resulting from the Budget Control Act.
Second, the CBO now expects about $1 trillion less in discretionary spending resulting from additional cuts (also a result of the BCA).
And finally, the CBO now expects about $1 trillion less in interest costs. These interest cost "savings" are the result of a combination of lower-than-expected interest rates and the aforementioned cuts in discretionary spending (relative to the previous projections).
Now, time to poke holes in these figures. First and perhaps most obviously, the CBO's expectations for GDP growth in 2011 and 2012 (2.3% and 2.7%, respectively) may be wildly optimistic at this point. But at least they reduced these estimates somewhat from the March projections. More important than those figures is the 3.6% average GDP growth assumption the CBO is now using for the 2013-2016 time frame.