The Surest Way to Spot Trouble: When Even the CBO Says There’s a Problem

The Congressional Budget Office (CBO) released its 2013 Long-Term Budget Outlook this morning, and its government debt projections are dismal.

As shown below, the so-called “baseline scenario” that adorns the report’s cover is pointed upwards for the first time, owing to January’s tax law changes. And the trajectory is steeper than in the projections I released in July.

cbo cover chart

But the CBO’s featured chart only tells a small part of the story. The baseline scenario happens to be bogus. Even as it shows our addiction to debt worsening, it doesn’t do justice to the severity of that addiction.

In an ideal world, the CBO would highlight a more meaningful chart, one that matches up better with economic, demographic and political realities.  Of course, there are statutes that restrict the content of CBO materials, but these can and should be changed. They, too, are bogus.

In any case, I’ve updated an alternative chart that we first put forward in August:

debt projection5

As I wrote last month, this is the chart that every taxpayer deserves to see. You’ll notice that it looks a little different than our last version (basically, worse).

The first three chart segments are now taken mostly from the spreadsheet that the CBO posted alongside today’s report, and the “with economic feedback” scenarios are new. I added them because they can no longer be untangled from the “alternative scenario,” which the CBO defined differently this time around. What’s more, they’re more realistic than the baseline, which implausibly assumes that there are no economic consequences to rising debt. However, because the CBO truncated its economic feedback calculations at 2038, I carried the growth rate forward to 2056 to match the other scenarios.

I’ll have more to say in the future about the alternative scenario, which clearly has an outsized effect on the projections. Keep in mind that this scenario has proven to be more accurate in the past than the baseline.

To explain the chart’s other features, I’ll borrow from our earlier post:

Using a more tangible debt measure

The usual approach of dividing debt by GDP is helpful in some ways but has two distinct drawbacks. First, GDP is a manufactured measure that depends entirely on how the government chooses to define it, as we saw in July when the Bureau of Economic Analysis (BEA) changed its methods and rewrote economic history. Second, it’s hard to develop an intuitive sense for how much debt-to-GDP is too much. Unless you are, say, a credit analyst accustomed to working with such ratios, debt-to-GDP is just another arcane statistic.

Although there’s no such thing as a perfect measure, the chart above is at least more easily understood than debt-to-GDP. It shows the U.S. dollar amount of debt per taxpayer, anchored to the 2013 purchasing power of the dollar. Each taxpayer’s share of the nation’s debt might grow according to the figures in the chart, which reflects both government commitments and economic realities. Needless to say, taxpayers deserve to see these figures.

Accounting for budget slippage

Notice that I just used the term “economic realities.” Unfortunately, the CBO’s debt projections are anything but reality. They’re based on the spectacularly false assumption that the economy will reach a hypothetical “full employment equilibrium” and then remain there forever. Like Steven A. Cohen’s dominance and Miley Cyrus’s innocence, recessions are a thing of the past according to the CBO. In fact, the CBO assumes that economic growth never dips below its long-term trend.

To correct for such a ridiculous assumption, the CBO should add an allowance for periods of sub-par growth. Research suggests that an allowance of 0.7% of GDP per year would have been sufficient historically.  This was the average business cycle effect on the budget deficit between 1981 and 2010.  It’s reflected in the chart above in the “recessions really exist” segment, which ratchets up the debt projections according to the estimated 0.7% per annum in budget slippage.

Update/Correction (October): We used the CBO’s new projections for this post, adjusted to its new definition of the “alternative scenario,” and sent the materials to CNBC. We later noticed that the CBO attributed a 0.3% increase in its long-term unemployment rate (from 5.0% to 5.3%) to recessions. It also lowered its potential GDP estimate by 0.6%, while leaving the long-term GDP growth rate unchanged. These adjustments are different to those in our “recessions really exist” chart segment above. They don’t kick in for at least ten years (the unemployment rate didn’t reach the recession-free assumption of 5.0% until 2031 in the CBO’s 2012 report); exclude recession costs such as stimulus packages (0.3% of GDP per year based on an historic average); and still leave the unemployment rate too low (the lowest historic average ending in the present is 5.8%, and you have to start at the beginning of the BLS data in 1948 to get that low). Nonetheless, it’s a step in the right direction. It’s the first time we’ve seen a recession assumption of any kind in CBO projections, and we’ve read recent years’ reports cover to cover. We’re taking full credit. (That’s a joke, but our web stats show steady traffic in even our older CBO posts – maybe this is from the Ford House?)  The business cycle still isn’t adequately considered, especially with an unemployment rate assumption lower than any reasonable historic average, but we’ll admit that the language in the two paragraphs above (which comes from our post in July) is now too harsh.

Acknowledging trust fund debt

This is another no-brainer. The CBO follows the common governmental practice of ignoring amounts that the Treasury Department borrows from various trust funds, such as the Social Security and Medicare trusts. These borrowings are said to be meaningless because trust funds don’t qualify as “the public.” Therefore, using the government’s definition of “debt held by the public,” the trust funds can be exploited to reduce reported debt totals.

I suggest being more transparent by pulling the trust fund borrowings out from under the carpet.  Most people recognize that entitlement payouts to retiring baby boomers will soon overwhelm contributions, meaning that trust fund debt will need to be either paid down or defaulted on just like any other debt. And that it’s downright disingenuous to claim that trust funds don’t represent the public. Trust fund borrowing should be added to total debt, just as it is in the chart above by including the “trust fund debt counts” segment.

When I posted our earlier version of the chart above, I suggested pressuring your congressman to request that the CBO produce something similar. I’ll add here that you may want to show the chart to your children. After all, they’ll be the ones who’ll have to deal with the debt we’re piling on today.

(For an historical perspective on why we shouldn’t be complacent about soaring government debt, see our research on “63 High Government Debt Episodes and What They Tell Us about Our Options Today.”  For a mathematical view, using assumptions suggested by none other than über-Keynesian Paul Krugman, see “Testing Krugman’s Debt Reduction Strategy And Finding It Fails.”)

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2 Responses to The Surest Way to Spot Trouble: When Even the CBO Says There’s a Problem

  1. Spud says:

    Does your chart include unfunded medicare / medicaid obligations?

    • ffwiley says:

      Today’s unfunded entitlement promises don’t show up in the first bar on the left, which represents actual debt securities held by the public plus intra-governmental debt (which is mostly debt held by the trust funds). But as you move through time in the projection and the promises come due they add to the projected deficit, and therefore, to the projected debt.

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