New calculations in the Congressional Budget Office's Long-Term Budget Outlook show that the high debt projected under current law could diminish average annual income by $2,000 within 25 years, and that a $4 trillion debt reduction package would not only prevent that $2,000 hit but could also increase average income in the economy by another $2,000, among other findings.
The report details the economic drag that will be caused by our growing debt once the economy has fully recovered by the Great Recession, if Congress does nothing to address it. Under CBO's "Extended Baseline Scenario," debt would increase from its current 74 percent of GDPto exceed the size of the economy, reaching 108 percent of GDP, by 2040. Yet even the Extended Baseline Scenario is perhaps too optimistic in assuming that some provisions are allowed to expire as scheduled and that Congress won't take any more fiscally irresponsible decisions. CBOalso projects an alternative baseline (the "Alternative Fiscal Scenario (AFS)"), which roughly illustrates what would occur if lawmakers continue current policies, keep non-health, non-Social Security spending from reaching historical lows, and do not allow taxes to continually increase as a result of "bracket creep." Under the AFS, debt skyrockets to 170 percent of GDPby 2040, over twice its current level.
CBO's standard budget estimates utilize historical trends of economic growth, inflation, and other variables. They do not, however, incorporate the effects of changing levels of debt on the economy, often called “feedback” or “dynamic" effects. In reality, high and growing debt levels will hinder long-term economic growth. In particular, CBOexplains that "higher debt crowds out investment in capital goods and thereby reduces output relative to what would otherwise occur." In other words, high debt harms economic growth.
In its report, CBO has analyzed the harmful effects of debt. If its economic projections are modified to include these negative effects, the economy is 3 percent smaller in 25 years. If lawmakers return to their more profligate ways and follow the policies in the AFS, the economy will be another 5 percent smaller. In contrast, reducing the debt can lead to modest but real gains in economic growth:a 2 percent larger economy within 25 years.
A bigger economy means increased income for each individual. CBOalso shows the effects on per-capita GNP, a rough proxy for average income. By 2039, GNPwould be $78,000 per person before accounting for the negative effects of high debt levels, in today's dollars. If the economic drag from higher debt is included, per capita GNPdrops to $76,000 – a $2,000 cut in income. If Congress continues profligate spending and increases debt to the levels in the AFS, GNP will drop by another $3,000, which means the average income will have dropped $5,000 dollars because of high debt.
On the flip side, a deficit reduction package of $4 trillion will put debt on a downward path as a share of the economy and increase per capita GNP by $2,000. Importantly, CBO's estimates of deficit reduction do not include any estimates of the types of tax and spending policies that are enacted. However, they note that higher effective marginal tax rates and larger transfer payments reduce output, while increased federal investment in education, infrastructure, and research and development can increase output. In effect, a smart deficit reduction plan that reforms the tax code and entitlements while increasing investments could increase economic growth even further.
Debt's "feedback" effect slows down economic growth. As a side effect, this slower economic growth will push debt even higher. Under the AFS, interest rates will increase by about three-quarters of a percentage point. As a result of higher interest rates and a slower economy, debt would rise to 183 percent of GDP, 20 points higher than if these feedback effects aren't included.
See our paper summarizing CBO's long-term outlook or the other entries in our blog series for more analysis.
I am an expert in economic policy and fiscal matters, well-versed in the intricacies of government budgeting and its impact on long-term economic outcomes. My expertise is grounded in a comprehensive understanding of economic principles, policy analysis, and a keen awareness of the ongoing discourse in the field. My background includes a thorough examination of reports, such as the Congressional Budget Office's Long-Term Budget Outlook, which serves as a crucial reference point in our discussion.
The article highlights the significant consequences of high national debt on the U.S. economy, emphasizing projections made by the Congressional Budget Office (CBO). The evidence presented suggests that if current policies persist, the national debt could reach alarming levels, with potential repercussions for average annual income.
The CBO introduces two key scenarios: the "Extended Baseline Scenario" and the "Alternative Fiscal Scenario (AFS)." The former envisions a debt increase to 108 percent of GDP by 2040, while the latter, a more pessimistic outlook, foresees debt skyrocketing to 170 percent of GDP by the same year. These scenarios underscore the urgency of addressing fiscal challenges to avert a potential economic crisis.
A critical aspect of the analysis involves the consideration of "feedback" or "dynamic" effects, acknowledging that high and growing debt can impede long-term economic growth. The CBO contends that increased debt levels crowd out investment in capital goods, ultimately hindering economic output. This insight provides a nuanced understanding of the complex relationship between fiscal policy and economic performance.
Furthermore, the CBO's projections indicate that the economy could be 3 percent smaller in 25 years if the negative effects of debt are factored in. Conversely, a reduction in debt, such as a $4 trillion debt reduction package, could not only prevent a $2,000 hit to average annual income but also potentially increase average income by another $2,000. These findings underscore the tangible economic benefits of responsible fiscal management.
The article also touches upon the broader impact on per-capita Gross National Product (GNP), serving as a proxy for average income. If the economic drag from higher debt is considered, per capita GNP could see a $2,000 reduction, rising to a $5,000 decrease if policies leading to higher debt levels are pursued.
In conclusion, the article emphasizes the importance of implementing a smart deficit reduction plan, noting that reforms to the tax code and entitlements, coupled with increased federal investments in education, infrastructure, and research and development, can foster economic growth. The intricate interplay between fiscal policies, economic growth, and debt dynamics requires careful consideration for policymakers aiming to secure the long-term economic health of the nation.
