CBO: America Faces "Fundamental" Budgetary Challenges That Will Require Big Changes

Want to fix the nation's budget problems? You can't tweak your way to fiscal stability. Small changes just won't be enough.  

That's one of the core messages of the new Congressional Budget Office (CBO) report on deficit reduction, which reads like a fiscal wake-up call to the nation's newly elected and reelected federal legislators.

The report warns of "fundamental" challenges to the future budget, and repeatedly describes the nation's current mix of spending levels and tax rates as "unsustainable." The problem, in a word, is debt: Under our current policy trajectory, debt held by the public is set to his 90 percent of the economy in a decade and "continue to rise rapidly thereafter." If that should happen, "the United States would quickly head into fiscal territory unfamiliar to it and most other developed nations." In short: Congratulations to Congress and President Obama: You've just been elected to budgetary hell.

Avoiding the worst won't be easy. "Making policy changes that are large enough to shrink the debt relative to the size of the economy—or even to keep the debt from growing—will be a formidable task," the report says. And transforming the entitlement system will almost certainly need to be part of the mix.

The CBO, a non-partisan office that doesn't published policy recommendations, doesn't say exactly how to change course. But it does make clear what won't work: tiny tweaks.

Entitlements, especially Social Security and Medicare, are the biggest drivers of the debt. The CBO reports that it would be possible to leave them essentially unchanged—but "only by raising taxes substantially, relative to current policies, for a broad segment of the population." Raising taxes on high earners, in other words, wouldn't fix the problem. Raising tax revenues just a little wouldn't fix it either: To close the gap with tax hikes would requiring raising tax revenues "significantly above their historical average as a percentage of GDP."

How big a tax hike are we talking about? Big. Very big. 

Historically, tax revenues average roughly 18-19 percent of gross domestic product. And they don't usually rise much higher: Since World War II, the government has never collected more than 20.9 percent of GDP in revenue. But on a current policy trajectory, the federal government will spend about 23 percent of GDP over the next decade and about 24 percent after. That means we'd have to hike tax revenues by about 26 percent above historical averages in order to match revenues to spending, which as the CBO suggests would mean raising taxes on the middle class as well as high earners.That seems neither desirable nor politically likely. 

Those numbers also make clear that small spending reductions aren't going to do the trick either. That's especially true given that changes will have to focus on popular entitlements like Social Security and Medicare. The CBO report makes clear that those ever-growing programs are biggest drivers of the long-term debt and the most in need of serious revamping: "Without significant changes in the laws governing Social Security, Medicare, and Medicaid," the report says, "those factors will boost federal outlays as a percentage of GDP well above the average of the past several decades—a conclusion that applies under any plausible assumptions about future trends in demographics, economic conditions, and health care costs." 

So here are the two takeaways. First, minor adjustments aren't going to be sufficient. Second, either entitlements will have to be substantially changed or we'll have to have a huge and historically unprecedented hike in tax revenues.

That explains a lot about why the nation's budget problems are so hard to fix. The public doesn't support higher taxes, except on a small cohort of top earners. Yet it's wary of big changes to the entitlement system as well. 

Something has to give. And both politics and economic history point in the same direction: Entitlements have to change. Politically, raising taxes on the middle class is a no-go in the United States. Republicans are adamantly opposed to tax hikes on anyone. And Democrats, led by President Obama, have repeatedly promised to not raise taxes on the middle class. Even if Democrats get their way and raise taxes on the rich, major fiscal adjustments will still be necessary.

That leaves overhauling the entitlement system and cutting spending down to size. As Reason has noted in the past, countries that successfully reform their budgets tend to do so by focusing primarily on spending cuts.

Polling suggests that there's more support for cutting the size of government than widespread taxes increases. There's very little support for higher taxes on the middle class: just 13 percent of the public says it wants to raise taxes on everyone. But there is widespread support for reducing the size and scope of the government: This week's election exit polls report that 53 percent of voters say that the government is doing too many things better done by businesses and individuals. 

Is the public ready for what's coming next? Neither party has done a good job of preparing the country for its fiscal challenges. They'll have to start soon. Big budgetary troubles are on the way. And big changes will be necessary to avoid them.