The independent Congressional Budget Office (CBO) has put its budget projections through its routine review. Although the CBO expects astoundingly strong economic growth for this year thanks to the recent tax reform, the fiscal outlook for the US federal budget is unsurprisingly rather sobering. The latest report confirms that the federal budget deficit, measured as a percentage of economic output , will increase significantly in the next few years. After -3.5 per cent last year it is likely to increase to -5.1 per cent by 2022. In ten years the CBO puts the national debt at around 96 per cent of gross domestic product, in other words around 20 percentage points higher than at the moment. Only after the Second World War and the after last great financial and economic crisis has such a significant deterioration in the public finances occurred.
But in reality it will no doubt turn out to be even worse. Our concern is fuelled by several aspects: the latest CBO projections are based on the current legal situation, according to which some tax cuts already expire again in the course of next year. However, these tax cuts are more likely to be prolonged as otherwise private households could be faced with mounting financial burdens during the campaign for the next presidential and congressional elections in 2019/ 2020. Neither of the two party blocks want this.
But also regardless of this, a change of direction in fiscal policy is not to be expected in the next few years. Reducing the national debt, which is already high, has no political majority whatsoever, otherwise the recent tax reform would hardly have been passed without proposals for financing it. Since 2015 the state has delivered a positive contribution to growth even though the US economy is growing solidly. This is due to the politicians’ interest in either holding on to existing voters or winning over new ones.
As mentioned above since the will to save has clearly dwindled in the last few years at the political level, a long-term fiscal outlook should assume that the tax breaks that have just come into force will be prolonged. However, because of legal requirements the CBO may only assume the present legal situation in its base scenario. Nevertheless, the CBO seems to share our concern. It did at least calculate an alternative scenario. In a comparatively short text it draws attention to the fact that in this scenario as of 2019 the budget deficit would be around one percentage point greater than in the basic scenario. According to the CBO’s calculations, in this scenario the debt ratio at the federal level alone would already be above the 100 per cent mark in ten years. Looking further into the future, the upside pressure on debt would be even more severe.
One needs to bear in mind here that the total public debt in the USA is actually around another 30 percentage points higher. This is namely the case when the obligations of the social security funds are added in. This measure of debt is used not only by the IMF, but also corresponds to the usual Maastricht criteria used in Europe.
Another reason why the CBO projections could turn out to be somewhat too optimistic in the next few years is the fact that the interest rate level is expected to come down slightly as of 2026. For the years before this it is assumed that interest rates will rise. The expense item “interest payments” in the annual federal budget has already been growing faster than all other cost areas in the last few years. However, in light of a steadily deteriorating budget situation investors may be expected to demand more for taking risks in the next few years. This also possibly suggests an even gloomier fiscal outlook.
Not to mention the fact that a substantial escalation of the trade dispute could visibly curb world trade and thus the world economy in the near future. Even the US economy, which is very much driven by domestic demand, is not immune to a global economic slowdown. Weaker growth would immediately widen the budget gap and thus in the long term exacerbate the legacy of the current lack of fiscal discipline.