If economic growth slows and costs rise at rates slightly less favorable than currently forecast, the federal budget could suffer increased deficits and lower-than-expected tax revenues over the next decade, the Congressional Budget Office said in a recent report.
The report, released in early June, analyzed how economic variables, or “rules of thumb,” could affect budget projections through 2032. The variables are growth of productivity, and gross domestic product; labor force growth; and interest and inflation rates.
The CBO examined the budget consequences if both productivity and the labor force grew at rates 0.1% less than forecast, and if all interest rates and wage-and-price indexes rose 0.1% more than expected. In doing so, the report concluded that the federal budget is “highly sensitive” to each variable.
“The rules of thumb are roughly symmetrical, so if productivity or the labor force increased more quickly than projected, or if interest rates or inflation were lower than projected, deficits would be smaller than they are in the agency’s baseline budget projections by about the same amounts,” the report said. It later emphasized that average annual growth of real GDP over the next five years will likely be within 1.3% of the projected rate.
According to CBO estimates, if productivity growth was 0.1% slower annually, GDP and total income would lag 1.2% behind the current forecast by 2032. Annual deficits would be $59 billion over projection by then, resulting in a cumulative deficit of $292 billion. Decreased production would hinder income tax collection, as there would be less total taxable income than expected.
“If workers produced less, the average hourly wage rate would be lower,” the CBO said. In this scenario, tax revenues would be $86 billion short in 2032.
Assuming no change in unemployment rate, slower labor force growth would result in a $128 billion cumulative deficit over the next 10 years, or a $27 billion yearly hit. To reach these figures, the CBO showed how slower labor force growth would push up the average estimated wage rate. While this may result in a short-term boost, the CBO found that “total labor income would be less than” it is in its baseline. The 2032 tax revenue shortfall would be $33 billion.
If all other economic variables were unchanged, interest rate hikes could also affect the budget, according to the CBO. The Treasury Department would borrow more following a $229 billion deficit increase from 2023 to 2032.
“That additional borrowing would raise the cost of servicing the debt by amounts that would increase each year and reach $8 billion” by the end of that period, the report concluded. An increase in interest rates of 0.1% would result in smaller amounts remitted to Treasury from the Federal Reserve, because additional earnings from interest on its portfolio would be outpaced by higher interest payments on reserves. The CBO estimated this would be a $20 billion gap over the next 10 years.
Factors affecting inflation that are measured as nominal, and not real, values include GDP, taxable income, and wage rates. For the final 0.1% rule-of-thumb adjustment, the CBO found that while there would be increased collection from individual income, payroll, and corporate income taxes due to larger price increases, “total outlays would be $575 billion more” than the $313 billion revenue boost through 2032. This comes out to a $262 billion rise to the projected deficit, the CBO said.
The findings aren’t indicative of a revision to the CBO’s budget outlook but are meant to serve as tools for measuring fluctuations in individual economic factors. However, the agency cautioned that if two or more of these “simplified scenarios” panned out as they did in its analysis, the economic effects would “interact and possible lower output growth by more or less than would be suggested by simply adding those effects.”
As the CBO conceded in its report, budgetary consequences from positive or negative economic shifts year to year “are difficult to accurately predict.”
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