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Long term budget projections, entitlements and demographics

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  • 1. Free Slides fromEd Dolan’s Econ Bloghttp://dolanecon.blogspot.com/Budget Basics (3): The Long-Term, Demographics, and EntitlementsPost prepared June 18, 2010
    Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers.
  • 2. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    Debt of the U.S. Federal Government, Past and Future
    Although much of the debate over fiscal policy focuses on stimulus vs. austerity in the short term, it is also important to look further ahead. These debt projections look half a century into the future.
  • 3. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    What Lies Behind the Projections?
    What assumptions are used to make projections so far into the future?
    Why is there such a wide range of projected rates of debt growth?
    Why do both the CBO’s lowest and highest projections show a debt that explodes to unsustainable levels?
  • 4. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    The Baseline Scenario
    The lower limit of future debt projections is given by a baseline scenario
    By law, the CBO’s 10-year baseline scenario is based on the assumption that there will be no changes in tax or spending laws
    For its long-term projections, the CBO extends this assumption far into the future. It is not intended to be realistic, but it provides a starting point.
    Extended Baseline Scenario
  • 5. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    The Alternative Fiscal Scenario
    The alternative fiscal scenario assumes that Congress will continue to make certain changes in laws that it has repeatedly made in the past:
    It will not allow the 2001 and 2003 tax cuts to expire in full at the end of 2010, as they are scheduled to do
    It will raise the minimum income level for the alternative minimum tax
    It will pass a “doc fix” law that blocks pending cuts to Medicare payments*
    Alternative Fiscal Scenario
    *On June 17, 2010, the Senate rejected a doc fix bill. Some observers fear that this will cause some doctors to stop accepting Medicare patients. Further action to pass doc fix in 2010 is still possible.
  • 6. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    Interest Rate Assumptions
    Interest rates are another source of uncertainty in long-term projections
    The CBO makes the conservative assumption that the US will be able to borrow at rates close to the historical average even as debt increases to new highs
    Some countries, like Greece, have experienced sharp rise in rates as their debt has increased, triggering a crisis (see chart)
    Others, like Japan, have managed to keep rates low even with very high debt ratios
  • 7. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    The Role of Entitlement Spending
    Growth of entitlement spending, especially Medicare, Medicaid, and Social Security, is the biggest source of future increases in the federal debt and deficit
    Entitlements are elements of the federal budget that are determined by formulas in long-term legislation, in contrast to discretionary spending, like defense or education, which is set by annual Congressional appropriations.
  • 8. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    Sources of Growth in Entitlement Spending
    The US population is aging, especially as baby-boomers reach retirement
    Medicare costs are growing faster than income per capita (“excess cost growth”)
    In the next 20 years, entitlement growth is driven mostly by aging, which cannot be much affected by policy changes
    After that, excess growth of medical costs are the main factor. These could, in principle, be affected by policy
  • 9. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    Effects of 2010 Health Care Legislation
    Data in previous slides do not include effects of 2010 health care bill
    The CBO estimates the bill will slightly reduce the deficit, especially in the first few years
    • The effects are small because most major cost-control measures were too controversial to make it into the health care bill as passed by Congress
    • 10. On balance, the 2010 health care bill does not greatly affect long-term budget projections
  • Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    Effects of Delaying Fiscal Adjustment
    To bring the budget to sustainability, it must be adjusted by reducing noninterest spending or increasing taxes or a combination of the two
    Because interest expense grows as the debt grows, the needed adjustment becomes larger each year that adjustment is delayed
  • 11. Post P100618 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/
    The Bottom Line
    “Under current law, the federal budget is on an unsustainable path”
    “The choice facing policymakers is not whether to address rising deficits and debt but when and how to do so.”
    “The longer that policy action on the budget is put off, the more costly and difficult it will be to resolve the long term budgetary imbalance.”

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