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Conclusion:  All joking aside, while the CBO shows a narrowing of the U.S. budget deficit over the coming years, its projections are predicated on a highly optimistic growth scenario.


The Congressional Budget Office came out with their revised economic and deficit projections this morning and they were interesting to say the least.  Perhaps the most noteworthy components, or potentially least reliable, were the economic assumptions in the CBO’s projections.  Our Healthcare Team did an excellent point grinding through the release in real time this morning.  As noted, the key red flag from the CBO’s numbers are the economic projections, specifically GDP growth.

The CBO’s GDP growth estimate for 2011 remains at 2.3%, which is going to be well off the mark, and then accelerates to 2.7% GDP growth in 2012.  Interestingly, the CBO’s growth forecast then hockey sticks to 3.6% from 2013 to 2016.  Based on the most recent data we’ve analyzed, these projections are highly optimistic to say the least, given the structural constraints facing the U.S. economy.

For comparative purposes, over the last ten years, starting with the most recent quarter, the U.S. economy has grown at an average real GDP growth rate of 1.6%.  If we extend back twenty years, the United States has grown on average at 2.6%.  So, while it is possible that the next five or so years will see an acceleration, it is somewhat unrealistic given the many headwinds still facing the economy.

The primary issue with being substantially off on GDP growth assumptions is that it really informs the remainders of the projections, namely long term debts and deficits.  The CBO, after also incorporating assumptions from the recent debt deal, now projects U.S. deficits to narrow over the coming years from an estimated -$1.3 trillion in 2011, to -$973 billion in 2012, to -$623 billion in 2013, and to -$380 billion in 2014.  That’s actually a decent narrowing of the deficit, but, of course, it assumes the optimistic growth assumptions above.

The key impact high GDP growth has on the federal government budget is on government revenue growth (more commonly known as tax revenue).  In the CBO’s estimates out today, government revenue grows at 8% per year over the next decade.  While part of this growth is driven by an expiration of the Bush Tax cuts at the end of 2012 (although that is questionable in the scenario that Obama loses), much of it is supported by economic growth and employing reverting to historical averages.

The CBO actually provides a perspective of the deficit outlook in a slower growth scenario.  According to their models, if real GDP growth was 0.1% lower per year, then the cumulative deficit through 2021 would be roughly $310 billion larger.  In the realistic scenario in which GDP growth is a full percent lower than the CBO predicts over the next ten years, that is a $3.1 trillion addition to the cumulative budget.

Historically, the CBO has been very inaccurate in projecting the deficit beyond the very short term.  In August 2009, which was exactly two years ago, the CBO was projecting a deficit for 2011 of $921BN.  The actual deficit for 2011 will be ~$1.3 trillion, or more than 40% higher than they projected just two years ago.  In addition, the projected deficit for 2012 back in August 2009 was -$590 billion.  The CBO is now projecting a deficit of -$973 billion for 2012, which is 56% more than their estimates from just two years ago.

We would strongly urge caution in reading too much into the projections of the CBO.  Historically, they have proven to be way off the mark and continue to incorporate economic projections that do not reflect reality.  The greater concern is that Congress takes the CBO’s projections seriously and underestimates the magnitude of debt and deficits challenges facing the Federal Government. If we’ve learned anything from Europe YTD, it’s that there’s an eventual end to the road on which the proverbial “can” is kicked.

Daryl G. Jones

Director of Research