CBO: Expect slower growth this decade — and, as a result, higher deficits

February 4

The Congressional Budget Office is out with its budget and economic outlook for the next decade. One big story here? The U.S. economy is in worse shape than forecasters previously thought. And that means budget deficits between 2014 and 2023 are now expected to be higher than previously thought:


Specifically, the CBO now expects federal budget deficits between 2014 and 2023 to be about $7.3 trillion in all, which is $1 trillion larger than the agency predicted they'd be last year. Why? Weaker economic growth:

The bulk of that change occurred in CBO’s estimates of revenues: The agency has reduced its projection of total revenues by $1.6 trillion, largely because of changes in the economic outlook. A decrease of $0.6 trillion in projected outlays through 2023 partially offset that change.

The CBO makes four important points here:

1) The U.S. economy has less potential than previously thought. Thanks to the lingering effects of the recession, the aging of the country, the shrinking of the labor force, and various tax and spending policies, CBO says, the nation now only has the potential to grow about 2.1 percent per year over the next decade, on average. That's how fast we'd be growing if the country were at full employment. And it's a sluggish rate — the slowest growth in potential output since the 1950s.

CBO potential GDP
2) And we're not even meeting that reduced potential. The CBO also thinks it will be a long time before the country gets back to full employment. The unemployment rate isn't expected to fall below 6 percent until late 2017.

The chart on the right shows this well — it will take years before the nation's GDP "catches up" with potential GDP: "CBO now expects that output will fall slightly short of its potential, on average, even after the economy has largely recovered from the recent economic downturn in the later years of the projection period. In the same vein, CBO has revised its projection for the unemployment rate in the second half of the coming decade so that it remains above the natural rate."

3) Half of the drop in the labor force is due to demographics. Half is due to the poor economy. We've seen before that the U.S. labor force is shrinking: The portion of working-age Americans who have a job or are looking for one dropped from 66 percent in 2007 to 62.9 percent at the end of 2013.

So why is this? In a separate report (pdf), the CBO estimates that about half that drop is due to simple demographics — more and more Americans are getting older and retiring. Another one-third of the drop is because the bad economy has kept some Americans out of the workforce temporarily (they've either gone back to school or started families or simply sat at home). Those workers should, in theory, come back as the economy slowly improves.

But one-sixth of the drop in labor-force participation — about half a percentage point — is permanent scarring from the recession. These are workers who have left the labor force due to a lack of job opportunities and will never return. Possibly they've gone on disability, or retired early, or are now taking care of their families. But they likely won't come back. That's bad economic news, and it helps explain why CBO is now lowering its estimate of the U.S. economy's potential.

4) The CBO's deficit projections are very sensitive to growth. Keep this in mind when you look at the deficit forecasts. Small changes in growth can make big differences in the budget:

For example, if the growth of real GDP and taxable income was 0.1 percentage point higher or lower per year than in CBO’s baseline projections, revenues would be roughly $270 billion higher or lower over the 2015–2024 period.

That's why projected deficits for the next decade rose by $1 trillion in the latest report. Projected growth was slightly weaker, so projected deficits rose. One way to fix that would be with higher growth: Even an 0.1 percentage point boost in growth would shrink the projected deficit by about 4 percent. But how we get there is a separate, much bigger question.

Further reading:

--The biggest question facing the economy: Why are people dropping out of the workforce? 

--My colleague Sarah Kliff breaks down what the CBO says about the Affordable Care Act.

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Brian Fung · February 4