The Congressional Budget Office released its annual 2015 Long Term Budget Outlook today, including the economic assumptions on which that outlook relies.
Setting aside the report’s confirmation of rapid growth in federal spending and a daunting fiscal outlook, the report contains some noteworthy changes in economic assumptions that affect the future budget outlook.
For starters, compared to CBO’s 2014 Outlook, real GDP growth is projected to be 0.1 percentage point lower over the 75-year long term outlook, averaging 2.2 percent per year compared to the previous 2.3 percent projection. A 0.1 percentage point reduction in growth may not seem like much, but it translates to more than $1.5 trillion in lost GDP over the next 10 years—the equivalent of more than $4,200 per capita. According to CBO’s rule of thumb for GDP growth, a 0.1 percentage point reduction corresponds to a $326 billion increase in the federal deficit over the next 10 years ($288 billion lower revenues and $37 billion higher spending).
Lower GDP growth is not only bad for the federal government’s bottom line, it’s also bad for individual and business pocketbooks. The reason tax revenues decline so much when GDP growth falls is that people have lower incomes and businesses have fewer profits on which they pay taxes.
In addition to lower GDP growth, CBO’s outlook reflects a sizeable reduction in interest rates, including a 0.5 percentage points reduction in 10-year Treasury rates over the next 10 years (from 2.5 percent in the 2014 outlook to 2.0 percent in the 2015 outlook) and a 0.2 percentage point reduction in the 75-year long-run. Using CBO’s rule of thumb on interest rates, a 0.5 percentage point reduction corresponds to an $873 billion reduction in the federal deficit over the next 10 years ($46 billion higher revenues and $827 lower outlays).
On the labor front, CBO revised downwards its near-term projection for the unemployment rate by 0.4 percentage points over the next ten years (from 5.8 percent to 5.4 percent) based on an expectation of economic expansion over the next few years. CBO’s long-term unemployment rate projections were unchanged. Finally, CBO reduced its assumption for hours of work, projecting a 2 percent decline in average hours of work by 2040, compared to a 1 percent decline projected in the 2014 Outlook. Fewer hours reflect an anticipated shift in the labor force towards those who tend to work fewer hours.
Economic assumptions are merely hypothesis, or best guesses about the future. Assumptions themselves have no impact on the economic and budget outlook, but actual changes in economic variables can generate profound, exponential effects. This is why it is so important that lawmakers implement policies that promote, rather than deter, economic growth.
