BUDGET IMPLICATIONS OF THE WAR
The nation faces significant challenges in the near-term in prosecuting
the war on terror abroad and defending our homeland from attack, in addition
to rejuvenating economic growth. These efforts will require substantial budgetary
resources. Fortunately, the United States has abundant resources to tap.
However, in order to ensure that the fiscal outlook remains positive over
the longer-term, tough fiscal choices must be made to direct funds toward
priority endeavors and away from poorly performing government programs. New
budget process reforms are needed to expedite this process.
The response to the terrorist attacks, both at home and abroad, and
the onset of recession have caused a notable shift in the near-term fiscal
outlook. Deficits now look likely over at least the next two years. However,
assuming the government pursues pro-growth policies and controls spending,
the budget should be back in surplus by 2004 or 2005.
The overall fiscal position remains strong even with this temporary
move into deficits. The 2003 deficit is projected to be less than one percent
of GDP—this compares with a 4.5 percent deficit during the last recession.
Indeed, despite simultaneous war, recession, and emergency spending, 2002s
fiscal position will be better than that recorded in any year between 1975
Impact of Recession
One would expect the fiscal picture to deteriorate as the economy goes
into recession, even absent the multi-front war on terror. Tax receipts decline
as activity slows, while expenditures rise for cyclically sensitive programs
like unemployment insurance. Furthermore, it is good economic policy to reduce
tax burdens explicitly during a recession, in order to limit the economic
slide and hasten recovery. While such policy actions may worsen the deficit
in the near-term, they will improve the fiscal outlook in the long run since
it is growth that ultimately generates any surpluses.
Evolution of the 2002 Fiscal Projection
(In billions of dollars)
|2002 Budget Baseline Projection||283
| Weaker Economy||-197
| Enacted Spending||-54
| June Bipartisan Tax Relief Package||-40
|2003 Budget Baseline Projection||–9
Economic weakness has been the largest source of erosion in
the current years fiscal projection, followed next by spending stemming
from the September 11th attacks. Economic changes
accounted for two thirds of the deterioration in the projected baseline fiscal
position since the last year. Spending accounted for an additional 20 percent
of the decline.
Debt and Interest
The combined effects of recession and war have interrupted progress
in paying down our publicly held debt. Nonetheless, debt will continue to
diminish as a factor in our fiscal affairs. The ratio of publicly held debt
to GDP will decline steadily from 2002 onward. After hitting 50 percent in
the mid-1990s, the debt/GDP ratio will be 33 percent in 2003 and is projected
to fall to 25 percent by 2007. Further evidence of this constructive backdrop
can be seen in the Treasury Departments decision last fall to discontinue
issuance of the 30 year Treasury bond.
As the share of publicly held debt to GDP declines, interest costs will
continue to fall as a share of total outlays. After totaling 15 percent of
federal outlays in the mid-1990s, this burden will be only nine percent in 2002,
dropping to eight percent by 2007.
The federal government issues debt to the public in order to finance
its budget deficits. As noted, this debt is expected to be broadly stable
in dollar terms over the next five years, while declining as a share of GDP.
However, the government also issues special Treasury debt to the federal
trust funds that generate surpluses, including Social Security. While debt
held by the public is a more meaningful measure of the governments
effect on private financial markets, Congress tracks the sum of publicly held
and governmentally held debt, and imposes a limit on the amount of total debt
outstanding. Since governmentally held debt rises steadily over time, the
debt limit must be raised periodically even if debt actually owed to the public
is not growing. In fact, debt subject to limit continued to rise during 1998–2001
even as the publicly held debt decreased.
The current limit on total debt is set at $5.95 trillion. In the Mid-Session
Review for 2002, total debt was expected to breach this limit by 2004, due
to ongoing trust fund purchases of Treasury securities. Given the deterioration
in the near-term fiscal picture due to the war and recession, however, the
debt limit now looks likely to be hit in early 2002.
The Need for a Realistic Budget Window
The events of last year underscore the difficulty of making reliable
budget estimates even one year ahead. No one expected the economic and fiscal
fall-out that resulted from last Septembers terrorist attacks and the
onset of recession. Similarly, no one knows what types of economic or political
shocks will arise in the future. The uncertainty surrounding such events
should make us cautious as we attempt to formulate our budget projections.
Indeed, over the last six years, the 10 year fiscal projections have
varied to a stunning degree. In the 1997 Budget, rising deficits were forecast
totaling $1.4 trillion over a 10 year horizon. By the 2002 Budget steadily
rising surpluses were projected over a 10 year period, totaling $5.6 trillion.
Due to the events of last year, the latest projections are in between these
wildly divergent estimates. Such enormous swings over a short period of time
raise doubts about the usefulness of 10 year projections and lead one to conclude
that the recent experiment with 10 year budget projections has been a failure.
Consequently, the Administration intends to phase out the use of 10 year budget
projections completely by the 2004 Budget. This years budget will
still provide aggregate 10 year projections for those who follow and still
find value in such numbers (see Summary Tables). However, agency totals and
supporting detail will be limited to five year projections.
It is easy to forget that 10 year budget forecasts are a relatively
new phenomenon. The 1996 Mid-Session Review was the first budget document
to use 10 year projections. In the prior 25 years, five year budget windows
were the norm. (In fact, prior to 1971, three year budget windows were used.)
Indeed, even five year estimates are fraught with uncertainty. The
average absolute errors in projecting the surplus or deficit since 1982 have
been large, and they increase in each year of the five year budget window.
There has been a $75 billion average absolute forecasting error for the budget
year alone (i.e., 2003 for this budget). This rises steadily to $205 billion
by the fourth year following the budget year (i.e., 2007 for this budget).
Since the experiment with 10 year budget projections has been brief, data
are not yet available to assess the average miss beyond five years. However,
the rising average absolute errors over the first five years point to steadily
rising errors over the subsequent five years as well. (For more information
on the historical record of differences between estimated and actual surpluses,
see Chapter 18 of the Analytical Perspectives volume,
Comparison of Actual to Estimated Totals.)
Average Absolute Miss in Budget Projections: 1982 to 2001
(In billions of dollars)
Budget Year Plus One
Budget Year Plus Two
Budget Year Plus Three
Budget Year Plus Four
History suggests that the current projections could be off by
an enormous margin. A 90 percent confidence range around the current projections
stretches from plus $480 billion to –$480 billion around the 2007 surplus
estimate. Based on the trend seen in the first five years, this confidence
range would be expected to widen further beyond 2007.
The Congressional Budget Office (CBO) has made similar calculations
and has estimated even larger uncertainty bands.
Responses to Uncertainty
There is widespread recognition of the difficulties
involved in making multi-year projections. For instance, the Administration
and CBO only attempt to forecast the economic cycle for the 18–24 month
period following the budget submission. Thereafter, both simply assume that
the economy returns to its long-run sustainable rate of growth. Most private
economic forecasters do not project the economy beyond a one to two year horizon.
In light of the remarkable swings over the last several years, it is
time to acknowledge the limitations of 10 year budget forecasts. Rather than
continue to assign false confidence to these numbers, the Administration will
begin shifting back to a maximum time horizon of five years.
It is critical that the increased funding for the war on terrorism and
restoring economic growth be matched with restraint in other areas. This
is necessary in order to avoid a worsening of the nations long-term
fiscal and economic outlook. Budget reforms are needed to enforce such restraint.
The current budget process is flawed. Instead of coming to agreement
on the broad outlines of the budget at the beginning of the year, there is
often lengthy debate on spending levels that often culminates in an explosion
of spending in a disorderly process of stop-gap funding measures and enormous
omnibus bills, late and over budget.
Last year was an extraordinary year, and the Congress moved swiftly
to send the President a $40 billion emergency appropriations bill within three
days of the terrorist attacks. Thereafter, spending threatened
to spin out of control until the President stated he would veto any appropriations
bill that exceeded the funding levels he had worked out with the Congress.
Ultimately, the President succeeded in keeping spending within the agreed-upon
However, this achievement came at the cost of an extended delay in the
enactment of the 13 regular appropriations bills that fund the government,
with the last three bills being signed into law on January 10, 2002, over
three months past the October 1, 2001 deadline. Two of the nations
departments with the highest priorities, the Departments of Defense and Education,
had to wait over three months to get their budgets. Such delays are unfortunate
during ordinary times, but are intolerable when the nation is fighting a war
both at home and abroad.
Need for Legally Enforceable Mechanisms
Last years success in staying within preset budget limits should
be institutionalized through the use of legally enforceable mechanisms. These
mechanisms include making the budget resolution a law and extending statutory
limits on spending. Such action is necessary if we are to maintain overall
spending discipline, while allocating resources to our defense, homeland,
and economic priorities in a timely fashion.
Despite the simultaneous impact of the war on terror and a recession,
the nations fiscal outlook remains positive. The 2003 deficit is expected
to be less than one percent of GDP. Furthermore, if growth-promoting policies
are pursued and spending restraint is exercised, deficits will be both small
As the nation addresses its defense, homeland, and economic priorities,
however, growth in the rest of government must be restrained to prevent an
explosion in spending. To achieve this goal, budget process reforms are needed.
Greater efficiencies must also be demanded from government. This is a good
idea at any stage, but is imperative in the current environment. By highlighting
good and poor performers, this budget attempts to set such a process in motion.