The Future Of U.S. Federal Debt

by: George Liu

The Congressional Budget Office recently released its 2012 Long-Term Budget Outlook. The outlook can be interpreted two ways, as the Congressional Budget Office has used two alternative scenarios as benchmarks for its statistical analyses.

The first of these scenarios is the extended baseline scenario. This scenario takes into account the assumption that current laws generally remain the same. No significant legislature will be tweaked under this scenario and lawmakers will forgo "adjustments routinely made in the past that have boosted deficits."

The extended base scenario provides a fairly positive outlook on U.S. federal debt accumulation in the future. The CBO projects that under this scenario, federal debt would decline significantly from an estimated 73 percent of GDP this year to 53 percent of GDP by 2037. Because this scenario includes such measures as the scheduled expiration of cuts in individual income taxes, the CBO projects that revenues would rise steadily and reach 24 percent of GDP by 2037.

The second of these scenarios is the extended alternative fiscal scenario. This scenario takes into account assumptions that certain current policies, such as the cuts in individual income taxes, will be continued. This scenario also factors in the modification of some provisions of law that may be unsustainable in the long term.

Under the extended alternative fiscal scenario, U.S. federal debt will increase significantly. Federal debt will exceed 90 percent of GDP in 2022, exceed its historical peak of 109 percent of GDP by 2026, and will approach 200 percent of GDP in 2037. Meanwhile, revenues are expected to remain at 18.5 percent of GDP after 2022.

So what does the Congressional Budget Office's budget outlook mean for lawmakers? The extended alternative fiscal scenario is largely representative of the policies of lawmakers right now, much more so than the extended base scenario. So, as the Congressional Budget Office notes, the exponential increase in U.S. federal debt under the extended alternative fiscal scenario "underscores the need for large and timely policy changes to put the federal government on a sustainable fiscal course."

Of course, lawmakers can also follow the extended baseline scenario, which would definitely prove to be interesting: lawmakers cannot do absolutely anything to current laws and the federal debt will shrink substantially, by itself, as a percentage of GDP. However, do not count on adoption of this alternative by lawmakers as party politics continue to play significant roles in the legislative process.

By the end of this year, the CBO estimates that federal debt will reach the highest percentage since the aftermath of World War I. This percentage, largely the result of significant imbalance between government revenues and spending in the recession, shows that the federal debt has become an increasingly burdensome issue that needs to be addressed by lawmakers, either by changing current policy or doing absolutely nothing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.