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CBO: Underlying Deficit Drivers Haven't Been Addressed

This week the Congressional Budget Office (CBO) released its latest long-term budget outlook. According to CBO, a recovering economy and recent spending and tax policy changes will stabilize publicly-held federal debt for the next several years. Currently, the debt sits at an elevated 73 percent of GDP; CBO predicts this will decline to 71 percent of GDP in 2023, and resume growth until it hits 100 percent of GDP in 2038. The report makes an important point about what's driving federal deficits that runs counter to the logic behind sequestration. Two charts make this point.

Most important for R&D is the changing mix of spending that makes up the federal budget. R&D lives in the discretionary budget, and is a relatively static slice of that budget, around 11 or 12 percent of discretionary spending since the 1980s. For decades, overall discretionary spending has been declining as a share of the overall federal budget with the rise of mandatory spending (a.k.a. entitlements). Trends like that are what lead to trends like these, in which federal R&D is declining as a share of the total budget and of the economy.

According to CBO, discretionary spending will drop to 5.3 percent of GDP by 2023 (chart at right, from page 58 of the report). Compare this future spending level with a 40-year average for discretionary spending of 8.4 percent of GDP (though it's been mostly declining for years, as this chart shows). The clear drop we can see in the chart is due to the spending caps put in place by the Budget Control Act; under these caps, after the sharp cuts happening now due to sequestration, spending basically increases from post-sequester levels at the rate of inflation, plus a little bit more. This means the pool of federal funding from which R&D is drawn will be deeply constrained under historically low levels for the next decade, barring a change to current law.

Yet while this is happening to the discretionary budget, the mandatory budget will continue growing, since sequestration leaves this part of the budget mostly untouched. Most of the mandatory budget is shown in the second chart, below. The largest components of the mandatory budget are Social Security, Medicare and Medicaid. The chart also includes net interest (the "other noninterest spending" line includes both the discretionary and "other mandatory" spending categories, same as the above chart).

Bear in mind, overall spending is still expected to shoot well past historical averages by 2038, even with historically constrained discretionary spending. Comparing the trajectory of the mandatory programs — especially the health-related entitlements — with the trajectory of discretionary spending above makes pretty clear what's really driving the long-term fiscal challenge on the spending side. This is part of the reason sequestration has been bludgeoned as an idea: it doesn't actually effect the parts of the budget that are causing the biggest problems, and instead attacks things like R&D that have much larger returns on investment, and can even increase future revenues by contributing to future growth.

Where are revenues in all this? According to CBO, revenues as a share of GDP will rise a couple percentage points above the historical average in the next decade and stay there, reaching 19.7 percent of GDP in 2038 (compared to federal spending of 26.2 percent). This is a structural shortfall in revenues versus spending that has existed for many decades, and will continue to grow, unless Congress can bring revenues and expenditures in line (and they have rarely been able to do that).

These various criss-crossing trends are what will lead to continuing difficulties in national fiscal politics, and continuing constraints on the federal R&D budget. To counteract these constraints, R&D could grow as a share of the discretionary budget, or the discretionary budget could grow as a share of the overall budget, or both. To achieve the latter, mandatory spending will likely need to be brought under control, though due to the nature of entitlements and their place in the political system, there's only so much deficit reduction we could (and, perhaps, should) expect from these programs, and so additional revenues will also be necessary. This logic is what's behind the balanced deficit plans proposed by the Domenici-Rivlin and Bowles-Simpson task forces, and shared by a great many observers. This is what it will take to get the debt under control, though with an often-heard caveat that some of these steps shouldn't kick in until after the economy has moved further into recovery.

Short of this kind of broad thinking from political actors in the budget process, federal R&D will likely continue its long-term stagnation within the federal budget and the economy.