The Federal Budget Outlook: Pre And Post Pandemic


The Congressional Budget Office (CBO) released its revised 10-year federal budget outlook on September 2, 2020. It only considers the spending and tax legislation that is currently authorized. It specifically takes a crack at estimating the impact and consequences of the COVID-19 pandemic: the Wuhan Flu. Suffice it to say that so far, all the experts i.e. medical, economic, psychological have miscalculated the course and consequences of the pandemic om public health, the economy, and the financial markets. We suspect this CBO analysis will not be any different.

Nonetheless, COVID-19 has dramatically changed the budgetary outlook. Tables I and IA attached show economic and budget projections for the pre- and post-pandemic periods. In January 2020, CBO forecast that real GDP growth would be 2.2% for this year and the jobless rate would be 3.5%. In its current outlook, the economy is expected to contract by 5.1% this year while the jobless rate is at 10.6%.

As a reminder, all CBO forecasts are predicated on current law. The current law baseline now includes the Coronavirus Preparedness and Response Act, the Families First Coronavirus Response Act, the Coronavirus Aid, Relief, and Economic Security Act, and the Paycheck Protection Program and Health Care Enhancement Act. Thus, any spending resulting from a new stimulus/relief bill now being discussed is not included. It also appears that the President’s recent executive orders transferring funds from FEMA to provide extra unemployment benefits and allow individuals’ payroll taxes to be deferred were not considered in CBO calculations.

Prior to the pandemic, federal outlays for 2020 were projected at $4,647 billion whereas in its latest iteration outlays are projected at $6,606 billion for a 42.1% increase. Meanwhile, revenue collection, which was forecast at $3,632 billion resulting in a $1.1 trillion deficit, is now forecast at $3,296 billion resulting in a $3.3 trillion deficit.

Assuming no business cycle swings etc., as it always does in its analyses, table I shows that in the January forecast, outlays in 2030 would rise to $7,487 billion. In its latest forecast, CBO projects outlays in 2030 at $7,084 billion. Assuming current law, revenue was projected to be $5,745 billion by 2030 for a deficit of about $1.7 trillion. Now revenue is projected at $5,457 billion in 2030 for a deficit of $1.6 trillion.

The net result of all this is that while the budget deficit for 2020 is substantially larger than originally forecast, CBO is not projecting a cumulative increase in the deficit. Not surprising, the deficit-to-GDP ratio for 2020 is now at a whopping 16% of GDP versus its earlier estimate of 4.2%. Whereas in its earlier forecast, the deficit-to-GDP ratio was forecast to be fairly stable around 4% now the ratio is forecast to decline steadily through 2027 before beginning to rise again.

In its January forecast, CBO projected that the debt-to-GDP ratio would be about 80% in 2020 and then rise gradually, hitting about 98% by 2030. In this latest outlook the ratio is forecast at 98% for this year and rise to 109% by 2030. The debt burden that arises as a result of combating the pandemic is rivaling the debt bomb that occurred in fighting World War II. Then the debt/GDP ratio for the U.S. peaked at around 119%, but then trended steadily lower until the mid-1970s when it began rising again.

In World War II, debt was incurred to outfit the military and build war-time machines, ships, etc. This time around is not on the production of goods for which debt is being incurred, but rather in the form of transfer payments. The impacts on prices for industrial materials, etc. are far different this time around and thus at least for the time being the spending is not showing up in inflation. This has important implications for economic and monetary policy, which we will get to.

In the aftermath of World War II, the global economy was blessed with expanding populations, rapid technological changes and thus rapid economic growth. This allowed for big increases in revenue growth versus spending growth and thus lower deficits and shrinking debt load. The process was painless. If current demographic and economic projections are reasonably accurate, the coming 10-year period will not see an acceleration of underlying growth either in the U.S. or globally. Populations are aging and, in some countries, declining. And the pace of technological change is seen as slowing, which is a negative for productivity. This makes the task of whittling down the debt load more difficult.

Considering this, it is at first blush surprising that CBO’s debt/GDP forecasts only rise from 98% to 108% by 2030. But the reason can be found in its forecast for net interest payments on the debt. In January, CBO forecast that the rate on three-month T-Bills would be 1.6% in 2020, climbing to 2.3% in 2026 and to 2.4% in 2030. In its latest forecast, the T-Bill rate is forecast at 0.4% for this year, even lower in 2026, and then 2.1% by 2030. Lower interest rates on the 10-year T-note are also projected as shown on the tables, albeit not as great as for T-Bills.

Apparently, CBO is taking current Fed Chair Powell at his word when he says that the Fed is not even thinking about thinking about altering the current aggressively accommodative stance of monetary policy. The implication is that interest rates will remain low for a long time. The Fed is not yet targeting the interest rate yield curve, but if long-term rates begin rising in earnest, the implication is that the Fed will move toward formally targeting the entire rate structure. The bet, of course, or should we say the forecast from the Fed is that loose labor markets and excess capacity will be the norm for years to come and in this context, inflation will remain low to non-existent. The hope is that this is right, because if interest rates were to begin rising in response to inflation, the debt picture would change demonstrably as interest payments explode.

With fingers crossed, the impact of these inputs is to lower the cumulative net interest payment on the federal debt for the 2012-2030 period from an earlier projected $5,922 billion to a current level of $3.736 billion. This alone is enough to reduce the projected total deficit for the 10-year period. It is now projected at $12,987 billion versus the earlier projection of $13,094 billion. So, the reduction in net interest payments more than offsets all the projected increases in deficits that results from lower revenue as a result of lower economic growth. This is even more impressive considering that the deficit for 2020 will be over $3 trillion versus the $1 trillion CBO had projected in January for 2020.

Of course, there are reasons to be suspicious of these forecasts even without any new COVID-19 legislation that may be enacted. Remembering that CBO must rely on current law assumptions, many seem unrealistic. For example, current calls for the expiration of personal tax cuts in 2025 while business tax cuts are permanent. A second term for the Trump administration is likely to push for more and permanent tax cuts. And while a Biden administration is promising tax increases on both capital and labor, the chance of actual passage seems slim in the context of an under-utilized economy.

There is also the issue of mandatory programs that will very likely continue beyond current expiration. These include the Supplemental Nutrition Assistance program that is set to expire in 2024. But in the immediate aftermath of the pandemic, this is more likely to expanded rather than shelved. There is also the assumption that postponed health care related taxes will be reinstated, but it would seem doubtful that any constituency can be formed to implement these. There is also the issue of the many tax provisions that expired at the end of 2017 which were extended by the Bipartisan Budget Act of 2018 and are very likely to be extended.

But above all, the magnitude and duration of the COVID-19 crisis is the key element for any economic forecast and to a large extent the outlook for the federal budget. Implicitly it seems that successful vaccine development is being presumed by CBO and that it will be widely distributed in 2021 so that some semblance of life as we knew will resume. This is despite the history that shows successful vaccine development takes years and not months. But the hope is that technology will shorten the time span and that current optimistic prognoses from the medical and scientific community come to fruition.

Several vaccines are undergoing double-blind phase 3 trials. Double-blind means that neither patient nor relevant medical personnel know if any dose is the actual vaccine or a placebo. At times drug trials are unblinded if there is reason to believe the drug is obviously very dangerous. Normally vaccine trials are not subject to early unblinded analysis since regulators would not approve a vaccine that did not conclude phase 3 trials. The COVID-19 situation is unique however and in fact the recent surge in infections could facilitate early successful determination of whether a vaccine is efficacious. We are all praying for early success for the sake of public health and for the sake of economic health in this country and worldwide.

Comparisons of CBO Forecasts January 2020 vs. August 2020
Table I January 2020

Real GDP GDP Price Index Unemployment Rate 10-Year Treasury Note 3-Month Treasury Bill
2019 2.4 1.9 3.7 2.5 2.2
2020 2.2 1.9 3.5 1.9 1.6
2021 2.1 2 3.5 2.1 1.6
2022 1.7 2.1 3.8 2.5 1.8
2023 1.6 2.1 4.1 2.7 2
2024 1.6 2.1 4.3 2.8 2.2
2025 1.5 2.1 4.5 2.8 2.3
2026 1.6 2 4.6 2.9 2.3
2027 1.7 2 4.6 2.9 2.3
2028 1.8 2 4.5 3 2.3
2029 1.7 2 4.5 3 2.4
2030 1.7 2 4.5 3.1 2.4

January 2020

Debt held

%GDP

%GDP

Revenues

Outlays

Net interest

by Public

Deficit

Deficit

Debt

2019

3462

4447

376

16803

984

4.6

79.2

2020

3632

4647

382

17855

1015

4.2

80.8

2021

3816

4816

394

18886

1000

4.4

82

2022

4001

5117

424

20066

1116

4.1

83.9

2023

4206

5325

470

21248

1119

3.9

85.6

2024

4382

5534

515

22453

1152

4.3

87.3

2025

4562

5877

561

23827

1315

4

89.4

2026

4851

6184

609

25196

1333

3.7

91.2

2027

5154

6467

658

26545

1313

4.1

92.6

2028

5343

6880

711

28152

1538

3.6

94.7

2029

5545

7012

761

29667

1466

4.2

96.2

2030

5745

7487

819

31447

1742

4.2

98.3

Table IA August 2020

Real GDP GDP Price Index Unemployment Rate 10-Year Treasury Note 3-Month Treasury Bill
2019 4.1 1.8 3.7 2.1 2.1
2020 -5.1 0.7 10.6 0.9 0.4
2021 4.8 0.8 8.4 0.9 0.2
2022 4.6 1.7 7.1 1.1 0.2
2023 4.1 1.9 6.5 1.4 0.2
2024 4.3 2 6 1.6 0.2
2025 4.4 2.1 5.6 1.9 0.2
2026 4.5 2.1 5.2 2.2 0.3
2027 4.4 2.1 4.8 2.6 0.6
2028 4.2 2 4.5 2.8 1.1
2029 3.9 2 4.4 3 1.6
2030 3.8 2 4.4 3.2 2.1

Debt held %GDP %GDP
Revenues Outlays Net interest by Public Deficit Deficit Debt
2019 3463 4447 375 16801 984 4.6 79.2
2020 3296 6606 338 20270 3311 16 98.2
2021 3256 5066 290 21931 1810 8.6 104.4
2022 3739 5075 273 23320 1336 5.8 105.6
2023 3980 5104 271 24520 1124 4.9 106.7
2024 4146 5226 274 25657 1081 4.8 107.1
2025 4334 5507 287 26818 1174 4.7 107.2
2026 4656 5772 316 27888 1116 4.3 106.7
2027 4952 6033 367 28993 1080 4 106.3
2028 5123 6456 448 30396 1333 4.3 106.8
2029 5296 6602 546 31773 1306 4.8 107.4
2030 5457 7084 664 33457 1627 5.3 108.9

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please note that this article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by BEACH INVESTMENT COUNSEL, INC. and is used with the permission of both.

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