Economics: When Debt Flies Off the Charts

The CBO baseline uses spending and revenue provisions as they exist under current law. Under this scenario, the Bush tax cuts are allowed to expire, the alternative minimum tax remains un-indexed to inflation, and revenue and spending in the healthcare bill occur as planned (note that these promises have already begun to be broken—projected cuts in Medicare reimbursement have been put off three times already this year). Even CBO finds this scenario highly unlikely.

This is why the scenario in black projects what CBO deems more likely. In the world of the alternative scenario, widely expected policy changes occur. These include:

• A gradual increase in the reimbursement rates of Medicare physicians

• Elimination of pay-as-you-go rules that control spending

• Congress protects middle-class families from the alternative minimum tax.

As you can see, things look bad in this case. But when the dynamic effects of government debt on the economy are incorporated, things look even worse. When government borrows money, there is less money available for the private sector to invest in capital; this results in decreased economic output in the long run. Economists refer to this effect as crowding out. The red line shown above captures the most likely projection of debt as a percentage of GDP, incorporating crowding-out effects.

For more, see When Debt Flies Off the Charts by Veronique De Rugy, July 15, 2010, at The American Enterprise Institute.