CBO offers mixed take on tax cuts and stimulus

NEW YORK (CNNMoney.com) -- If the Bush tax cuts for the majority of Americans are extended, and stimulus spending is allowed to continue, that could boost the economy and help lower unemployment in the near term, the Congressional Budget Office said Thursday.

But that lift comes with a big trade-off: Higher debt and ultimately lower economic growth by the end of the decade.

"[It would provide] a considerable boost to economic activity in 2011 and beyond for a few years," said CBO Director Douglas Elmendorf. "Over time, [however,] the negative consequences of very high federal borrowing build up."

According to the CBO, if the tax cuts for all but the wealthiest households were made permanent, as President Obama has proposed, and if future annual spending remained where it is as a share of the economy, the deficit would account for 8% of GDP by 2020.

And the nation's accrued debt, not including money owed to Social Security and other government trust funds, would approach 100% of GDP, up from 62% this year.

Things would get worse after that.

"Beyond the 10-year budget window, the nation will face daunting long-term fiscal challenges posed by the aging of the population and rising costs for health care," the CBO said. "Continued large deficits and the resulting increases in federal debt over time would reduce long-term economic growth."

The CBO's projections are based on the agency's assumptions that interest rates will rise considerably as the economy recovers. That's because there will be increased demand for loans as consumers and businesses increase borrowing at the same time the federal government will be tapping investors for more money, Elmendorf said.

Some economists, however, question that rates will head higher. If rates stay contained, the debt load would also be lower than the CBO is projecting.

For this year, the CBO expects the second highest annual deficit in 65 years - $1.3 trillion, or 9.1% of GDP. Last year, the deficit was 9.9% of the economy.

The story for both years is the same: The economic crisis decimated federal tax receipts and forced the government to spend more to combat the recession.

The CBO's report comes at a time when Congress is engaged in a mind-bending debate about whether it should do more to boost the economy through higher spending at the risk of increasing the country's debt.

While deficit hawks say Congress should deal with the long-term debt issue sooner rather than later, many also say that lawmakers can begin to take steps in that direction while simultaneously ensuring that the economic recovery doesn't sputter by pulling in the fiscal reins too soon.

Among them is Alice Rivlin, the founding director of the CBO who served as White House budget director under President Bill Clinton. She now co-chairs a debt-reduction task force of the Bipartisan Policy Center and sits on the President Obama's fiscal reform commission.

"The two things we really need to keep in our heads at once is we should not make the recession worse until we're sure we're on a recovery track by restricting the budget deficit too much," Rivlin said.

"At the same time we need to be ... taking steps now to reduce future deficits and to stabilize the debt. That's not impossible."

By that, she and others often refer to putting in place a debt-reduction plan now that would phase in various measures over time.