CBO chief: Budget outlook 'daunting'

WASHINGTON (CNNMoney.com) -- Douglas Elmendorf, chief budget cruncher for Congress, got to play the role of bad-news bear before the president's bipartisan fiscal commission on Wednesday.

His job: Present the Congressional Budget Office's latest assessment of the long-term federal budget.

The gist of his testimony went something like this: The outlook is bad under current law and daunting if many current policies are extended as expected. And even that may understate the fiscal problem the country faces, because it doesn't factor in potential effects of debt on economic growth.

Under the rosiest scenario painted by Elmendorf, the debt held by the public is on track to rise to 80% in 2035 from 62% at the end of this year. At that point, interest payments on that debt would jump to 4% of GDP, up from roughly 1% today. That's the equivalent of a third of all federal revenue.

From there, the increases are stark under an alternative policy scenario, which includes an extension of the 2001 and 2003 tax cuts for most people, permanently protecting the middle class from the Alternative Minimum Tax and a permanent increase in Medicare payments to doctors.

Based on current policies, debt held by the public would hit 185% of GDP in 2035. And interest payments on that debt would jump to nearly 9% of GDP.

Focus on health spending: Spending on health care remains the federal budget's biggest problem, even after accounting for the estimated impact of the health reform law enacted in March.

The health care law "made a dent in the problem but did not significantly reduce the challenge," Elmendorf said. "If all the health law measures are implemented, we end up with slightly lower federal health spending by the end of the 2020s."

Specifically, Elmendorf noted that spending on major mandatory health care programs such as Medicare is on track to double by 2035, up to 10% of GDP from 5% today. That increase is the equivalent of $700 billion this year in additional spending, Elmendorf said.

Add in the less dramatic increase in Social Security spending, and the cost to federal coffers of mandatory entitlement programs will reach 16% of GDP by 2035. That's not very far below what the government has spent on all federal programs and activities on average over the past 40 years.

A few Democratic members of the commission registered their concerns that the CBO's assumptions about the effects of the new law are understating its potential to reduce costs.

The 18-member fiscal commission,, which includes 12 members of Congress and 6 presidential appointees, will submit a report by Dec. 1 recommending ways to bring down deficits and stabilize the country's long-run debt.

Debt can sap growth: The larger the debt burden grows, the less money there will be for domestic investment. That, in turn, can suppress income growth and economic growth, which then reduces tax revenue.

The only way to bring the federal budget into better balance would be to sharply reduce U.S. spending, drastically increase taxes to rates never before seen in the United States or some less dramatic combination of the two, Elmendorf said.

The challenges are great, and the longer policymakers wait to stabilize the debt, the harder their task, Elmendorf said.

He gave an example: Say Congress started implementing measures next year to bring public debt back to what it was before the financial crisis. They would immediately and permanently need to cut spending by or increase taxes by 5% of GDP. That's $700 billion a year. And if they wait until 2020 they'd need to make changes worth 8% of GDP.

The hearing touched on one of the trickiest fiscal questions facing Congress: When to pivot from economic stimulus to fiscal restraint.

Elmendorf said that most economists believe cutting spending and raising taxes this year or next could slow economic recovery. But he added that "reaching agreement as quickly as possible would support the economic recovery because it would provide some clarity [in policy]."

While deficits can help boost the economy in a recession, over time government debt can drag it down, he said.

"If debt grows unchecked," Elmendorf said, "it means declines in people's standard of living."