Thursday, February 6, 2014

CBO Report - Budget Outlook 2014-2024

This is the Cover Page of the recently released CBO 10 year Budget Outlook. Most of the talk you have heard has focused on the effects the ACA might have on jobs. Conservatives claimed the CBO Report documents that Obamacare is a job-killer. Progressives quickly, and accurately responded that giving hard-working folks a chance to work less, because their healthcare is no longer tied to their work, does not represent any reduction in jobs. It signifies a voluntary decrease in the labor supply, which might even tighten that supply in some markets, and improve wages for those staying in the market to work. The Conservative case is very weak, which many now admit. So will not comment further on this. The CBO did reaffirm its earlier enrollment forecasts, while acknowledging that Year One might be a little short:
  • 6MM Exchange and 8MM Medicaid enrollees expected in 2014 down 1MM in each category.
  • Years 2 and 3 will see the shortfalls made up with total Exchange enrollment reaching 25 million and new Medicaid hitting 13MM.
  • As originally forecasted, employers over time will reduce insurance coverage for 7MM workers and the Non-Group market will shrink by 5MM.
  • The pool of Uninsured will shrink from 55MM to 31MM, a 24MM drop.
So nothing in the CBO forecasts has changed, except for timing. This is great news.

What I want to focus on now is the 2014-2024 forecasts and what they say about the country's economic health and financial stability. Here are some summary comments.
  • As the above cover image shows, deficits will drop in 2014 and again in 2015, before starting to move back up.
  • Mandatory expenses (Social Security, Medicare, Medicaid) go up as a percentage of GDP. Discretionary spending goes down as a percentage an equivalent amount. What causes the deficit to start growing again in 2018 are interest costs, which are returned to their "normal" levels of 3-4% on 90 day Treasury Notes and 5% on 10 year Bonds. I think the CBO is probably wrong here, and will show you what happens if we cap the average rate Treasury pays at 3% (mix of short notes and long bonds).
  • Believe CBO has accepted the fact that a transformation of the healthcare delivery system is well underway and that it will continue for the foreseeable future. Real healthcare costs per capita are forecasted to grow at just 1.5%, well below the growth of real GDP per capita. This is great news, and should result in a solid improvement in the deficit and debt picture, when the CBO publishes their Long Term Outlook, most likely in June.
Here is a chart I put together using the CBO data. I wanted to see what would happen if I capped average interest costs for Treasury at 3%. Here's what I came up with:

Capping the average interest rate at 3% has no effect until 2018, when you can see how the CBO forecast line diverges from mine. The end result is both the Primary Deficits (before interest) and the Total deficits flatten out, which indicates we have most likely reached solid and stable financial ground. You can also see from the first and detailed chart that the Debt/GDP number also starts to look pretty stable.

I think a very good case can be made that we need to redefine what "normal" interest rates are in this low inflation environment we seem to be in. We are not in deflation, as Japan has been, so we will certainly not see 10 year Bonds at .6-.7%, versus our 2.7-3.0%; but I am very skeptical that we will see 5% again for a good long while. Inflation hawks will disagree; but then they have been consistently wrong for the last five years.

If the CBO's Long Term Outlook coming in June continues to eliminate Excess Cost Growth in healthcare, we will have our first look at a long term horizon where deficit and debt levels are stable. And when we get to the end of this current 10 year forecast period (2024), we will be three quarters of the way through the Baby Boomer demographic bulge that has pressured both Social Security and healthcare.

If healthcare costs grow no faster than real GDP per capita through the long budget horizon, and we will have successfully absorbed the Baby Boom Bulge, we will be in good shape.

And that's where I believe we actually are.

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