Explaining Ryan's "Fiscal Dividend"
A new feature of House Budget Committee Chairman Paul Ryan's (R-WI) FY 2015 budget is assumption of a "fiscal dividend," which reflects the economic impact of the deficit reduction in the budget. Policy changes have both direct and indirect budgetary impacts. Directly, increases in revenue or cuts in spending lower the deficit. Indirectly, deficit reduction can produce economic effects which, in turn, contribute to additional deficit reduction.
Chairman Ryan's FY 2015 budget relies on $175 billion in deficit reduction from fiscal dividends, or "macroeconomic fiscal impacts," to achieve a balanced budget by FY 2024. CBO's accompanying analysis details how the changes in the budget would affect the economy, similar to their analysis of illustrative deficit reduction packages last year. CBO caveats that it only looks at differences in deficits and debt, so it assumes that other factors such as marginal tax rates or spending on public investments would remain the same, even though Ryan's budget would change both significantly.
CBO projects that economic output will be lower relative to their baseline under Chairman Ryan's budget from FY 2015-2017, then increase relative to the baseline beginning in FY 2018. Lower deficits lead to lower output in the short term as a result of decreased aggregate demand. Over the longer term, when the economy (at least by CBO projections) has returned to full capacity, lower deficits reduce "crowding out" of private investment – when savings that would otherwise fund private investment instead purchase government debt – leading to higher domestic investment, national savings, and economic output.
In 2025, real per capita GNP would be 2 percent higher under the Ryan budget than it would be under current law. By 2040, that effect would grow to 9 percent. Under the Ryan budget, nominal GDP would be almost 5 percent higher in 2040 than under current law.
The economic effects of the deficit reduction feed back into the budget as well. Higher economic growth boosts revenue, and lower interest rates from less crowding out result in lower interest spending. Also, higher GDP means that the ratios of debt and deficits to GDP shrink. The Ryan budget quantifies these effects with the fiscal dividend. The Ryan budget, to its credit, includes both the negative and positive economic effects.
As we explained yesterday, the fiscal dividend results in a slight improvement in the debt situation and allows the budget to be balanced in 2024. Debt in 2024 would be 56 percent of GDP, or 57 percent without the fiscal dividend. The budget would have a deficit of about one-quarter of a percent of GDP without the fiscal dividend rather than a small surplus.
Source: House Budget Committee, CBO, OMB, CRFB calculations
Note: President's budget uses OMB GDP, which differs from the GDP used in the other debt paths
Although this is the first Ryan budget to incorporate dynamic scoring into its budget totals, it is not entirely unprecedented in budget resolutions. In particular, the budget resolution included with the 1997 balanced budget agreement incorporated a fiscal dividend into its projections to get the budget to balance by 2002. As it turns out, that projection was overly pessimistic, as the budget balanced the next year instead.
As a general rule, we believe that dynamic analysis should be provided as a supplement to formal budget scoring to provide policymakers with additional information about the economic effects of legislation but should not be incorporated into the official score or used to meet fiscal goals. However, Chairman Ryan’s budget sets an extremely ambitious fiscal goal and would still put the debt on a downward path and bring it below 60 percent of GDP within the decade without including the effects of the fiscal dividend. By itself, the inclusion of this effect is not a big deal, but it creates a troubling precedent. As the Concord Coalition said:
It is one thing to give an illustrative estimate of the effects that a particular path of deficit reduction may have on the economy, as the Congressional Budget Office (CBO) has done at Ryan’s request. But it is quite another to count that as a year-by-year score.
This is particularly true when specific policy details are absent, as they are in a congressional budget resolution. One set of policy details could have a much different feedback effect than another.
Chairman Ryan has proposed significant levels of deficit reduction through policy changes, and that deficit reduction is likely to have a longer-term economic benefit given the high levels of debt projected in current law. However, as CBO notes, their estimates of the economic and budgetary effects of deficit reduction are "highly uncertain." Evaluating the economic effects of proposals is helpful, but policymakers should avoid banking any deficit reduction from these effects because of the inherent uncertainty in the estimates. Still, even without the fiscal dividend, the Ryan budget would clearly put debt on a downward path.
See our other analyses of the Ryan budget here.