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The Congressional Budget Office indicates in its recently released The 2021 Long-Term Budget Outlook(3/4/2021) that the COVID-19 pandemic and related policy have significantly worsened the federal government's long-term fiscal imbalance. EY has quantified the further impact on the federal government's long-term fiscal imbalance of the $1.9 trillion of COVID relief enacted by Congress last week (American Rescue Plan Act of 2021).

Highlights include:

Federal deficit

• The federal deficit was $3.1 trillion in 2020 and is estimated to be $3.4 trillion in 2021 and $1.6 trillion in 2022 — see figure 1 below.
• Although the deficit will fall over the next several years, the deficit is estimated to exceed $1 trillion in each of the next 10 years, will reach $1.9 trillion in 2031 and total $13 trillion over the 2022–2031 budget window.
• In relation to the size of the US economy (measured by gross domestic product), the deficit was 14.9% of GDP in 2020, is estimated to be 14.9% of GDP in 2021, will fall to 6.7% of GDP in 2022, and will average 4.6% over the next 10 years (2022–2031).

Note: Deficit estimates include impact of COVID relief enacted through March 2021.

Sources: Congressional Budget Office, 10-Year Budget Projections, February 2021; CBO, Estimated Budgetary Effects of American Rescue Plan Act of 2021, March 2021; EY analysis.

Federal debt

• Federal debt held by the public in relation to the size of the US economy reached 100% in 2020 and is estimated to reach 105% in 2021 and 112% by 2030, the highest since World War II — see figure 2 below.
• The debt-GDP ratio is projected to reach nearly 210% by 2050, with COVID-19-related policy and the associated economic recession increasing this ratio by 27 percentage points.

Note: Impact of COVID-19 and related stimulus is estimated by the difference in CBO's reported figures from January 2020 and February 2021 accompanied by CBO's Estimated Budgetary Effects of American Rescue Plan Act of 2021 from March 2021.

Sources: Congressional Budget Office, Historical Budget Data, February 2021; CBO, 10-Year Budget Projections, February 2021; CBO, Long-Term Budget Projections, March 2021; CBO, Estimated Budgetary Effects of American Rescue Plan Act of 2021, March 2021; EY analysis.

The economic disruption caused by the pandemic and the $5.8 trillion of COVID-related relief enacted by Congress are the primary drivers of the historic budget deficits in 2020 ($3.1 trillion or 14.9% of GDP) and 2021 ($3.4 trillion or 14.9% of GDP). The increases in the deficit that begin in the second half of the 10-year budget window and then extend into the future are primarily due to the growth in the major federal entitlement programs — Medicare and Social Security — and the consequent increase in interest expenses on federal government debt.

Impact of increasing federal debt

The CBO reports that the large long-term increase in federal debt could have significant negative consequences for the US economy:

• Decreased national saving and future income. Because increased federal debt crowds out private investment, labor productivity and real wages would be lower than otherwise.
• Pressure for larger tax increases or spending cuts in the future. Since increased federal debt would result in higher federal interest payments, additional federal revenue would be required to provide the same level of government services or federal spending would need to be reduced.
• Reduced ability to respond to domestic and international problems. Unexpected events such as recessions or foreign conflicts are often accompanied by significant increases in federal government spending. A long-term increase in federal debt may reduce the ability of the federal government to respond to such situations.
• Greater chance of a financial crisis. CBO projects federal debt held by the public to increase to more than 200% of GDP in 2051. The CBO projection assumes that investors will continue to lend to the federal government and would do so at relatively low interest rates. A loss in investor confidence could be accompanied by a loss of access to capital markets or significant interest rate increases. The debt-to-GDP ratio at which such a situation might occur, however, is subject to considerable uncertainty.

Implications

Companies need to be aware that the long-term pressures on the federal government's finances persist and are a major driver of future policy. In addition to driving possible changes to federal entitlement programs, the long-term fiscal imbalance may be a driver for major changes in tax policy spending to raise additional revenue.

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