Productivity growth has slowed in the United States in the past decade, and some analysts expect growth to remain low in coming years. Besides being an important determinant of living standards and GDP, productivity growth also affects the fiscal outlook, because expenditures and revenues tend to move with GDP and because productivity growth might have a direct effect on government borrowing costs. The author calculates the likely effects of slower productivity growth on the long-term budget outlooks of federal and state and local governments. In particular, she examines how projections of deficits and debt change if annual labor productivity growth is 0.6 percentage points slower than in Congressional Budget Office’s current baseline. For the federal government, she finds that the effect of slower productivity growth is to worsen primary deficits, because some outlays are invariant to changes in productivity growth while revenues move more than one for one with it. These increased deficits imply that the federal debt will reach 146 to 173 percent of GDP by 2042, compared with the baseline estimate of 130 percent of GDP, with the range depending on the assumption about how interest rates move with productivity growth. Changes in productivity growth appear less important for the state and local sector. Revenues are more likely to move one for one with productivity growth, because state and local income taxes are less progressive than federal taxes and because sales taxes and property taxes make up a much larger fraction of tax collections. A slowdown in productivity growth is likely to exert some upward pressure on state and local spending relative to GDP, stemming from the somewhat heavier burden of pension spending and increased eligibility for Medicaid and other poverty-related programs, but these increases are likely to be small.
The data underlying this analysis are available here.