Another Trillion Dollar Deficit Bummer
Business + Economy

Another Trillion Dollar Deficit Bummer

Reuters/Jonathan Ernst

Continued sluggish growth will keep the nation’s deficit above $1 trillion for the fourth consecutive year, the Congressional Budget Office said in its annual forecast Tuesday. And while the deficit next year begins to shrink, it will remain very large by historical standards, the study said.

The continued large deficits are being driven by historically low tax collections and an economy that continues to spin its wheels due to the prolonged slump in employment and economic growth rates that remain far below the economy’s capacity. The CBO projected the economy will grow just 2 percent this year and unemployment will actually rise to 8.9 percent.

While CBO did project a $217 billion reduction from last year’s deficit, the $3 trillion projected increase in the national debt over the next decade will drive net interest costs from 1.4 percent of gross domestic product this year to 2.5 percent in 2022. “To put the budget on a sustainable path, Congress has to increase the percentage of tax collections, cut Social Security and health care programs, or some combination,” said CBO director Doug Elmendorf. While the outlook’s accuracy does depend on the economy’s overall performance, he admitted, “more critical will be the choices made by lawmakers.”
Even with those stark numbers, CBO’s projected deficit is far more optimistic than the political signals from Capitol Hill and the White House warrant. The non-partisan agency’s baseline budget presumes current law, which dictates that the Bush era tax cuts and other tax provisions that have been a major drain on government revenues expire at the end of this year. It also presumes that over $1 trillion in new budget cuts go into effect starting in January 2013. Neither is likely.

That’s why the new CBO budget and economic outlook projects that unemployment will remain above 7 percent until 2015, absent any major change in current law.  “That [economic] pace of growth partly reflects the dampening effect on economic activity from the higher tax rates and curbs on spending scheduled to occur this year and especially next,” the report stated.

If the tax increases and budget go into effect, it would have a dramatic impact on future deficits. Starting next year deficits will be cut by over 40 percent and continue shrinking for most of the rest of the decade, the report said. Between 2013 and 2022, the nation would add just $3 trillion to the national debt, which is significantly less than has been added in just the last three years.

As a result, debt held by the public would drop, from 75 percent of the Gross Domestic Product in 2013 to 62 percent of GDP in 2022, which the study notes is still higher than in any year between 1952 and 2009.

While it is politically unthinkable that Congress would fail to act before January 1, 2013 to block the expiration of some of the major tax cuts,  it’s instructive to look at would happen if Congress chose not to act:

• All the budget cuts contained in last August’s Budget Control Act (BCA), including the $1 trillion in cuts scheduled through sequestration, would go into effect, leaving discretionary spending for both defense and non-defense programs essentially unchanged between now and 2022. That would shrink discretionary spending to 5.6 percent of the economy, down from 8.4 percent today and the lowest level since before World War II.

• All the Bush-era tax cuts would expire, as would several reductions in the estate and gift tax. That alone will cut the 10-year budget deficit projection by $4.3 trillion. Throw in indexing the alternative minimum tax for inflation and total increased revenue from this “alternative” scenario rises to $5.4 trillion.

• Total federal debt would fall to 60 percent of gross domestic product in 2022, down from 75 percent today. The government’s total tax take of 20.9 percent of GDP by that year would be up sharply from this year’s 16.3 percent, but it would still only be two percentage points above the post-war average.

What’s most amazing about this “take your medicine now” approach to deficit reduction is what CBO says it will do to the economy. Democrats who look at that scenario will insist the budget cuts will remove badly needed stimulus. Both parties will scream that the tax increases will undermine consumer demand and throw the economy back into recession.
But the CBO forecast projects continued economic growth in 2013 under its baseline scenario. It will fall to 1.1 percent, a half percentage below where it was in 2011 – a pretty lousy year. But over the next four years, the economy will rocket ahead at an average 4.1 percent growth rate, CBO says, before settling into its projected long-term sustainable growth path of 2.5 percent for the remainder of the decade.

Job hunters certainly won’t like it. Unemployment would rise to 9.2 percent next year under this scenario. But the rapid growth in the following four years would lower the unemployment rate below 6 percent.

Since doing nothing is not where policymakers are heading (Is anyone on the campaign trail calling for an end to the middle-class tax cuts?), CBO also prepared its “alternative” scenario, which includes more reasonable assumptions. In the alternative, all the tax cuts are extended, Medicare’s payment rates for physicians remain unchanged, and the automatic spending reductions required by the BCA do not take effect.

Under the alternative, revenues rise to 18.3 percent of GDP, spending rises to 24.4 percent of GDP, and the deficit soars by $11 trillion, compared to just $3 trillion of additional debt under current law.
The most immediate choice facing Congress is extending the two-percentage-point cut in payroll taxes, which will pump about $100 billion into the economy this year. “It might add a quarter percentage point to GDP by the end of 2012,” Elmendorf said, “and unemployment would be a tenth or two (percentage points) lower.”

When it acts as expected, Congress will be taking its first baby steps into “alternative scenario” land.