The Congressional Budget Office’s new budget outlook tells a familiar story about the deficit and the economy, but one that’s easily confused.
- The deficit is narrowing ever so slightly to $1.3 trillion in 2010 and will continue to shrink as the economic recovery sputters along.
- But the structural deficit – what’s left after the recovery – will still be far too high. Even if all the Bush tax cuts were allowed to expire – which won’t happen – the deficit would be 4.2 percent of gross domestic product by 2012 and remain about 3 percent of GDP through the decade.
- If the Bush tax cuts are all made permanent and the Alternative Minimum Tax is prevented from expanding, the deficits would be up in the range of 6 percent of GDP.
As always, the most important thing to remember about the CBO projections is that they are based on current law. That means they assume the Bush tax cuts all expire and that the AMT is allowed to explode, which would add $4 trillion in revenue over the next decade. So, for example, the CBO report appears much gloomier about the economic recovery next year than the administration. CBO predicts 2.0 percent growth from the fourth quarter of 2010 to fourth quarter of 2011. The White House, which assumes enactment of Obama's policies, including extending the tax cuts to all but the wealthiest Americans, is expecting 4.0 percent. That's a misleading gap, because the tax cuts' expiration would be a significant drag on growth. CBO is still gloomier than the White House, but their predictions are in the same range.
CBO also offers “alternative’’ scenarios that give an idea of what would happen if some Obama budget proposals became law. The deficits would be lower, but still very high in the absence of much bigger changes – for example, radical surgery on tax expenditures, which total more than $1 trillion a year, or on mandatory entitlement programs.
In the end, it isn't very important whether next year's deficit is $1 trillion or $1.5 trillion. What really matters is whether the budget gets down to a sustainable level once employment and growth get back to normal levels.
"Sustainable" -- which means manageable, though not necessarily ideal -- would be deficits no higher than normal U.S. economic growth. That would be 3 percent of GDP or a bit less. The CBO numbers, adjusted for political reality, indicate that we're not on that path yet.
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