The Federal Deficit is Shrinking Dramatically: So Why Aren’t We Celebrating?

This year’s federal budget deficit is shrinking, and shrinking faster than anyone had anticipated: surely this is good news.  There have been a number of really positive developments on the budget and the economy over the last several months, mostly unexpected.  Just last month, the House and Senate both passed budget resolutions, for the first time in five years.  In February, the Congressional Budget Office (CBO) revised its FY13 deficit projection downward to $845 billion, the first time in five years that the deficit will fall below $1 trillion. Then on Tuesday, CBO again revised its FY13 deficit projection, to $642 billion, a reduction of an additional $203 billion.

The Good News: A Healthier Economy
CBO attributed the dramatic change in the deficit forecast to a healthier growing economy that, along with the January tax increases, has resulted in higher than expected individual and corporate tax revenue, and record profits by Fannie Mae and Freddie Mac, which translate into higher dividend payments to the Treasury. For the first seven months of the fiscal year, the FY13 deficit is down 32% from the same period last year.  It should be noted that the new deficit projection is not based on the $85 billion in spending cuts mandated by the sequester, which were already incorporated into CBO’s February forecast.

The new deficit projection would be equal to 4% of GDP, down from the earlier estimate of 5.3% of GDP, and is projected to shrink to only 2.1% of GDP by 2015.  The ten year deficit would be $618 billion smaller than the February forecast, based primarily on lower projected spending in Medicare, Medicaid, Social Security, and interest on the debt.

The Bad News: The Long-Term Outlook
The bad news is that the good news is only short term, and that the long-term fiscal situation is still of great concern.  CBO projects that after 2015 the deficit will begin to increase again due to the aging population, increased health care costs, and higher interest on the debt.  In addition, some observers contend that the higher than expected revenue is illusory, because it’s in part due to one-time moves by wealthy taxpayers at the end of 2012 to avoid higher tax rates that take effect in 2013.  And while CBO revised its 10 year deficit projection downward by $618 billion, it still forecasts deficits totaling $6.3 trillion over the period, raising the debt to more than $25 trillion by 2023.

More Bad News: Prospects for a Grand Bargain Dim
Although the law suspending the debt limit expires on Saturday, the improved fiscal situation will again push back the date at which the Treasury Department would need Congress’s approval to increase the debt limit, probably to October or even November.  Postponing yet another confrontation over the debt ceiling into the next fiscal year would seem to be good news, as it removes a major complication from negotiations over what will almost certainly be a FY14 continuing resolution to fund next year’s federal spending.

However, the fact that Congress and the president have more time to negotiate a “grand bargain” that would address the long-term fiscal situation, spending cuts, entitlement spending and tax reform isn’t necessarily good news, as it removes much of the pressure to reach an agreement.  Given the propensity to reach agreements only at the eleventh hour, it likely pushes the negotiations closer to the 2014 elections, which could make it even more challenging to reach a compromise.  It’s been reported that the bipartisan effort that’s been underway since the beginning of the year to reach a grand bargain has ended, in large part because of the new deficit projections.