What the decrease in the deficit is all about

CBO's new deficit estimate 15 May 2013 CBO released their updated economic and budget baseline today, in advance of their estimate of the President’s budget due out later this week. At first the headline sounds like good news: the deficit for this year will be “only” $642 B, 4% of GDP. That’s about $200 B smaller than CBO projected for this year in their January baseline document. Should we celebrate? No, not unless you like the “fiscal cliff” tax rate increases and you like the government owning Fannie Mae and Freddie Mac. Those are the reasons why the deficit projection declined. Deficits and Debt You should know three benchmarks when thinking about federal budget deficits, each measured in % of GDP: A roughly 3% deficit will hold debt/GDP constant;  The historic average deficit (pre-2008 crisis) is about 2% of GDP; and  Of course, a balanced budget is zero deficit.  Any time you hear a deficit number, compare it to zero, two and three, and you’ll have a good feel for where we are. A 4 percent deficit for this year is not good: it’s almost twice as high as the historic average, and it’s high enough that our debt will continue to increase faster than our economy will grow. You will hear “But that 4 percent projection is much lower than the 5.4% projected in January. Surely that’s good news. It is certainly an improvement over where we thought we were this year.” This is where we need to review levels, rates of change, and expectations. This is tricky so I’ll break it down into small steps. The level of our debt/GDP is quite high: 73% at the end of last year. That’s bad, and there’s a debate about just how bad it is.  The deficit is the change in our debt for this year. A deficit means our debt is increasing, and a deficit greater than 3% of GDP means our debt is increasing relative to our economy. So our level is high (bad), and because our 4% deficit is greater than the 3% benchmark, our level is increasing (getting worse).  But it’s getting worse much more slowly than it was getting worse a few years ago. In 2009 the deficit was 10% of GDP. With a 4% deficit this year, our situation (level, debt/GDP) is getting worse much more slowly than it was four years ago.  That does not, of course, mean we’re in a better position (debt level) than four years ago. Our debt/GDP at the end of 2008 was 41%. At the end of last year it was 73%, and CBO projects it will increase to 75% at the end of this year. That our debt is growing much more slowly this year than it was four years ago is hardly cause for celebration.  Looking for a silver lining, our projected deficit (4%) is significantly smaller than was projected just four months ago (5.4%, projected in January). It is therefore a better (less bad, really) number than priorexpectations.  I know that’s probably more complicated than you want. Sorry, best I can do. Why did the projection change so much? CBO was not particularly surprised by this change. Their estimate changed mostly because they are required to project current law, even when they are pretty sure it will change. They did their January baseline estimates before tax laws changed on January 2nd, so that baseline does not incorporate the effects of the “fiscal cliff” tax increases. CBO did not change their economic forecast, and other than tiny tweaks to Social Security and Medicare, they didn’t change their spending forecasts much either. Their new deficit estimate for this year came down by $203 B, and $200 B of that is from more money coming into the government: The payroll tax credit expired; Tax rates on income, dividends and capital gains all increased for “the rich”; In anticipation of those rate increases, some individuals realized income in late 2012 rather than 2013, shifting tax collections on that income into this year’s column on the government ledger; Corporate tax receipts are recovering a bit faster than CBO had previously estimated; and Fannie Mae and Freddie Mac, now quite profitable, are making big dividend payments to the Treasury. These payments show up on the outlay side of the federal budget ledger, but they are in effect receipts of the U.S. government. The other big consequence of the nature of these changes is that they are mostly one-time bumps. So the 2013 numbers improved quite a bit, but the numbers for following years don’t increase nearly as much. Enough already! How should I feel about this? If you supported the tax rate increases then this is marginally good news. But don’t celebrate; our fiscal picture is still grim. If, like me, you hate tax rate increases on anyone and detest having the government own two massive mortgage finance companies, then you should feel no comfort from today’s deficit news, which is almost entirely the result of those policies. I’d happily return to a 5.4% deficit if you let me repeal the tax rate increases and replace Fannie & Freddie with a private mortgage securitization market. And then I’d cut government spending. A lot. -kbh