CBO’s new deficit estimate

CBO’s new deficit estimate

Update: In the original version of this post I erred in explaining why CBO increased their revenue projection.  I simply misread the CBO document. A fuller explanation of my error is here. Corrections are in green below.

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:

  1. A roughly 3% deficit will hold debt/GDP constant;
  2. The historic average deficit (pre-2008 crisis) is about 2% of GDP; and
  3. 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 prior expectations.

I know that’s probably more complicated than you want.  Sorry, best I can do.

Why did the projection change so much?

Update:  I struck a lot of text from the original version of this post, in which I misread the reasons why CBO’s revenue projection went up.  The correct version is in green here.

  • Based on tax data collected through April of this year, both income and corporate tax collections on income earned in 2012 (and therefore collected in 2013) are coming in higher than CBO anticipated;
  • 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.

CBO’s best guess at this point is that the first factor is because taxpayers realized more income in late 2012 (rather than in 2013) in anticipation of 2013 rate increases than CBO had originally anticipated.

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.

19 responses

  1. Can you break down the $200B by source? That is, how much is due to payroll tax increase, how much due to tax rate increases, etc? I am particularly interested in the effect of the shift of individual income into 2012 and the divided payments from Freddie Mac and Fannie Mae.

  2. What is your response to conservatives that say discretionary spending cuts have been sufficient over the last couple years, and the focus now needs to pivot to entitlement reform, tax reform, and, most importantly, growth of the denominator- the GDP? Are we missing this by Congress constantly trying to chip away at comparatively inconsequential cuts while missing the big picture? Thanks for your analysis, always thoughtful and appreciated.

  3. Is the 75% debt to GDP only based on Public Debt, or does it include the amounts owed as intergovernmental, i.e., like the 2+ Trillion owed to SS Trust Fund ? I thought the $16.5 Trillion total debt was around 100% of GDP.

  4. As you point out (as Heritage and others do) many of the impacts are temporary.

    In addition the Federal Reserve published a study last year the last few decades of CBO deficit projections and found that (where RW=”Random Walk”):
    http://research.stlouisfed.org/publications/review/12/01/21-40Kliesen.pdf “the CBO’s cumulative 5-year projections are considerably worse than projections from the RW model; [...]the deficit projections beyond a year were unreliable. Importantly, we found that the projections were biased in the direction of underprojecting the size of the deficit or overprojecting the size of the surplus.”

    The CBO forecast is a “baseline” forecast which assumes current laws don’t change, and even things they always renew are allowed to expire, and optimistic projections for things like entitlement spending. Their “current policy” scenario is usually a little more realistic since it assumes laws are changed to reflect current policy, however even that is based on optimistic forecasts for things like GDP growth. The GAO does a similar forecast, and the Dec. 2012. The page below updated that to use more conservative GDP and other estimates from the Social Security Administration’s alternative forecasts. It doesn’t factor in the temporary changes people are optimistic now, but given it is unlikely there have been major permanent changes yet it still gives a general picture:

    http://www.politicsdebunked.com/article-list/budget-lottery

    It links to a page noting however that the Social Security Administration’s estimates for future entitlement spending are likely also too optimistic and their projections have many flaws which means things could be worse than we expect. (e.g. despite supposedly doing “low cost” and “high cost” alternate scenarios, the “high cost” scenario turns out to be high cost only in nominal $, but *low cost* in real inflation adjusted $, their ranges are so narrow they are implying they can forecast GDP out to 2090 even more accurately than it is measured (based on GDP-GDI statistical discrepancy, they project labor force participation rates higher than the BLS does, etc, etc).

  5. Keith, Tks for the 2,3, & 4 benchmarks. I wish you wrote all the news for us. Best regards, Jonathan’s Dad

  6. The CBO charts using %GDP seem to be slightly misleading. I could graph my household expense budget as a %of expected future earnings and make my home mortgage costs look as though they were declining based on a rosy assumption of future pay increases– but the actual value would be the same. The same principle is at work here isn’t it?

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