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Understanding the Upcoming Deficit Numbers

Understanding the Upcoming Deficit Numbers

By Keith Hennessey - August 19, 2009

The Mid-Session Review is a budget document released by the Administration each summer.  It updates the Administration’s economic and budget forecasts.  It shows the budgetary effects of any laws enacted since the President’s budget was released, as well as any new policies proposed by the President.

Within the next week the Obama Administration will release the Mid-Session Review.  Next Tuesday morning the Congressional Budget Office will release their updated budget and economic forecast.  Here are some things to watch for in these upcoming releases.

1.New deficit numbers

The headline of the MSR is always the new deficit forecast.  CBO will update their forecast as well.  Here are the numbers to be updated:

 

2009 deficit

2010 deficit

Administration (March forecast)

$1.75 trillion

$1.17 trillion

Congressional Budget Office

$1.67 trillion

$1.14 trillion

These are staggeringly large numbers.  They are more analytically useful when we compare them to the size of the economy.

 

2009 deficit

2010 deficit

Administration (March forecast)

12.3% of GDP

8% of GDP

Congressional Budget Office

11.9% of GDP

7.9% of GDP

Over the past two decades the U.S. government averaged a deficit of 1.9% of GDP.  Current deficits are four to six times larger than average.  These are dangerously high levels.  Deficits this year and next are abnormally large primarily because of the fiscal policy actions taken by the government last Winter:  the $700 billion TARP (Trouble Asset Relief Program) and the fiscal stimulus law, which will increase deficits by $787 billion spread out over several years.  The TARP was broadly bipartisan, while the fiscal stimulus was mostly partisan.

In addition, the U.S. economy has been weaker than forecast and government revenues are coming in lower than predicted.  The projected deficits will increase – the big question is how much?

What you’ll see:  Headlines with the topline 2009 and 2010 deficit figures:  “Administration/CBO projects higher budget deficit of $1.X trillion…”

What really matters:  How much of an increase above 12% of GDP and 8% of GDP are the new projected 2009 and 2010 budget deficits?

Why it matters:  Budget deficits crowd our private borrowing and raise interest rates.  It costs more to get a mortgage, a car loan, or a student loan.  Higher interest rates and their effect on the dollar cause the U.S. economy to grow more slowly, meaning fewer jobs are created and wage growth slows.

2.New economics forecast

While the 2009 and 2010 deficit forecasts will likely dominate the headlines, the updated economics forecasts are even more important in the short run.  Here are the numbers to be updated:

Projected Economic Growth

 

2009 real GDP

2010 real GDP

Administration (March forecast)

-1.2%

+3.2%

CBO (Jan forecast)

-2.2%

+1.5%

In January CBO forecasted a sharper economic decline in 2009 and a slower recovery next year than the Administration projected.  Forecasts of the unemployment rate look similar:

 

2009 avg unemployment rate

2010 avg unemployment rate

Administration (March forecast)

8.1%

7.9%

CBO (Jan forecast)

8.3%

9.0%

Actual through July (BLS)

8.8%

 

It’s tough to tell much about the timing of the projected recovery from annual averages, but these two tables show the Administration was more optimistic about a strong 2010 recovery than was CBO.

We know now that both forecasts for 2009 were too optimistic.

What really matters:  We will be able to tell the Administration’s and CBO projected GDP growth for the last four months of this year from the new 2009 numbers.  How much worse are the 2010 forecasts than those made earlier this year?

What reporters should ask the Administration and CBO:

1.       When do you think the unemployment rate will peak?  When do you project it will begin to steadily decline?

2.       When did you “lock” this forecast?  Does it include the more positive July jobs data?

3.       Does this change your forecast of employment levels for 2009 and 2010?  If so, by how much?

3. New policies

I do not expect the President to roll out major new policy initiatives in this MSR, especially since his team seems to be trying to bury the bad deficit news in the dog days of August when many in Washington are on vacation.  The President has his hands full right now.

More important than new policies are the legislative realities that have developed since the President proposed his budget in March.  The deficit projections I gave above are for the baseline – what we expect if the law is not changed.  The projected policy deficits are higher.  CBO projects that the President’s policies would increase the deficit above the baseline deficits by 1.1% of GDP in 2009 and another 1.9% of GDP in 2010. 

In the real world those projected policy deficits are too optimistic because they assume three policy changes that Congress has rejected:

1.       The President proposed spending about $600 B over ten years on a new health care entitlement.  Pending legislation adds another $400 B -- $600 B to that amount.
2.       Congressional Democrats quickly killed the President’s proposal to raise taxes by $318 B over ten years on high-income people who itemize deductions.
3.       The President assumed that $526 B over ten years from cap-and-trade revenues would reduce the deficit.  The cap-and-trade bill passed by the House would spend all the revenues collected.

These Congressional realities mean you should expect medium-term deficits even higher than those projected by CBO and the President.

What this means:  Assuming the MSR leaves these proposed-but-rejected policies in place, the Administration’s display of projected medium-term deficits will significantly understate what’s likely.  That’s standard budgeting practice, but it makes the information conveyed by the MSR too optimistic and somewhat less useful.

What you should care about:  The President needs to show a credible path to returning to budget deficits that are economically sustainable.  Bad economic news combines with deficit-increasing policy proposals to undermine that credibility.

4.       The Administration’s deficit message

The President has stressed three fiscal policy messages so far:

1.       I inherited a huge deficit.

2.       All of my proposed policies will be paid for and will not increase the deficit.

3.       The biggest deficit problem is the long-run one driven by health care costs.  Health care reform will bring down long-run budget deficits.

His first point is true, although the President omits that as a Senator he voted for the $700 B TARP and the annual spending bills.

The second point is inconsistent with legislative reality.  The $787 B fiscal stimulus increased the deficit.  The nonpartisan Congressional Budget Office paints a bleak picture:  $4 trillion more debt over the next decade if the President’s policies were enacted. 

The President has boxed himself in with different messages on fiscal policy and health policy.  He argues we must slow the growth of long-term health spending, but has not offered policies that unbiased analysts say would achieve that goal.  In health care reform, Congress is in no mood to make the painful choices needed to reduce future deficits, so the President has fallen back to a more modest goal of not increasing future deficits.  If health care reform should actually become law this year, expect the long-run budget picture to get dramatically worse.  Pending bills would create a rapidly-growing enormous new spending commitment that would quickly outstrip the proposed spending cuts and tax increases.  In an effort to rescue health care reform the President has shifted away from a cost control message.  Congress will read this signal and look for ways to avoid the pain of deficit reduction, knowing that the President will sign any bill that reaches his desk.

What to expect:  A lot of talk about the past:  “We inherited …”

What to listen for:  How does the President plan to reduce future deficits?  Do unbiased observers think pending health care legislation will make unsustainable future deficits better or worse?

5. My view

The President entered office in an extraordinary fiscal policy situation.  He began his term with a large budget deficit primarily resulting from the bipartisan TARP and a severe drop in GDP.  The long-term spending pressures of retiring Baby Boomers and exploding Social Security, Medicare, and Medicaid costs are only a few years away.  Economic recovery and addressing long-term spending pressures should be his top priorities.

Instead he tried to do everything at once, including an ordinary liberal policy agenda.  The fiscal stimulus included long-term spending increases unrelated to short-term economic growth.  The cap-and-trade bill will not reduce the budget deficit as the President proposed.  Health care reform that begins with a massive expansion of entitlement spending will not reduce costs.  By pursuing his non-economic policy goals, he is exacerbating a bad macroeconomic and deficit picture. 

The President’s social policy agenda is throwing gasoline on a deficit fire.

Keith Hennessey served as a senior White House economic advisor to President George W. Bush from 2002-2009. He teaches as a Lecturer at the Stanford Graduate School of Business and the Stanford Law School.

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