CBO Projections Point to Worsening Economic Data

I looked like a real Pollyanna in Wednesday’s New York Times where I’m cited as “estimating” (way too generous a word) a 7 percent of GDP federal budget deficit for fiscal year 2009. Hah! Wednesday morning I learn from the Congressional Budget Office that the economy is much worse off than I thought (or at least that I had factored in), leading to CBO’s baseline deficit forecast of $1.2 trillion for the current fiscal year, which is (yikes) 8.3 percent of an economy that’s only $14–not $15–trillion big.

CBO’s last baseline forecast projected a fiscal year 2009 deficit of “just” $438 billion. In other words, the forecast just deteriorated by about $750 billion (to $1.186 trillion)–and for this fiscal year alone. According to Table 8 of the report (pages 27-28), the ten-year deficit forecast for fiscal years 2009-18 has gone from $2.313 trillion, to an astounding $4.085 trillion–a deterioration of $1.772 trillion. (The ten-year deficit corresponding to the new budget window of 2010-19 is $3.135 trillion.)

Table 2 of the report (page 12) focuses on the deterioration in CBO’s economic forecast since last September (by which time they had already revised their forecasts significantly downward). In September they expected that GDP for (calendar year) 2009 would be $14.9 trillion; now they forecast it at $14.2 trillion. Real GDP growth had been projected at +1.1%; now it is -2.2%. Unemployment had been predicted to be 6.2%; now they expect it to be 8.3%. The much weaker economy led to a deterioration in baseline revenues, due to “economic” and “technical” factors, of more than $250 billion, for this fiscal year alone.

Although most of the greater pessimism in CBO’s economic forecast in the major economic indicators is confined to the early part of the budget window (calendar years 2009 and 2010), the budgetary effects stretch over the entire ten-year window, largely because of the more permanent declines in the size of the tax base. Note that for the entire ten-year budget window, the economic revisions to revenues alone account for more than 100% of the deterioration in the ten-year deficit outlook. (Economic factors account for a more than $2 trillion decrease in revenues over ten years; technical factors reduce revenues by over $600 billion more.)

How about some context for this $2 trillion revenue cost that’s due to the weaker-than-previously-expected economy alone?: That’s larger than the original ten-year legislative cost of the Bush tax cuts–remember, the $1 1/2 trillion or so that we (or at least some of us) complained was unaffordable? And this shrinking of the revenue base is even before we consider any extension of (any part of) the Bush tax cuts, relief from the Alternative Minimum Tax (AMT), or tax cuts to become part of Stimulus II. What does that speak to me? That our revenue system is inadequate and already (with current-law policy) in crisis.

The only “saving grace” in CBO’s revised economic forecast for the federal budget? Inflation and interest rates are now very low. The economic revisions to federal spending generate a $24 billion decrease for the current fiscal year, because net interest is now $44 billion lower, more than offsetting the additional required safety-net spending (mostly $12 billion extra in unemployment compensation).

Although the economic effect of currently-low interest rates helps the budget outlook, the effect of much larger debt service throughout the ten-year budget window largely offsets the savings. Over the new ten-year budget window (2010-19), CBO estimates that net interest costs will be $3.654 trillion. And the revision for higher debt service alone accounts for $579 billion in extra costs (and higher deficits) just through fiscal year 2018 (the prior budget window endpoint), compared with CBO’s prior forecast.

And by the way, this is all before we account for the budgetary effects of any additional stimulus that has yet to be enacted. The really bad economics are also before accounting for the additional stimulus–which should give policymakers something to focus on: can we come up with a stimulus proposal that doesn’t just worsen the budget outlook without improving the economic outlook? Minimizing the former (adverse effect on deficit) while maximizing the latter (beneficial effect on economy) is what prioritizing policy goals, and maximizing “economic bang per buck,” would do.

Comments

[Crocodilian:]

"Can we come up with a stimulus proposal that doesn’t just worsen the budget outlook without improving the economic outlook?"

Great question. We have not had a rigorous discussion of
1) where we are
2) what would happen without a stimulus package
3) what a stimulus package can reasonably be expected to achieve

So far, Hank Paulson has been a study in panic . . . each time he testifies about the new new plan, I get the feeling that I ought to be way more frightened than I am. He stimulates industry, sure enough, canned goods, generators and water purifiers.

My guess is that the economy can be improved by stimulus, but that this will necessarily weaken the budget. One thing to be considered is that to have the economy "not do worse" may actually be a success, though it wouldn't look like it. Think about it this way: We have had a banking crisis, pretty much without any bank runs. That's an achievement. The lines at Indymac, and the "secret run" at WaMu could easily have been repeated elsewhere.

They weren't . . . and we have to count that as a success.

Jan 07 08:36 PM

[John Lounsbury:]

The CBO report is in substantial agreemnet with ECRI measurements reported on frequently by Steven Hanson in SA articles. While the ECRI indicators only look forward for six months, the one to two year outlook of the CBO report is more ominous.

The key to minimizing long term negative effects is how much of the added deficits enable future economic growth vs being spent to support current expense or pay for past misdeeds. So far, what has been done is in the second category and not directed toward future economic growth. Will 2009 see an improvement?

Jan 07 11:28 PM