CBO says lower deifcit, slower growth. Do we want that?

This week, the Congressional Budget Office released its updated figures based on the fiscal cliff deal at the start of the year, and it featured two interesting forecasts. The CBO estimated that the deficit would fall by more than $200 billion this year, but that GDP growth would be lower than in recent years, and both can be chalked up to the budget-cutting sequester that's due to hit in 3 weeks.

Economic growth will remain slow this year, the Congressional Budget Office (CBO) anticipates, as gradual improvement in many of the forces that drive the economy is offset by the effects of budgetary changes that are scheduled to occur under current law. After this year, economic growth will speed up, CBO projects, causing the unemployment rate to decline and inflation and interest rates to eventually rise from their current low levels. Nevertheless, the unemployment rate is expected to remain above 7½ percent through next year; if that happens, 2014 will be the sixth consecutive year with unemployment exceeding 7½ percent of the labor
force—the longest such period in the past 70 years.

If the current laws that govern federal taxes and spending do not change, the budget deficit will shrink this year to $845 billion, or 5.3 percent of gross domestic product (GDP), its smallest size since 2008.

So if you're a believer in the deficit being handled above all other priorities, this should be good news to you. In fact, the CBO says the 2013 deficit will be cut in half again by 2015, due to other changes in tax and spending policy that would automatically hit over the next two years if the laws are not changed over the next two years. The CBO also assumes that all agencies will continue to be funded at the same levels after March 27, so the only overall spendng cuts would be due to the March 1 sequester. Obviously if spending is cut further after March 27, these numbers would be further modified.

However, the long-term deficit persists, and they are expected to grow again after 2015, with more to follow if Congress continues to allow Medicare payments to providers to increase as they have in recent years (often called the "doc fix"). A big reasons behind this is an assumption that interest rates will not remain at the low levels that they have been (still under 2% on the 10-year note) and this would raise the cost of interest on the debt, increasing deficits in future years.

The other interesting part is that the CBO anticipates the worst-case scenario it mentioned two months ago does not seem like it will happen- there will be no decline in GDP growth for 2013, and instead the CBO now predicts GDP growth of 1.4% for this year, even if the sequester takes effect. (Here's a post I did 3 months ago on those scenarios, and you'll see the GDP number largely matches the "Social Security tax cuts and tax breaks for the rich goes away" scenario). From there, the CBO says the economy will pick up and grow by an average of 3.5% from 2014-2018, which means the economy will finally get back to full potential with unemployment below 6%, which it hasn't been able to do since the Great Recession hit at the end of 2007.

But then things are projected to slow again, and a lot of the reason why is demographic.

For the second half of the coming decade, CBO does not attempt to predict the cyclical ups and downs of the economy; rather, CBO assumes that GDP will stay at its maximum sustainable level. On that basis, CBO projects that both actual and potential real GDP will grow at an average rate of 2¼ percent a year between 2019 and 2023. That pace is much slower than the average growth rate of potential GDP since 1950. The main reason is that the growth of the labor force will slow down because of the retirement of the baby boomers and an end to the long-standing increase in women’s participation in the labor force. CBO also projects that the unemployment rate will fall to 5.2 percent by 2023 and that inflation and interest rates will stay at about their 2018 levels throughout the 2019–2023 period.

One other noteworthy part in the CBO's report comes later on, where it breaks down individual programs. And as you'll see, several programs are already having cutbacks in spending from where they were at the depths of the recession, and that trend will continue in 2013. We'll start with Medicare, which might already be seeing some bending of the cost curve due to Obamacare.

Medicare. Net outlays for Medicare (excluding the effects of the shift in the timing of the first scheduled payments to health plans from fiscal year 2012 into fiscal year 2011) grew by 3 percent (or $16 billion) in 2012— a slower rate of growth than any recorded since 2000. Medicare’s outlays will increase by 4 percent (or $21 billion) in 2013, CBO estimates. (Those amounts are net of receipts from premiums paid by the program’s beneficiaries.)

Unemployment Compensation. The largest decline in spending in 2012 was for unemployment compensation. The number of people receiving first-time payments of regular unemployment benefits, which peaked in 2009 at 14.4 million, continued to fall in 2012, totaling 8.7 million. As a result, outlays for unemployment compensation dropped by $26 billion last year, to $93 billion. The decline is expected to continue—to $76 billion in 2013—as fewer of the long-term unemployed will be in states that qualify to provide the maximum number of weeks of emergency and extended unemployment benefits. (Wisconsin is one of these states)

Medicaid. Medicaid spending also declined in 2012—by $24 billion (or 9 percent)—primarily because a temporary increase in the federal share of the program’s costs expired in June 2011. That increase initially took effect in 2009 under the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5) and was extended in modified form through June 2011; it was therefore not in place in fiscal year 2012. In 2013, Medicaid outlays will increase by $15 billion (or 6 percent), CBO estimates.

The Making Work Pay Tax Credit. This refundable tax credit (which expired at the end of December 2010) amounted to 6.2 percent of an eligible individual’s earned income for tax years 2009 and 2010 (up to a maximum of $400 for individuals or $800 for joint filers). Because it was refundable, any portion that exceeded an individual’s tax liability was paid to that person and recorded as an outlay in the budget. Because the credit expired, its associated outlays fell by $14 billion between fiscal year 2011 and fiscal year 2012.

This doesn't even bring up the cutbacks at the state and local levels, which have combined with the federal cutbacks to drop expenses lower than they were 5 years ago, despite an increasing population.

So the CBO report should blow up any suggestion of "out of control government spending", because it isn't happening in America. Some of that has happened due to legislative action (like state and local budget cuts), but a lot of it is a result of a recovering economy since the middle of 2009. And this leads to my point- why aren't we concentrating on getting unemployment down, and further reducing the need for spending like unemployment compensation and Medicaid? At the same time, this will raise revenues and could possibly keep us at the same reduced deficit figure, while having more employment than a GOP-approved austerity scenario would give us. If Dems are smart, they're saying we should stay the course of the gradual "brake" of the 2009 stimulus, while continuing some spending and stabilization that allows GDP growth to continue.

And there's an unlikely group that also would like the growth scenario to continue- the large number of TeaBag governors that are up for re-election in 2014. Many of these states rely on help from the feds to keep their budgets in balance, and even Governor Walker's own DOA admitted that if sequestration hit, it would increase the state's budget deficit by $174 million in the next budget. Sequestration and related austerity would also cut the projected growth that the LFB gave in its revenue estimates last month, as the LFB estimated that growth would be 1.7% for the U.S. this year, above the 1.3% the CBO figures with the sequester.

So keep an eye on the events in D.C. over the next month, as allowing the sequester and related austerity would hold back the economic recovery that seemed to be picking up at the end of 2012. And keep it in mind when Governor Walker releases his 2-year budget next week, because I got a feeling that it's going to include a rosy scenario that his GOP buddies in Congress don't want to allow. We have to be ready for this obvious deception, and call it out before it gets passed into law, and dooms Wisconsin to a big deficit that it might not be able to fix after the new governor would come in for 2015.