Thursday, November 9, 2023

A big jump in the deficit for 2023. And the Fed ain't helping

Yesterday, the Congressional Budget Office released their full breakdown of the budget figures for the recently completed 2023 Fiscal Year. And a big finding is that after 2 years of lower deficits, things reversed in FFY 2023.

See that dotted line for 2022 and 2023. That's because federal budget officials counted President Biden's plan to forgive large amounts of student loan debt as a $379 billion, one-time payment in FFY 2022. When the US Supreme Court struck down that plan, that one-time payment was reversed, which was registered as a $333 billion reduction in expenses. And if you get rid of those one-time changes, the CBO says the US budget deficit more than doubled in 2023.

If the actions concerning the Administration’s plan for student loan cancellations were excluded from both years, the deficit for 2022 would have been smaller and the deficit for 2023 would have been larger. The deficit for 2022 was $1.3 trillion, after removing the effects of timing shifts. Excluding the cost recorded in 2022 for the student loan cancellation plan, the deficit that year would have been $0.9 trillion. Excluding the savings associated with reversing the effects of that policy, the deficit for 2023 would have been $2.0 trillion (7.5 percent of GDP) instead of $1.7 trillion (6.3 percent of GDP). Thus, without the effects of debt cancellation (and excluding the effects of timing shifts), the deficit would have grown by nearly $1.1 trillion from 2022 to 2023. That increase results from a combination of lower revenues and higher outlays, mostly for major mandatory programs and for payments of interest on the debt.

You can see that a lot of the reason behind the higher deficit is a drop in revenues of more than $400 billion. And the CBO explains that the main culprit is a drop in income tax revenues, and it includes a lot of odd one-time things, including post-COVID adjustments and a bad year in the stock market.
• Nonwithheld payments of individual income taxes fell by $292 billion (or 25 percent), relative to payments in the same period in fiscal year 2022. The decline began in January and continued through tax-filing season, mostly reflecting a decrease in payments for 2022 and 2023 tax liabilities. One factor may be smaller collections of taxes on capital gains, which had been unusually large in 2022. In addition, payments from taxpayers in areas affected by natural disasters may have been delayed because of the IRS postponement of some filing deadlines; most of those payments are now due in fiscal year 2024.
• Individual income tax refunds were $127 billion (or 52 percent) larger than in 2022, reducing net receipts…..

Part of the drop in individual income taxes is explained by the Treasury’s reclassification of receipts from individual income to payroll taxes: That reclassification was larger in 2023 than in 2022. In 2023, the Treasury reclassified as payroll taxes $48 billion of receipts initially recorded as individual income tax revenues. In 2022, the amount reclassified as payroll taxes was $17 billion. Those reclassifications occur because, when the Treasury receives payments of withheld taxes, it cannot distinguish payroll taxes from individual income taxes. Instead, it first allocates withheld taxes to one source or the other on the basis of estimates made in advance of actual collections. As additional information becomes available, including detailed information from tax returns, the Treasury makes periodic reallocations to revise past allocations.
Interestingly, while income taxes went down, payroll taxes which go to programs like Social Security and Medicare had solid growth in Fiscal Year 2023, reflecting more employment and higher wages at the lower levels of the wage scale.

On the expense side, outlays dropped overall. Much of it was due to the reversing of the student loan relief, but it also included the ending of some other COVID-era stimulus aids.
Outlays for certain refundable tax credits totaled $171 billion—a decrease of $120 billion, or 41 percent.4 That reduction occurred because the expanded child tax credit has expired. (In tax year 2021, eligibility for that credit was expanded and the size of the credit was increased; advance payments were made between July and December 2021.)

Spending by the Treasury on coronavirus relief to state, local, tribal, and territorial governments decreased by $105 billion.
On the other hand, there were sizable increases in spending on Social Security (due to an 8.7% Cost-of-living increase and higher number of recipients), and Medicare. Medicaid spending also continued to increase, as the COVID-era unwinding of the assistance rolls didn't start until more than halfway into the 2023 Fiscal Year.

We’ve also seen the cost pay for our debt have a massive increase over the last 2 years, as the high deficits have continued and the Fed has jacked up interest rates, meaning that cost nearly reached our large level of military spending in 2023. That increase in debt costs has almost entirely made up for the big decline in COVID-related assistance that included expanded tax credits and direct spending on services and aid to states and localities.

That’s what might be annoying going forward from a budgetary standpoint. It didn't cost nearly as much to pay for the massive deficits of 2020 and 2021 when the Fed Funds rates were near zero in those years. But now that the Fed has pushed its rates above 5%, and plan to stay at that level for a while (based on what Fed Chair Jerome Powell told Congress today), it is now a high, ongoing expense.

Maybe that manufactured extra expense for to pay for the debt something the Fed should keep in mind, and all the more reason that rates should come down sooner than later. Inflation is largely under control now, but if the Fed keeps causing debt service to keep rising due to high rates, it could cause higher deficits through a slower economy (limiting revenues and causing more services to be needed), and make the dollar so pricey that it makes it harder for some investors to want to buy debt and other US products.

I've said that the higher deficits in itself weren't a problem, but the higher rates that are being imposed by the Fed are (and yes, that move was partly in reaction to the inflation that fired in the wake of a deficit-influenced strong economy in 2021). And if the need to keep financing the debt causes supply of bonds to outrun demand (as we saw today), then that could keep rates legitimately high and hurt the real economy that way. That's the concern I'd have with these deficit figures, more than the numbers themselves.

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