(Newsroom America) -- The Congressional Budget Office says planned sharp cuts in spending and increases in taxes at the end of the year would dramatically reduce the federal deficit but would probably lead to a recession early next year.
For fiscal year 2012 (which ends on September 30), the federal budget deficit will total $1.1 trillion, CBO estimates, marking the fourth year in a row with a deficit of more than $1 trillion.
That projection is down slightly from the $1.2 trillion deficit that CBO projected in March, the CBO said in an Update to the Budget and Economic Outlook released today.
At 7.3 percent of gross domestic product (GDP), this year's deficit will be three-quarters as large as the deficit in 2009 when measured relative to the size of the economy. Federal debt held by the public will reach 73 percent of GDP by the end of this fiscal year—the highest level since 1950 and about twice the share that it measured at the end of 2007, before the financial crisis and recent recession.
CBO expects the economic recovery to continue at a modest pace for the remainder of calendar year 2012, with real (inflation-adjusted) GDP growing at an annual rate of about 2¼ percent in the second half of the year, compared with a rate of about 1¾ percent in the first half.
The unemployment rate will stay above 8 percent for the rest of the year, CBO estimates, and the rate of inflation in consumer prices will remain low.
CBO has prepared—as it does under its routine procedures—baseline projections that incorporate the assumption that current laws generally remain in place; those projections are designed to serve as a benchmark that policymakers can use when considering possible changes to those laws.
"However, the outlook for the budget deficit, federal debt, and the economy are especially uncertain now because substantial changes to tax and spending policies are scheduled to take effect in January 2013. Therefore, CBO has also prepared projections under an alternative fiscal scenario, which embodies the assumption that many policies that have recently been in effect will be continued," it said.
CBO said among the policy changes that are due to occur in January under current law, the following will have the largest impact on the budget and the economy:
* A host of significant provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) are set to expire, including provisions that extended reductions in tax rates and expansions of tax credits and deductions originally enacted in 2001, 2003, or 2009. (Provisions designed to limit the reach of the alternative minimum tax, or AMT, expired on December 31, 2011.)
* Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.
* Automatic enforcement procedures established by the Budget Control Act of 2011 (P.L. 112-25) to restrain discretionary and mandatory spending are set to go into effect.
* Extensions of emergency unemployment benefits and a reduction of 2 percentage points in the payroll tax for Social Security are scheduled to expire.
On the Budget and Economic Outlook for 2013, taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:
* The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012. * Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013.
* Because of the large amount of unused resources in the economy and other factors, the rate of inflation (as measured by the personal consumption expenditures, or PCE, price index) will remain low in 2013. In addition, interest rates on Treasury securities are expected to be very low next year.
To illustrate the consequences of possible changes to current law, CBO has produced projections under an alternative fiscal scenario that incorporates the following assumptions:
* that all expiring tax provisions are extended indefinitely (except the payroll tax reduction in effect in calendar years 2011 and 2012);
* that the AMT is indexed for inflation after 2011; that Medicare’s payment rates for physicians’ services are held constant at their current level;
* and that the automatic spending reductions required by the Budget Control Act, which are set to take effect in January 2013, do not occur (although the law’s original caps on discretionary appropriations are assumed to remain in place).
CBO said that set of alternative policies would lead to budgetary and economic outcomes that would differ significantly, both in the near term and in later years, from those in CBO’s baseline:
* In 2013, the deficit would total $1.0 trillion, almost $400 billion (or 2.5 percent of GDP) more than the deficit projected to occur under current law. * The economy would be stronger in 2013: Real GDP would grow by 1.7 percent between the fourth quarter of 2012 and the fourth quarter of 2013, and the unemployment rate would be about 8 percent by the end of 2013, CBO projects.
CBO said the Budget Outlook for 2014 to 2022 Under Current Law would see budget deficits projected to continue to shrink for several years—to 2.4 percent of GDP in 2014 and 0.4 percent by 2018—before rising again to 0.9 percent by 2022.
"With deficits small relative to the size of the economy, debt held by the public is also projected to drop relative to GDP—from about 77 percent in 2014 to about 58 percent in 2022. Even with that decline, however, debt would represent a larger share of GDP in 2022 than in any year between 1955 and 2009," it said.
Most of the projected decline in the deficit occurs because revenues are set to rise considerably in the coming years under current law—from 15.7 percent of GDP in 2012 to 19.6 percent in 2014 and 21.4 percent in 2022.
Between 2012 and 2014 alone, revenues in CBO’s baseline shoot up by one-quarter as a share of GDP because of the expiration of various tax cuts at the end of 2012, the expiration of provisions related to the AMT at the end of 2011 (which will boost tax receipts mainly in 2013 and later), and other factors.
Outlays, by contrast, are projected to be a smaller share of GDP in 2022 under current law (22.3 percent) than they are in 2012 (22.9 percent). Discretionary spending is projected to decline relative to GDP throughout the next 10 years because of the caps on discretionary funding that stem from provisions of the Budget Control Act. By CBO’s estimate, discretionary spending will fall to 5.6 percent of GDP by 2022—the lowest level in at least 50 years. Mandatory outlays will remain about the same as a share of GDP through 2019, CBO projects, and then will grow faster than the economy, reaching 14.4 percent of GDP in 2022, compared with 13.2 percent in 2012.
Despite the surge in federal borrowing in recent years, net interest outlays are projected to hold steady at 1.4 percent of GDP through 2015, primarily because interest rates are expected to remain near historic lows for the next few years. Interest rates are anticipated to rise noticeably thereafter, causing net interest outlays to increase to 2.3 percent of GDP by 2020, CBO projects.
CBO said the Economic Outlook for 2014 to 2022 Under Current Law includes:
* Economic Growth from 2014 to 2017: As the economy adjusts to a lower path for budget deficits, real GDP is projected to begin growing again in late 2013. The pace of economic expansion will average 4.3 percent from 2014 through 2017, CBO projects, although the economy will continue to operate below its potential level (when output reflects a high rate of use of labor and capital) until 2018. * Unemployment Rate from 2014 to 2017: As economic growth picks up, the unemployment rate is projected to decline to 8.4 percent in the fourth quarter of 2014 and to 5.7 percent by the fourth quarter of 2017. * Inflation and Interest Rates from 2014 to 2017: Inflation (as measured by the PCE price index) is projected to inch up toward 2 percent by 2017. CBO anticipates that, as the economy strengthens, interest rates will return to more-typical levels; the rate on 3-month Treasury bills is projected to be 3.4 percent at the end of 2017, and the rate on 10-year Treasury notes is projected to be 4.6 percent. * The Outlook for 2018 Through 2022: Beyond 2017, CBO does not attempt to predict the timing or magnitude of fluctuations in business cycles. CBO’s economic projections for the 2018–2022 period are based on trends in the factors that underlie the economy’s potential output, such as the size of the labor force, the stock of productive capital, and productivity. In those projections, the growth of real GDP averages 2.4 percent between 2018 and 2022, and inflation hovers around 2 percent. By late 2022, the unemployment rate declines to 5.3 percent, and interest rates on 3-month Treasury bills and 10-year Treasury notes are 3.8 percent and 5.0 percent, respectively.
What Is the Budget and Economic Outlook for 2014 to 2022 If Many Current Policies Are Continued?
Under the alternative fiscal scenario, deficits over the 2014–2022 period would be much higher than those projected in CBO’s baseline, averaging about 5 percent of GDP rather than 1 percent. Revenues would remain below 19 percent of GDP throughout that period, and outlays would rise to more than 24 percent. Debt held by the public would climb to 90 percent of GDP by 2022—higher than at any time since shortly after World War II.
Real GDP would be higher in the first few years of the projection period than in CBO’s baseline economic forecast, and the unemployment rate would be lower. However, the persistence of large budget deficits and rapidly escalating federal debt would hinder national saving and investment, thus reducing GDP and income relative to the levels that would occur with smaller deficits.
"In the later part of the projection period, the economy would grow more slowly than in CBO’s baseline, and interest rates would be higher. Ultimately, the policies assumed in the alternative fiscal scenario would lead to a level of federal debt that would be unsustainable from both a budgetary and an economic perspective," the CBO said.