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CBO Predicts Smaller 2007 US Deficit

by Mike Godfrey,, Washington

29 January 2007

The Congressional Budget Office has estimated that if America's laws and the government's policies do not change in the coming year, the budget deficit will equal $172 billion in 2007.

In a report released last week, the CBO, a non-partisan arm of Congress, predicted that current laws and policies would translate to total federal spending of $2.7 trillion and would yield tax revenues of $2.5 trillion.

The additional funding that is likely to be needed to finance military operations in Iraq and Afghanistan would put that deficit in the vicinity of $200 billion. Even so, this year’s shortfall would be smaller than the 2006 deficit of $248 billion, the CBO forecast.

Current laws and policies would also reduce the deficit in 2008 to $98 billion, the report predicted. That decrease results primarily from two factors. On the revenue side of the budget, receipts from the alternative minimum tax (AMT) are estimated to increase by about $60 billion next year because of the scheduled expiration of the relief provided through tax year 2006. (In addition, telephone- tax refunds, which totaled $13 billion in 2007, are projected to drop by $10 billion in 2008.) On the spending side of the budget, outlays for operations in Iraq and Afghanistan and for relief and recovery from hurricane damage are about $14 billion lower in 2008 than in 2007 under the assumptions of the baseline.

The baseline deficit is projected by the CBO to rise modestly over the following two years, 2009 and 2010, as outlays grow by about 3.8% annually, and revenues increase by about 3.3% a year. That projected growth rate for revenues is lower than in recent years, mainly because corporate profits and capital gains realizations are expected by the CBO to revert to levels that are more consistent with their historical relationship to GDP.

After 2010, the report predicts that spending related to the aging of the baby-boom generation will begin to raise the growth rate of total outlays. The baby boomers will start becoming eligible for Social Security retirement benefits in 2008, when the first members of that generation turn 62. As a result, the annual growth rate of Social Security spending is expected to increase from about 4.5% in 2008 to 6.5% by 2017.

In addition, because the cost of health care is likely to continue rising rapidly, spending for Medicare and Medicaid is projected to grow even faster — in the range of 7% to 8% annually. Total outlays for those two health care programs are projected to more than double by 2017, increasing by 124%, while nominal GDP is projected to grow only half as much, by 63%. Consequently, under the assumptions of CBO’s baseline, spending for Medicare, Medicaid, and Social Security will together equal nearly 11% of GDP in 2017, compared with a little less than 9% this year.

Tax revenues are projected to increase sharply after 2010, given the assumption that various tax provisions expire as scheduled. In the baseline, total revenues would grow by 9.2% in 2011 and by 7.5% in 2012, thereby bringing the budget into surplus. Beyond 2012, revenues are projected to grow at about the same pace as outlays (by roughly 4.5% a year), keeping the budget in the black through 2017 under baseline assumptions.

Relative to the size of the economy, outlays are projected to range between 18.8% and 19.7% of GDP during the 2008–2017 period under the assumptions of CBO’s baseline — lower than the 20.6% average of the past 40 years. Mandatory spending (funding determined by laws other than annual appropriation acts) is projected to grow by 5.9% a year over that period, which is faster than the economy as a whole. By contrast, discretionary appropriations are assumed simply to keep pace with inflation and, to a lesser extent, with the growth of wages. Thus, discretionary outlays are projected to increase by about 2.0% a year, on average, or less than half as fast as nominal GDP.

CBO projects that revenues will average 18.7% of GDP from 2008 to 2010 (close to the 18.6% level expected for this year) before jumping sharply in 2011 and 2012 with the expiration of tax provisions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). After that, revenues are projected to continue growing faster than the overall economy for three reasons: the progressive structure of the tax code combined with increases in total real income, withdrawals of retirement savings as the population ages, and the fact that the AMT is not indexed for inflation. Under the assumptions of the baseline, CBO projects that revenues will equal 20.1% of GDP by 2017 — a level reached only once since World War II.

Federal government debt that is held by the public (mainly in the form of Treasury securities sold directly in the capital markets) is expected to equal almost 37% of GDP at the end of this year. Thereafter, the baseline’s projections of smaller annual deficits and emerging surpluses diminish the government’s need for additional borrowing, causing debt held by the public to shrink to 20% of GDP by 2017.

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