Budget Deficit Will Narrow Once Tax Breaks Expire

The Congressional Budget Office estimated that the federal budget deficit for 2010 will exceed $1.3 trillion—$71 billion below last year's total and $27 billion lower than the amount that CBO projected in March 2010, when it issued its previous estimate, but that projection is predicated on the Bush tax cuts and other tax breaks expiring.

Relative to the size of the economy, this year's deficit is expected to be the second largest shortfall in the past 65 years, the CBO reported on Thursday. At 9.1 percent of gross domestic product, it is exceeded only by last year's deficit of 9.9 percent of GDP. "As was the case last year, this year's deficit is attributable in large part to a combination of weak revenues and elevated spending associated with the economic downturn and the policies implemented in response to it," wrote CBO director Douglas Elmendorf.

The report presents CBO's updated budget and economic projections spanning the 2010–2020 period. The projections reflect the assumption that current laws affecting the budget will remain unchanged—and thus the projections serve as a neutral benchmark that lawmakers can use to assess the potential effects of policy decisions.

As such, CBO assumes that tax reductions enacted earlier this decade that are currently set to expire at the end of this year do so as scheduled. It also assumes that no new legislation aimed at keeping the alternative minimum tax from affecting many more taxpayers is enacted.

In addition, CBO assumes that the measures enacted in the past two years to provide fiscal stimulus to the weakened economy will expire as currently scheduled and that future annual appropriations will be kept constant in real (inflation-adjusted) terms. Under those assumptions, the federal budget deficit would decline substantially over the next two years—to 4.2 percent of GDP by 2012—and, consequently, the budget would provide much less support to the economy than has been the case for the past two years.

According to the CBO's projections, the recovery from the economic downturn will continue at a modest pace during the next few years. "Growth in the nation's output since the middle of calendar year 2009 has been anemic in comparison with that of previous recoveries following deep recessions, and the unemployment rate has remained quite high, averaging 9.7 percent in the first half of this year," wrote Elmendorf. "Such weak growth tends to occur in recoveries from recessions spurred by financial crises. The considerable number of vacant houses and underused factories and offices will be a continuing drag on residential construction and business investment, and slow income growth as well as lost wealth will weigh on consumer spending."

All of those forces, along with the waning of federal fiscal support, will tend to restrain spending by individuals and businesses—and, therefore, economic growth—during the recovery, he added. The CBO projects that the economy will grow by only 2.0 percent from the fourth quarter of 2010 to the fourth quarter of 2011; even with faster growth in subsequent years, the unemployment rate will not fall to around 5 percent until the end of 2014.