In January 2012, the Congressional Budget Office (CBO) issued its latest projections regarding the U.S. deficit, government expenditures and the general financial picture for the years ahead. In the CBO’s report, “The Budget and Economic Outlook: Fiscal Years 2012 to 2022,” issues such as the payroll tax cut and the status of unemployment benefits play a key role in the forecasts. Because there was uncertainty around these policy matters at the time of publication, the agency calculated figures under two different scenarios.

Under one scenario, the forecasts assume that current law stands and there are no legislative changes to existing policies; but under an alternative fiscal scenario, the CBO makes estimates based on the assumption that the payroll tax cut is extended through 2012, the alternative minimum tax (AMT) is indexed for inflation, Medicare contributions towards physicians and caregivers stay at their present levels and automatic spending cuts do not come into effect.

The findings below summarize CBO’s projections for 2012 and 2013. Except where noted, the figures assume that current law will stand:

• The CBO forecasts a budget deficit of $1.1 trillion (7% of GDP) for 2012, smaller than the $1.3 trillion recorded in 2011, as government spending ($3.6 trillion) comes in higher than revenues ($2.5 trillion). Gaps between federal income and expenses will be met by government borrowings. Public debt will continue its upward trend in 2012, reaching its peak at 75% of GDP in 2013 and declining thereafter.
• Assuming current law will hold, deficits will decline to 3.7% of GDP in 2013 because of higher tax collections and the expiration of certain tax exemptions in 2012. However, if the payroll tax reduction is extended until the end of 2012, revenues will fall short by $75 billion in 2012 and by $25 billion in 2013, thus limiting the degree of deficit reduction projected.
• Real GDP growth (i.e., GDP growth adjusted for inflation) is projected to increase by 2.2% in 2012 and 1% in 2013. The slow growth rate will result in an unemployment rate of 8-9% this year and the next. Growth will be driven largely by business investments in equipment and software. The CBO forecasts weak consumer spending and small increases in exports. Limited economic growth implies labor demand will continue to remain weak.
• Inflation is expected to be 1.5% on average over the next two years, while interest rates will continue to remain at very low levels — roughly 0.1%. Hence, even though the cost of living will not rise substantially, income on deposits could potentially generate negative real returns because inflation rate is higher than the interest rate.
• Revenues will increase by 10% to $2.5 trillion, amounting to 16.5% of GDP.  Revenue increases are mostly due to the expiring of certain tax exemptions, particularly the 2-percentage point reduction in payroll tax rate for Social Security, as well as tax deductions that businesses were allowed to take for depreciation on new equipment. Revenues from social insurance taxes, corporate income tax and individual income tax are expected to increase by equal dollar amounts of approximately $70 billion each.
• Total federal expenditures are expected to remain mostly unchanged from last year at $3.6 trillion (23.2% of GDP). Increases in mandatory spending of $45 billion will be negated by a decline of the same amount in discretionary spending, which is projected to decline to $1.3 trillion in 2012.
• The second largest expenditure category is Social Security benefits, which are expected to grow by $45 billion (i.e. 6% growth) — twice as much as last year. Overall spending on federal programs for the elderly and disabled are forecasted to increase at an average annual rate of 7% during 2013-2022 — significantly higher than nominal GDP growth predicted for the same time period.
• Defense spending is projected to decline by 6% from last year (a reduction of $42 billion), as military operations in Iraq and Afghanistan are scaled back. Over the past few decades defense expenses have largely dominated trends in discretionary spending. It is forecasted to decline by another $88 billion in 2013.
• House prices and construction of new houses will remain weak due to the large supply of vacant houses. Prices could grow by 1.1% on average over 2012 and 2013.

Tags: economy