News Column

Federal Deficit Declining but Will Reach $642 Billion

August 12, 2013
The federal deficit is on the decline.
The federal deficit is on the decline.

According to the Congressional Budget Office's May forecast, the federal budget deficit in fiscal year 2013, which ends on Sept. 30, will be $642 billion, or 4% of GDP. This is a significant improvement from the fiscal year 2012 deficit of 81,087 billion, or 7% of GDP. It also is down from the $845 billion forecast from February.

A number of factors are contributing to the improving budget outlook. With almost four years of subdued recovery, economic activity has boosted incomes and corporate profits, leading to stronger federal revenues. Tax receipts also are up because of increases in the Social Security payroll tax and top personal-income tax rate that took effect on Jan. 1. Seven months into fiscal year 2013, revenues are about 16% greater than at the same point in fiscal year 2012.

At the same time, federal spending is falling. With the better economy, there is less need for social programs, such as unemployment insurance. Congress and the Obama administration also have worked to reduce spending. Defense spending is falling with the winding down of operations in Iraq and Afghanistan. And now the spending cuts under the sequester are reducing outlays. Total federal spending this fiscal year, through April, is down about 1% from the same period in fiscal year 2012.

Another factor adding to the improved budget outlook is slower growth in healthcare spending in recent years. Because of this, the CBO has reduced the assumed rate of growth for future healthcare spending, which means greater near-term deficit reduction. This slowing in growth may be due to cost-containment measures included in healthcare reform.

Also, Fannie Mae and Freddie Mac are supporting the federal government's bottom line this year. The housing finance giants, which were placed under federal conservatorship during the housing crisis, have returned to profitability with the recovery in the housing market. They are turning most of their profits over to the federal government. According to the CBO, the two companies will add nearly $100 billion to the government's bottom line this fiscal year.

While the tax increases and spending cuts are reducing the deficit, they also are a drag on economic growth. With higher taxes, households have less money to spend. Reduced payments to federal contractors will hit profits and lead to job cuts. Although unpaid furloughs of federal government employees from the sequester will not affect payroll employment-these workers will still be counted as employed-the cuts will reduce incomes for these workers. This, in turn, will be an additional drag on consumer spending. According to the CBO, deficit reduction efforts will reduce economic growth in 2013 by about 1.5 percentage points. This, in turn, will lead to slightly weaker job growth as well as a slower drop in the unemployment rate.

Tighter fiscal policy and trade will lead to slower real GDP growth in the middle two quarters of 2013. But continued business investment and the housing market recovery will allow for ongoing economic expansion, thanks to highly expansionary monetary policy. Growth will pick up toward the end of this year, as the drags from tax increases and spending cuts fade and global growth reaccelerates. Year-over-year, real GDP growth in the fourth quarter of 2013 will be about 2.1%.

Stuart Hoffman is chief economist at PNC Capital Markets, LLC, and a member of the ABA Economic Advisory committee.

Source: Copyright ABA Banking Journal 2013

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