Why federal budget deficit is falling faster than CBO expected

After years of trillion-dollar annual deficits, federal red ink is lessening – and pace of the decline now looks much quicker than forecasters thought it would be.

That’s good news for American taxpayers worried about a pileup of debt – and the risk that would pose for their pocketbooks in the future. The debt problem isn’t solved, but this is progress.

Here are the new numbers:

The federal budget deficit will shrink this year to $642 billion, the nonpartisan Congressional Budget Office now estimates. Just three months ago, the CBO was forecasting a deficit of $845 billion for the 2013 fiscal year, which ends in September.

“Relative to the size of the economy, the deficit this year ... will be less than half as large as the shortfall in 2009,” the CBO said in releasing its new estimate Tuesday. The deficit peaked at 10.1 percent of gross domestic product then, but it's on track for 4 percent of GDP this year.

Why is the deficit falling so fast, and will it continue?

The CBO’s predicted budget shortfall has shrunk for several reasons:

• Tax revenues are recovering better than expected – resulting in a $105 billion shift in this year’s deficit, compared with the forecast three months ago. That’s partly from corporate and mostly from individual income taxes.

• The outlook for spending has improved in Social Security, Medicare, and Medicaid. These programs are still huge and growing, but some modest changes in the forecast, such as that fewer people will sign up for Social Security disability insurance, reduces the 10-year outlook for federal deficits by more than $200 billion. However, the downshift in entitlement costs has little effect in the current fiscal year.

• And the government is getting a special windfall: an increase in payments to the Treasury by Fannie Mae and Freddie Mac, mortgage firms that have been in federal conservatorship since the financial crisis. (The companies are required to make quarterly payments related to their net worth, which has jumped because of accounting changes.)

The impacts of the "sequester," the automatic spending cuts that went into effect in March across many federal programs, did not change in the CBO outlook between February and today.

Overall, the CBO still projects substantial deficits between 2014 and 2023. But the improving outlook has brought the 10-year total down by $618 billion, to a total of some $6.3 trillion.

Whether the progress continues will depend on the performance of the US and global economies – and on the outcome of partisan debates over federal fiscal policy.

For now, the CBO’s outlook is that budget deficits will keep shrinking for two more years, as a share of the economy, and then start rising again because of growing interest on the national debt and the cost of baby boomer retirements in terms of Social Security and Medicare.

“Because revenues, under current law, are projected to rise more rapidly than spending in the next two years, deficits in CBO’s baseline projections continue to shrink, falling to 2.1 percent of GDP by 2015,” the accounting arm of Congress says.

After 2015, it’s possible that red ink could be on an upward track again. In the CBO’s new forecast, the deficit would reach 3.6 percent of GDP in 2022 – with programs like Medicare a growing burden on the economy going forward.

Obamacare is another factor that promises to push up federal spending, according to the CBO report. The subsidies for moderate-income households to buy health insurance under the 2010 Affordable Care Act will grow from 0.1 percent of GDP in 2014 to 0.5 percent 10 years from now, the report predicts.

The CBO’s forecast assumes the economy grows at a steady pace.

As is always the case with such forecasts, a recession could change the budget trajectory considerably, reducing revenues and causing spending to rise. Similarly, if the economy grows faster than expected, the outlook would brighten.