CBO knows its deficit forecasts are too cheery. So what will really happen?

The CBO is forecasting a $1.1 trillion deficit in 2012, followed by several years of a much lower amount. But CBO officials know that's a fantasy, so it has prepared a more pessimistic outlook.

The US government will run a $1.1 trillion deficit in fiscal year 2012, according to the Congressional Budget Office‘s just-released Budget and Economic Outlook. Measured as a share of the nation’s economic output – which is how economists like to measure it – the FY 2012 deficit will constitute 7 percent of US Gross Domestic Product. That’s down a tick from 2011, when the deficit ran to 9 percent of US GDP.

Well, it looks like things are getting a bit better, red ink-wise. What’s going to happen in the budgeter’s magical world of the out years, the fiscal years to come?

According to CBO’s basic forecast, deficits will start to plummet. They will drop below $200 billion annually in fairly short order. Between 2013 and 2022, deficits would average only 1.5 percent of GDP, under CBO’s current-law projection.

Wow! That’s great, right? So everything’s under control. Nothing to see here in the budget. Move along, folks. Why, over there, we notice an exciting proposal to build a US colony on the moon over there – why don’t you go gawk at that?

Not so fast. Here’s the problem: CBO’s basic forecast is almost certainly wrong – and the folks at CBO, from the director on down, know it.

That’s because CBO has to build its forecasts based on current law. At the moment, existing law calls for a number of fiscally exciting things to happen. Bush-era tax cuts are supposed to expire, for instance.

Congress is more than likely to wrestle over the question of whether, and how, to extend some or all of those cuts. Congress will also consider whether to continue to protect many Americans from the jaws of the Alternative Minimum Tax, and whether to allow deep cuts in Medicare reimbursements to physicians to take effect, among other things.

“The decisions made by lawmakers as they confront those policy choices will have a significant impact on budget outcomes in the coming years,” wrote CBO director Doug Elmendorf on Jan. uary 31 on his blog.

As it happens, the CBO this time around prepared an alternative budget scenario that is based on what might happen, as opposed to current law. Call it a vision brought to you by the Ghost of Budgets Future.

Under this vision, most expiring tax cuts are extended. (That costs $3.8 trillion from 2013 to 2022.)

The Alternative Minimum Tax is indexed for inflation. (Under current law, it is fixed. The number of taxpayers it affects is scheduled to jump from 4 million in 2011 to 30 million in 2012.)

Medicare’s payments to physicians are kept at the current rate. (Under current law, they’re supposed to be slashed by 27 percent in March.)

The automatic spending cuts mandated by the inability of Congress to agree on a budget reduction plan in the fall don’t take effect. (Right now they’re supposed to whack some $109 billion a year out of the budget beginning in January.)

All of the above actions are at least politically plausible, in varying degrees. Taken together, they’d devastate deficit reduction efforts. Deficits would average about 5.4 percent of GDP during the 2013-2022 timeframe, instead of 1.5 percent.

“Under that alternative fiscal scenario, far larger deficits and much greater debt would result than are shown in CBO’s baseline,” writes CBO chief Elmendorf.

The budget watchdog group Concord Coalition constructs what it calls a plausible budget baseline based on realistic assumptions about what Congress will and won’t do. (Congress has continually acted to prevent the cuts in Medicare payments to doctors from taking effect, for instance.)

Under this realistic scenario, annual deficits remain in the trillion dollar range for years to come. If nothing else, this demonstrates that the budget isn’t going to be brought under control by nips and tucks and an attack on waste, fraud, and abuse, notes Concord Coalition director Robert L. Bixby.

“We need a comprehensive plan that spreads the burdens and sacrifices fairly, and includes all major areas of the budget: entitlement programs, domestic discretionary spending, defense and taxes. In addition, we need reforms in the congressional budget process to help ensure that solid deficit-reduction plans are not derailed,” Mr. Bixby said in a statement linked to the Tuesday release of CBO’s report.