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Budget Deficit Down in FY12, But Still Elevated

Contributed by Raymond James

The fiscal year ended in September. The good news is that the deficit is down. The bad news is that it’s still very high. Hitting the fiscal cliff would be one way to deal with the shortfall, but it would not be a popular path.

Treasury has reported that the FY12 budget deficit was $1.089 trillion (about 7.0% of GDP), down from $1.297 trillion (8.7% of GDP) in FY11. Tax receipts rose 6.4% in FY12, reflecting increased economic activity (not higher tax rates). Spending fell 1.7%, reflecting lower defense spending (the end of the war in Iraq), lower Medicare spending, and lower interest payments.

Now, conspiracy theorists will contend that the September surplus is “convenient” ahead of the November 6 election. Treasury can surely shift some spending into the new fiscal year, making the deficit look smaller – this appears to have happened often in past years. However, September is traditionally a budget surplus month, as individuals and corporations make quarter-end tax payments. So, it’s hard to tell.

It’s interesting to note that federal outlays for FY12 were not much different than what was expected four years ago, before the current administration took office. In September 2008, the Congressional Budget Office (CBO) projected that spending would hit $3.577 trillion in FY12. The actual figure was $3.599 trillion – off by +0.6%. In contrast, tax receipts were significantly lower: about $2.302 trillion, vs. a projection of $3.451 trillion – off by 35%. Some of that is due to the extension (two years ago) of the Bush-era tax cuts and the reduction in payroll taxes. However, most is due to the gradual nature of the economic recovery. Tax revenues have been slow to recover. Revenues should improve as the recovery picks up. However, the pace is likely to remain relatively limited in the near term.

In August, the CBO projected that the budget deficit would drop to $641 billion (4.0% of GDP) in FY13, $387 billion (2.4% of GDP) in FY14, and $213 billion (1.2% of GDP) in FY15. However, those projections were based on current law, which assumes the fiscal cliff (and no extension of the fix to the Alternative Minimum Tax, etc.). That illustrates the tradeoff. Avoid the fiscal cliff, and deficits will remain high; let the cliff hit, and we’ll see substantial reduction in the deficit (as well as more pronounced economic weakness in the first half of 2013).

The problem is that we must reduce the budget deficit over the long term, but too much austerity too soon would undermine the economic recovery. We’ve already seen substantial evidence of the dangers of this in the United Kingdom and the eurozone periphery. Determining how to reduce the deficit and how rapidly are not easy choices. They are political as well as economic decisions. That said, the American public deserves some level of detail in proposed plans to reduce the deficit. It’s not getting that from either party. Moreover, the eventual path to lower deficit is likely to involve some degree of compromise, and there’s not much hope of that.