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Hidden Thorns in CBO's Rosy Deficit Report

By Deborah Solomon
February 05, 2013 4:28 PM EST

President Barack Obama, sensing another "self-inflicted" wound in the making, asked Congress today to consider passing a small package of spending and tax changes to avert deep and "indiscriminate" budget cuts slated to kick in March 1.

It's no secret that lawmakers will be unable to agree quickly (if ever) on a budget deal as they try to bridge an ideological divide over spending and tax policy. A budget agreement will require the kind of "grand bargain" discussions Congress has all-too-eagerly kicked down the road, and there's no reason to think this time will be different.

In fact, making progress on those talks will only be complicated by today's Congressional Budget Office report, which shows the short-term budget deficit is largely under control. That will only harden the position of many Democrats, who insist the deficit is not an immediate problem and have so far been unwilling to make changes to unsustainable entitlement programs like Social Security and Medicare.

Assuming there are no changes to current tax and spending law, CBO estimates the U.S. budget deficit will shrink to $845 billion this year -- falling below $1 trillion for the first time since 2008. The estimates also have the U.S. reaching a key milestone in 2015, when the deficit as a percentage of gross domestic product falls below the magic 3 percent most economists believe the U.S. must achieve.

Yet the CBO's numbers are less rosy than they seem at first blush and shouldn't be an excuse for delaying necessary changes to both taxes and spending. The deficit reduction is based on assumptions, many of which may never come to pass.

For instance, the roughly $1.1 trillion in spending cuts Obama is trying to avert -- the so-called "sequester" -- are factored into CBO's projections. Obama has called on Congress to "delay the economically damaging effects of the sequester for a few more months" and replace the cuts "with a smarter solution." Yet there's no guarantee that will happen -- lawmakers already temporarily delayed the onset of the first $85 billion in cuts scheduled to take effect this year when they passed a bill averting the so-called fiscal cliff.

If Congress simply cancels the spending cuts -- or delays them indefinitely -- CBO projects the deficit will be "substantially larger" in coming decades.

The bigger problem is the debt, which continues to grow despite the winnowing deficit (which, it should be noted, begins widening in 2022). For the next decade, debt held by the public is projected to be "significantly greater" relative to GDP than at any time since after World War II. CBO estimates debt as a percentage of GDP will equal roughly 77 percent in 2013. It will fall slightly after 2014 but balloon again in 2023 and beyond. 

Most economists suggest a stable debt load is one at roughly 70 percent of GDP. As CBO warns in its report, a large amount of federal debt will result in a fiscal spiral, with higher interest payments sapping revenue, triggering additional reliance on government borrowing and, ultimately, causing a fiscal crisis "during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates."

The underlying problem, of course, is entitlement spending. Medicare and Medicaid outlays are projected to jump more than 90 percent over the next decade and the pace will only grow with an aging population and fewer workers to compensate for the retiring workforce. That will increase the debt load and balloon the deficit.

Obama said today the deals he offered in the lead-up to the fiscal cliff -- reductions in Medicare and Social Security spending and tax changes that increase revenue without raising marginal rates -- remain on the table. In a perfect world, lawmakers would come together and compromise -- accepting some reduction in entitlement benefits in exchange for more tax revenue from limiting deductions and other loopholes for wealthier Americans. Yet given lawmakers were unable to reach a bipartisan agreement as the sword of Damocles (otherwise known as the fiscal cliff) dangled above them, it's hard to see how they'll be propelled into action now. If anything, today's CBO report gives them political cover to continue playing kick-the-can. 

(Deborah Solomon is a member of the Bloomberg View editorial board. Follow her on Twitter.)

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