Trillion Dollar Deficits … Part Two

Having waded my way through the Congressional Budget Office forecast a few things stand out.

First: the proposed stimulus plan is actually quite small when compared with the hole in the economy that is emerging. The best way to calculate the needed ‘fix’ is to look at where the economy would be were it operating at full capacity and then compare that performance to where it is expected to be. The CBO report does this for us. The gap between capacity and expected performance is a staggering 8.0%, a gap not seen since the 1981/82 recession. In contrast, the proposed stimulus package is being talked of in the 3% of GDP range. So even though some people are being scared by the size of the stimulus package, at anywhere up to $750 billion, it is actually quite small compared to the scope of the problem it is supposed to help fix. Are we being too timid in our response? It sure looks that way.

Second: The CBO has unemployment topping out at around 9.2% in early 2010, which is lower than the peak of 10.8% reached in 1981/82. I have a feeling this is optimistic. Rumor has it that the latest figures to be published shortly will cause an upward revision of the CBO number. A more likely peak this time could easily be 10.5% – 11.0% by 2010.

Third: The full impact of the Bush lunacy is made obvious in the details the CBO gives of variations to its forecasts. By law the CBO has to project the economy assuming current legislation stays on the books. The reason for this is that the CBO report is used as a baseline for legislators to look at the impact of any actions they take. An effect of this is the absurdity of the Bush tax cuts of 2001 and 2003. Both have provisions expiring in the next couple of years. So, since that is the current law, the CBO has to forecast as if Congress allows those tax cuts to expire. The effect on the Federal Deficit projected by the CBO is $889 billion over the next five years. That is the Federal deficit will be $889 billion less than it would were those tax cuts kept on the books. It seems to me highly unlikely that Congress or Obama will want to let the cuts expire right at the bottom of a recession. So realistically we should add their effect back to the deficit when we analyze the CBO report. The same argument goes for indexing Alternative Minimum Tax. The CBO is required to report AMT unindexed, whereas Congress is likely to legislate some kind of temporary fix. Consequently we need to add a further $251 billion to the accumulated five year deficit. Lastly there are other Bush tax cuts [capital Gains etc] that potentially add even more, another $227 billion. That’s a total of $1.367 trillion added to the Federal Deficit over five years just from the impact of Bush and his tax cuts for the wealthy.

Fourth: At the back of the report the CBO reveals the impact of interest costs. Those of you who pay attention, or stay awake long enough, will have noticed that interest costs are forecast to be much lower than had been expected even as recently as September 2008. This is despite the huge expansion of the debt being serviced. The obvious reason is that interest rates have been driven nearly to zero on short term government bonds and notes. The downside to this benefit is that, as the economy recovers, interest rates will inevitably rise and therefore the debt burden as expressed in interest costs in the budget will rise rapidly. For instance they are expected to jump by 31%, or $69 billion, alone in 2012. That puts pressure on the budget and will likely force some adjustment in other areas of spending.

Lastly: Also at the back of the report is an appendix listing all the various actions taken by Federal Agencies as part of the bailout and legislative recovery programs so far enacted. The list is both long and eye popping. If anyone still thinks this recession is somehow modest I suggest a few minutes going over this list. The risk to the taxpayer is enormous. Potential costs for extending Federal Deposit Insurance, all the bailouts, purchases of assets, and the issuance of guarantees [such as to Citibank] are incalculable.

Once again I recommend that you browse this report. It will form the basis upon which Congress acts. So its contents will be thrown around in the press and in conversation. The most obvious example is the news released today that the Federal Deficit is expected to hit $1.186 trillion in 2009. We have never seen a deficit that large. Even when expressed as a percentage of GDP it will eclipse the lunacy of Ronald Reagan who only managed to get the deficit up to around 6.0%. In contrast this year we will easily hit a deficit of 8.0% of GDP.

Welcome to the days of trillion dollar deficits.