Rising Revenue Undercuts Parties’ Tax-Spending Arguments

Photographer: Pete Marovich/Bloomberg

U.S. Treasury Secretary Jacob J. Lew said in a May 10 interview with CNBC Television that the government won’t need additional borrowing authority “until at least Labor Day,” Sept. 2. Close

U.S. Treasury Secretary Jacob J. Lew said in a May 10 interview with CNBC Television... Read More

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Photographer: Pete Marovich/Bloomberg

U.S. Treasury Secretary Jacob J. Lew said in a May 10 interview with CNBC Television that the government won’t need additional borrowing authority “until at least Labor Day,” Sept. 2.

A shrinking U.S. federal deficit is undermining the favorite tax-and-spending arguments of both Republicans and Democrats.

During the recurring fiscal crises of the past few years, Republicans have pressed for deep budget cuts, including fundamental changes to programs such as Medicare and Social Security. Democrats have called for increasing the tax burden on the wealthiest Americans.

Both will be harder sells in an unfamiliar era of falling deficits.

“It does take the air out of the balloon,” said Tony Fratto, who was deputy White House press secretary under Republican President George W. Bush. “It takes away the ferocity behind these two views.”

The deficit for the first seven months of fiscal 2013 -- October 2012 through April -- fell 32 percent to $489 billion compared with the same period a year earlier, according to the Congressional Budget Office.

Most of the decline is the result of higher-than-expected revenue from an improving economy, tax increases that took effect on Jan. 1, and $85 billion in automatic government spending cuts known as sequestration. Last week, President Barack Obama boasted that the deficit is “falling at the fastest rate in decades.”

The government’s fiscal profile also will improve this year thanks to payments from the mortgage-finance companies Fannie Mae, which plans to pay the government $59.4 billion in dividends at the end of June, and Freddie Mac, which plans to repay $7 billion in government aid at the same time.

Fight Postponed

Those payments will delay the next political confrontation over raising the government’s borrowing limit, which was initially scheduled to occur on May 19.

Treasury Secretary Jacob J. Lewsaid in a May 10 interview with CNBC television that the government won’t need additional borrowing authority “until at least Labor Day,” Sept. 2.

Investors remain sanguine about the government’s borrowing needs. The yield on the 10-year Treasury bond was 1.9 percent on May 10 in New York compared with 2.38 percent the day Obama was inaugurated for his first term.

“The deficit isn’t really an issue for the next four or five years; it’s clearly going to be moving down,” said Jim O’Sullivan, chief U.S. economist for High-Frequency Economics Ltd. in Valhalla, New York.

Fourth Year

The deficit’s decline as a percentage of GDP, now in its fourth year, promises to reshape -- though not end -- the almost nonstop political combat over government finances that included the first credit downgrade of the U.S. in August 2011.

The deficit will fall to less than 4 percent of gross domestic product in the fiscal year beginning Oct. 1 from a peak of more than 10 percent five years earlier, say economists such as O’Sullivan and John Makin of the Republican-leaning American Enterprise Institute.

“It takes the pressure off,” Makin said. “There’s not a crisis there, by any means. The deficit scolds don’t have much to talk about anymore.”

Tomorrow, the Congressional Budget Office is scheduled to release updated projections, including a deficit forecast for the next fiscal year that will probably be smaller than the 3.7 percent figure in its January report.

On Capitol Hill, some Republicans are backing away from long-standing demands for cuts in planned spending on Medicare and Social Security, said Representative Tom Cole, an Oklahoma Republican.

Tax Code

Entitlement cuts are “falling out of favor” with some Republicans who see pushing to overhaul the tax code as more politically attractive, he said.

“It’s much more popular because somehow everybody envisions their taxes going down,” Cole said. “Everybody around here wants dessert -- nobody wants to eat spinach.”

The austerity argument also suffered a blow last month when errors were found in an academic paper by economists Carmen Reinhart and Kenneth Rogoff that had identified a link between high public debt and slower economic growth. Republican lawmakers had cited the paper, “Growth in a Time of Debt,” as supporting their anti-deficit campaign.

Today’s narrowing deficit represents “another step down the road away from austerity as a political rallying cry,” said Anne Mathias, managing director for research at Guggenheim Partners Investment Management in Washington.

Buffett Rule

Obama’s proposal to raise taxes on higher-income Americans -- and institute the “Buffett rule,” a minimum tax on millionaires, named after billionaire Warren Buffett, who supports the idea -- also faces stiffening political headwinds, she said. And Makin said he expects the economy to weaken around midyear because of government spending cuts, making tax increases -- or further spending cuts -- politically toxic.

Though the 10-year financial forecast is brightening, the government’s long-run financial problems remain unresolved. By 2040, debt held by the public will exceed 103 percent of the nation’s economy, up from 73 percent at the end of last year.

In February, the president signed legislation suspending the $16.4 trillion debt limit through May 18. The ceiling will increase on May 19 to accommodate additional borrowing that occurred during the intervening months. The Treasury then plans to use what it calls “extraordinary measures” to pay the government’s bills and delay the need to raise the debt ceiling.

Sometime this fall, congressional Republicans and the White House will resume their struggle over the debt limit. With the deficit shrinking, the outcome is likely to be more budgetary “incrementalism” rather than a so-called grand bargain that overhauls entitlement programs and the tax code, says Donald Marron, former executive director of the congressional Joint Economic Committee.

“It’s fun to talk about grand bargains,” Marron said. “But it’s very hard to get elected folks to agree to so many moving parts.”

To contact the reporter on this story: David J. Lynch in Washington at dlynch27@bloomberg.net

To contact the editor responsible for this story: Clark Hoyt at choyt2@bloomberg.net

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