Aug. 6 (Bloomberg) -- As congressional Republicans prepare to risk a government shutdown or U.S. debt default over the budget, one economic indicator undercuts the urgency for a showdown: The deficit is steadily shrinking.
The federal budget deficit narrowed from more than 10 percent of the gross domestic product at the end of 2009 to 5.7 percent of GDP for the 12 months ended March 31 -- the smallest gap in four years, according to data compiled by Bloomberg.
With tax collections rising and spending growth slowing down, the deficit is on track to drop to 4 percent of the $16 trillion U.S. GDP for the fiscal year ending Sept. 30, according to a May forecast by the Congressional Budget Office. It will shrink to 3.4 percent of GDP next year, the CBO says, close to the 3.3 percent average over the past 30 years, according to Bloomberg data.
“When you look at the 10-year projections for the deficit and debt as a percentage of GDP, it’s not an issue,” said Jim O’Sullivan, chief U.S. economist for High Frequency Economics in Valhalla, New York.
At the same time, should House Republicans carry out a threat to default on U.S. debt, even if only for a day or two, “you’d never be able to reverse that,” O’Sullivan said. “You’d probably always have a little bit of an extra premium” that investors would demand on U.S. obligations.
The improving budget outlook hasn’t eased the partisan battles in Washington over federal finances. President Barack Obama says Congress must raise the legal debt limit with no conditions attached, while some Republicans want to shut down the government unless he agrees to cut off funding for his health-care law.
“The deficit has never been a substantive issue, and the fact that it’s getting better doesn’t change the politics one iota,” said Stan Collender, a partner at Quorvis Communications and a former Democratic congressional budget aide. “This is an emotional issue, not a substantive issue.”
Legislation to fund highway, aviation, rail and other transportation projects for next year collapsed last week in the House and the Senate, reflecting a stalemate over the budget.
Congress is now on a five-week break and won’t return until Sept. 9, just three weeks before government funding runs out. In November, the U.S. government is expected to reach its $16.7 trillion legal debt limit.
Meanwhile, tax revenue has poured in this year with the economy strengthening. The CBO projected in May that tax revenue will increase in 2013 by 15 percent to $2.81 trillion. That would put it at 17.5 percent of GDP, close to the 40-year average of 17.9 percent, according to the nonpartisan budget office.
Bond investors have been unfazed by the political confrontations.
In 2011, after months of lawmakers fighting over raising the nation’s debt limit, Obama signed the increase into law on Aug. 2 of that year, the day the Treasury Department warned that U.S. borrowing authority would expire.
Credit markets disregarded the standoff, with yields on 10-year Treasury notes declining to 2.61 percent on Aug. 2 of that year, from 3.18 percent on July 1, 2011, and continued to fall to 1.88 percent at year-end. Yields on 10-year-Treasuries were trading at 2.64 percent at 4:32 p.m. New York time yesterday, up 0.88 percentage points since Dec. 31.
Standard & Poor’s downgraded the U.S. credit rating for the first time on Aug. 5, 2011, citing the partisan gridlock over the debt-limit impasse. Stock investors did get rattled, with the benchmark Standard & Poor’s 500 Index falling 16.8 percent between July 22, when talks on a broad deal faltered, and Aug. 8, the first trading day after the downgrade.
This year, U.S. stocks have been rising, with the S&P 500 up 19.7 percent since Dec. 31 as of the market close yesterday.
Collender rates the risk of a temporary government shutdown during the dispute at “40 percent,” though he considers it unlikely that congressional leaders will permit a debt default.
“Being willing to shut down the government, even if it’s just for a couple days over Obamacare, may be what the Tea Party wing needs, to show its voters they were willing to do” that, Collender said. “And it may be what John Boehner needs to do to show the Tea Party wing he should continue to be speaker.”
The diminishing deficit makes it more likely that austerity measures will continue to focus on the short term rather than on the nation’s long-term fiscal picture, which is challenged by the impact of the aging baby boom generation on retirement programs such as Medicare and Social Security, said Steve Bell, a former top Senate Republican budget aide.
That’s because the better fiscal outlook encourages Republicans to dig in on their resistance to tax increases and Democrats on their opposition to cutting Social Security and Medicare benefits, said Bell, now a senior director at the Bipartisan Policy Center in Washington. That, in turn, makes it harder for Obama and Republican leaders to reach a deal on the more far-reaching budget issues presented by the so-called entitlement programs.
Instead, Congress is likely to continue next year with more of the across-the-board spending cuts, known as sequestration, that Obama, Democrats and many Republicans have criticized.
“This makes people less willing to make the hard votes,” said Bell.
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