The massive budget deficits of recent years are starting to shrink, according to the Congressional Budget Office. But as CBO officials readily admit, the agency's projections don't fully capture reality.
The nonpartisan CBO, which must assume no changes in current law, expects a deficit of $337 billion this fiscal year, ending on Sept. 30, falling to $270 billion next year. By 2012, the budget would be roughly in balance -- with a surplus of about $38 billion.
But those estimates are not shared by private economists, who can make more realistic political forecasts. According to Kathleen Stephansen, director of global economics at Credit Suisse Group (CSR ), the fiscal 2006 deficit will hit $394 billion. The shortfall is projected to swell to $514 billion by 2012.
The problem is the CBO must make some unlikely assumptions. Future discretionary spending -- non-mandatory outlays that are decided each year -- must be assumed to grow at the same rate as expected inflation, or 2.8% for 2006 and about 2.2% after that. Since 1965, discretionary outlays have risen by 6.4% on average, and Stephansen forecasts spending growth of 10% this fiscal year and no less than 5% in the coming decade.
The fiscal 2006 estimate by the CBO also omits the additional funding for operations in Iraq and Afghanistan, as well as outlays to cover insurance claims after Hurricane Katrina. By the CBO's own admission, this would push the 2006 deficit to about $360 billion.
Plus, spending and revenue projections must also be based on current tax laws. So the CBO assumes that the tax cut provisions passed in 2001 and 2003 will all sunset as currently scheduled. But in the latest budget proposal it is clear that the White House will be fighting hard to make permanent as many of the current tax breaks as possible.
Larger deficits also mean bigger interest payments, especially if the Fed's rate hikes start pushing up long-term rates or if foreign investors begin parking their money elsewhere. And the task of trimming deficits will only get tougher starting in 2008, when the oldest baby boomers can begin collecting Social Security retirement benefits.
By James Mehring in New York