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Outlook for federal budget improves after debt deal, CBO says

The CBO projected that big reductions in government spending worked out in a deal earlier this month will cut federal budget deficits in half over the next decade.

First, the good news: According to new official estimates, federal deficits are poised to fall steadily from now through the middle of the decade – and to remain low through 2021.

The other news is that the Congressional Budget Office, in releasing this forecast Wednesday, also said it’s uncertain if it will actually come true.

“The baseline projections understate the budgetary challenges facing the federal government in the coming years,” CBO Director Douglas Elmendorf said in a blog post accompanying the update on federal finances.

The good news in the deficit forecast comes from one noteworthy policy change: The bipartisan deal earlier this month that calls for steep cuts in federal spending. Those belt-tightening measures will cut federal deficits fully in half over the next decade, by the CBO’s accounting.

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But here’s the uncertainty. Or several uncertainties. It’s not clear that the CBO’s economic forecasts, which also play a key role in the federal budget outlook, will be accurate. It’s also not a sure thing that Congress will follow through successfully on the spending cuts outlined in the Budget Control Act of 2011, enacted at the beginning of August.

And not least, the CBO’s “baseline” assumes that certain policies (notably on the tax-cut front) will expire as slated under current law, even though Congress has shown a penchant for changing such laws in the past.

“Changes in policy that are scheduled to take effect,” Mr. Elmendorf writes, “will produce a federal tax system and spending for some federal programs and activities that differ noticeably from what people have been accustomed to.”

So, even while presenting what seems to be an encouraging outlook, the agency states bluntly in the report: “The United States is facing profound budgetary and economic challenges.”

Leading the list of challenges, at least for the government’s long-term fiscal position, are entitlement programs where costs are expected to soar as baby boomers retire. That burden hits home largely after 2021, whereas the projections released Wednesday cover a 10-year period.

The outlook for Medicare, Medicaid, and Social Security was essentially unaffected by the recent budget act.

Here are key details in Wednesday’s report by the CBO, which acts as a nonpartisan accounting arm of Congress:

• This year’s budget deficit is expected to be $1.3 trillion, or 8.5 percent of gross domestic product. That’s a sum the United States has exceeded only by the deficits of the preceding two years.

• The CBO expects the economy to grow, but slowly over the next couple of years. In this scenario, the agency sees the unemployment rate falling from 9.1 percent to 8.5 percent by the fourth quarter of 2012, staying above 8 percent in 2013, and reaching about 5 percent later in the decade.

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• Federal deficits appear poised to “drop markedly as a share of GDP,” averaging 1.2 percent of GDP from 2014 to 2021.

• If the base-line forecast holds true, cumulative deficits total $3.5 trillion between 2012 and 2021 – about half of the $6.7 trillion that the agency projected in March. Public debt would equal 61 percent of GDP by 2021.

• In reality, the national debt could rise much higher. If Congress does not allow provisions of the Bush-era tax cuts to expire as now scheduled at the end of 2012, that would deepen projected deficits by $2.5 trillion. If Congress also continues to index the alternative minimum tax for inflation, and to prevent cuts to Medicare’s payment rates for physicians’ services, then the public debt would reach 82 percent of GDP in a decade.

Many economists consider such a level of public debt in a danger zone that could expose the nation to higher interest rates and slower economic growth.

In that scenario, federal deficits would average 4.3 percent of GDP during the period from 2012 to 2021, compared with 1.8 percent in CBO’s base-line projections.