More from the Mid-Session Review
The OMB's Mid-Session Review (MSR) came out late on Friday afternoon with no fanfare from the Administration (though we did put out a paper yesterday). While the MSR showed improvement in the 2010 deficit number (the fiscal year that ends in September), there was little change in the ten year deficit and debt projections. However, the one number that jumped out for those who took a closer look was the much higher deficit projection for FY 2011, almost a full percentage point of GDP higher. Similarly, for 2012, the deficit is now foreseen at 5.6% of GDP - above February's view of 5.1%.
The $150 billion jump in deficits for 2011 is almost entirely accounted for by a drop in revenue. OMB projects the government to collect a full percentage point of GDP less in revenue in 2011 than it predicted back in February. In fact, over just the next three years (not including 2010), OMB has revised its estimate of revenue downward by $339 billion.
But revisions for this and the next two years do not lend themselves to a simple story, unfortunately. The difference is not because the economy was weaker than expected - at least as still forecast by the Administration for this year. The revisions essentially reflect what the Administration calls "technical" re-estimates related to how much revenue is raised from a given amount of income, based on new tax collection data. Although there can be a fine line between economic versus technical revisions, in this case the culprit appears to be “technical”. (The revisions also reflect some shifting of tax relief measures – revenue losers - expected to be in place earlier into 2011 – the Administration gives the example of accelerated depreciation of new business investment.) However, we'll see later this week whether this "technical" revision portends a downward revision of GDP as well, when the Bureau of Economic Analysis does its annual benchmark revisions. This might not be a good thing for the fiscal picture.
This is not to elevate technical matters above economic projections. The projections are very important, in fact, when discussing the President's Budget and the MSR. The Administration's projections, while still in the reasonable range, are actually on the high side (or the low side, in the case of inflation and interest rates) compared to most estimates. This perspective makes a huge difference, since economic projections change both the numerator (both revenue and spending effects) and the denominator of the debt-to-GDP ratio. Thus, small differences in predictions can make large differences in debt projections - especially over time.
These differences are borne out when comparing the MSR and the latest Blue Chip forecast. The Blue Chip, an average of some 50 top forecasters, is the widely used proxy for the reasonable market view. It has a much less bullish forecast for 2011, which, if it is more realistic, could mean deficit numbers reaching 2010 levels for that year. The MSR is usually also compared to the CBO's estimate of the President's Budget, but their economic estimate is from March and it is difficult to say whether they would revise their numbers up or down; they are currently in the process of doing that.
We believe in being prudent or conservative in economic estimates, to prepare more for downside risks. A prudential forecast will provide more fiscal room for maneuver in the case of problems - and it will yield dividends in the form of unanticipated additional revenue, if things are better than expected. Other countries take this approach, which is considered quite useful fiscal management.
How realistic is the Administration's near-term economic outlook? It’s hard to say, with cross currents in the economy making any read quite difficult. But, if additional stimulus is nonetheless pursued, it should be done by pairing short-term stimulus with a medium-term deficit reduction plan. As we have said many times, this would provide a boost to the economy not just from the stimulus of demand, but, through the expectations channel, contribute to downward pressure on interest rates. That way, the Administration could hopefully fulfill its growth projections and make the necessary fiscal adjustment more manageable.
But, parse as we might the near-term outlook, the bottom line remains the same: while our debt path will show some improvement as the economy recovers and stimulus spending ends, it will set out on a new path that is not sustainable, particularly once the fiscal costs of an aging population kick in.