Federal fiscal shape is actually getting better, but will get worse again absent a grand fix

WASHINGTON - The annual federal budget deficit is sinking out of $1 trillion-plus nosebleed territory where it has hovered for the past four years. Government borrowing has dropped to roughly 25 cents for every dollar it spends, down from over 40 cents-per-dollar spent a few years ago. Tax receipts are rising and spending is moderating.

For once, the government's financial shape is actually improving and will get better still over the next few years as the U.S. economy continues to pull itself slowly out of the worst recession since the 1930s.

But unless a long-term legislative fix can be found, the economy will soon reverse course and start getting worse again — much worse.

The short-lived improvement in the government's ledger comes as Republicans and Democrats propose rival deficit-trimming budget plans on Capitol Hill and President Barack Obama reaches out to lawmakers of both parties in search of elusive common fiscal ground.

The federal budget deficit will drop to $845 billion this year after topping $1 trillion for four straight years, the nonpartisan Congressional Budget Office projects. Even if Congress does nothing further to cut spending or raise tax revenues, deficits will continue to shrink — to $430 billion by fiscal 2015, the CBO said.

Absent a major budget deal between the president and Congress to permanently trim debt, the government's finances will start to worsen again as the three major entitlement programs — Social Security, Medicare and Medicaid — become more and more expensive and unmanageable under the increasing weight of retiring baby boomers.

Recent budget improvements were helped along by increasing tax revenues as corporate America and many better-off Americans snapped back from the economic downturn and paid more in taxes. Stocks are setting new multi-year levels and corporate profits are soaring.

Yet the recent improvements on corporate and government ledgers haven't been shared by millions of working-class Americans. It's almost as if there were separate side-by-side economies.

Unemployment is still a high 7.7 per cent nearly four years after the worst recession since the Great Depression officially ended, still far above the pre-recession levels of around 5 per cent. Companies feel little pressure to raise wages since the pool of job seekers is large. Those with jobs are pressed to work harder, increasing productivity for corporations.

Companies also have benefited from the Federal Reserve's easy-money policies over the past four-plus years.

In keeping interest rates near zero and flooding financial markets with newly printed dollars, the Fed has helped drive up stock prices — partly at the expense of many retired people and other savers who've seen interest earnings on their bank accounts dwindle.

"The private economy is doing very well and is steadily improving," said Mark Zandi, chief economist at Moody's Analytics. "Earnings are at record levels, profit margins have never been wider. That's particularly true for large companies whose stock is traded."

Looking ahead, Zandi said: "I'm hopeful things will simmer down in Washington, and that the deficit will stabilize by the end of the decade and into the next decade. After that, it will start rising again."

House Republicans on Tuesday unveiled a spending outline by Budget Committee Chairman Paul Ryan, R-Wis., that seeks to balance the budget in ten years with deep domestic spending cuts, the repeal of Obama's landmark health-care overhaul, and without further tax hikes. Senate Democrats planned to offer a counterproposal on Wednesday that combines spending cuts with higher taxes on the wealthy.

Even before the $85 billion in automatic cuts started kicking in on March 1, government spending was shrinking because of the expiration of federal stimulus and other recession-fighting programs of Presidents George W. Bush and Barack Obama.

Steven Rattner, Obama's former "car czar," has criticized Obama for exaggerating in depicting the $85 billion sequester cuts as a disaster imperiling the nation. Obama has since toned down his rhetoric and reached out to congressional Republicans. That pleased Rattner.

"I said he should stop just saying the sky is falling, which he's done," Rattner tweeted.

Legislation passed by Congress over the past two years will reduce deficits by roughly $2.3 trillion over the next decade — two-thirds of it from spending cuts and one-third from more tax revenues.

The increased flow of cash to the government includes higher marginal income taxes on wealthy Americans from the New Year's "fiscal cliff" deal and the ending of the tax break for all workers on Social Security payroll taxes.

The $2.3 trillion less that Washington will be borrowing over the next decade takes the government much of the way toward the $4 trillion, 10-year goal set by Obama and the co-chairmen of his deficit commission, former Republican Sen. Alan Simpson and former Democratic White House staff chief Erskine Bowles.

"I don't know why the president doesn't talk more about that," said James Thurber, a political scientist at American University. Thurber said he thinks the immediate outlook is "that we're going to lurch, unfortunately" from one self-imposed crisis to another.

The budget deficit is the difference between what the government spends in a given year and the revenues it collects. The government makes up the difference by borrowing, just as a family may put excess spending on a credit card.

In the government's case, it borrows money by selling Treasury bonds, here and around the world.

The national debt — $16.66 trillion today — is the sum of everything the government owes, the accumulation of past deficits. It's the federal equivalent of a family's total outstanding debt.

Without higher taxes, changes in the big benefit programs like Medicare, Medicaid and Social Security, cuts in other government services or a combination of the three, deficits by the end of the decade will again be in the $800 billion range, according to the Congressional Budget Office.

"The fiscal problems worsen after the next 10 years under all scenarios," economists William Gale and Alan J. Auerbach wrote in a new analysis for the Brookings Institution, a think-tank .

"We are letting the legacy programs of the past — the mandatory spending programs — crowd out our ability to do discretionary spending, which is all about the next generation," said economist Douglas Holtz-Eakin, a former CBO director and economic adviser to 2008 GOP presidential nominee John McCain. "So we are building a trap to really do a disservice to the next generation."

"Because the baby boom's now retiring, the debt is very high," Holtz-Eakin said. "We've given up our cushion and our lead time and we have to move more quickly."

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