Farr: Deficit To Be $1.44 Trillion Higher

The Congressional Budget Office released its updated "Budget and Economic Outlook" last month. This document projects federal government revenues and outlays over the next ten years.

Obviously, this latest version presents a more dire budgetary outlook than the previous version, which did not include the effects of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

This bill, passed in December, reduced payroll taxes, extended unemployment benefits and tax incentives for businesses, instituted a lower-than-expected estate tax, and extended the Bush tax cuts (previously scheduled to expire in 2011). The net result, in the short term, is that the budget deficit for 2011 is now expected to approach $1.5 trillion, or 9.8% of Gross Domestic Product (GDP). The previous estimate had been less than $1.1 trillion, or 7.0% of GDP. For the entire 10-year forecast period, the cumulative deficit is now expected to be $1.44 trillion higher than under the prior CBO estimates.

Nice work, esteemed Congress people.

A glance at the chart above, which contains the CBO's updated projections for 2011-2021, may be alarming (if not, it should be). However, there are many factors to suggest that the latest CBO estimates may be far too optimistic. First, the projections are based on a number of assumptions, which may or may not actually materialize ("may not" is a safer bet):

  • Sharp reductions in Medicare's payment rates for physicians' services take effect as scheduled at the end of 2011;
  • Extensions of unemployment compensation, the one-year reduction in the payroll tax, and the two-year extension of provisions designed to limit the reach of the alternative minimum tax all expire as scheduled at the end of 2011;
  • Other provisions of the 2010 tax act, including extensions of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and ARRA, expire as scheduled at the end of 2012; and
  • Funding for discretionary spending increases with inflation rather than at the considerably faster pace seen over the dozen years leading up the recent recession.

Secondly, it is important to note that under current projections, federal government debt held by the public is expected to increase from $9 trillion at the end of 2010 to over $18 trillion at the end of 2021. Over that time frame, interest costs to the government are expected to rise from less than $200 billion in 2010 (or 1.4% of GDP) to nearly $800 billion in 2021 (or 3.3% of GDP). Given the astronomical rise in federal government debt, it is reasonable to question the CBO's assumptions with regard to the interest rates expected on that debt. Currently, the CBO expects the average rate paid on all debt held by the public to rise from an estimated 2.38% in 2010 to an estimated 4.44% by the year 2021. We wonder what will happen if interest rates rise more dramatically than the CBO's assumptions.

And finally, we think it makes sense to question the CBO's expectations for GDP growth. As stated above, the CBO's assumptions include the expiration of numerous tax benefits (for both consumers and businesses) which were designed to spur economic growth. As these benefits expire (if they indeed do) at the end of 2011 and 2012, it is reasonable to wonder if the economy can post acceptable growth in the face of those tax increases. A look at the chart below reveals that the CBO expects GDP growth to accelerate in 2013 just as all of the tax benefits are expected to roll off. Given the economy's inability to stand on its own two feet without massive government support, we are unsure whether these growth expectations are realistic.

As we have repeated warned over the past couple of years, it is imperative that something be done NOW to address the long-term structural deficits. Politicians continue to hand out goodies in the short-term while not addressing the long-term issues. We fear that it may take a crisis to get Congress to wake up to these issues, which we believe affect no less than our national security. We continue to favor large-cap multi-national blue chips in this environment.

Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.