The Downside of a Declining Federal Deficit

With tax revenues on the rise and spending growth reined in by the sequester, Congress isn't interested in real fixes.

Washington has once again slipped into complacency about the federal budget. Politicians see that federal revenues are up — swelled by the slowly growing economy and tax hikes, plus some $95 billion in repayments of funds doled out during the 2008-2009 financial crisis to Fannie Mae and Freddie Mac, the behemoth quasi-governmental mortgage backers. Members of Congress also see spending being reined in through the budget sequester — now firmly in place for the 2013 fiscal year and likely to remain there for at least another fiscal year or two. The federal deficit is expected to drop to $642 billion this year, then slide to just $378 billion in fiscal 2015.

The heat is off. But the fire is still burning. Starting in 2016, deficits will increase again. Nothing in the budget deals of the past two years addresses the two long-term cost juggernauts of Medicare and Social Security. The costs of these two programs will soar as 10,000 people a day turn 65 for the next 17 years, adding 30 million to the ranks of America’s senior citizens.

In 2026, the Medicare trust fund will be exhausted. Already, its outflows exceed its income. By 2021, Social Security payouts will outstrip funds coming in. And in 2033, the Social Security trust fund accumulated over 75 years will be kaput.

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Compounding the problem, interest payments on the national debt will nearly quadruple by 2024, as federal debt keeps rising (even as yearly deficits decline) and interest rates climb. Once the Federal Reserve deems the economy strong enough to thrive on its own, the ultra-easy-money policies that have held rates at rock-bottom levels will dry up. As a result, squeezing the budget will become even more painful —every penny spent financing the debt is a penny less to build roads, pay the military, feed the needy and so on.

Lawmakers show no signs of grappling with the issues. Recent fracturing within the House GOP bodes especially ill, with its tea party wing increasingly flexing its muscles.

Odds of serious, bipartisan problem solving are nil. Instead, the country faces yet another round of punting and wishful thinking from Washington. Come fall, lawmakers will likely approve a continuing resolution that funds the government for six more months, possibly a year, at current levels (including continuation of the current sequestration). They’ll give a grudging and last-minute OK to a higher debt ceiling, avoiding default by the U.S. Treasury and delaying, if not avoiding, a downgrading of Uncle Sam’s credit rating. But there will be no hard look at problematic entitlement programs. And no real tax reform aimed at raising revenue as well as closing loopholes and simplifying the code. It’ll just be more of the same.

Glenn Somerville
Associate Editor, The Kiplinger Letter