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Slow Economic Recovery will Lead to Record Deficits

By , Money Morning •

The current recession will lead to large budget deficits that far exceed previous estimates and a doubling of the national debt, the White House's Office of Management and Budget (OMB) and the Congressional Budget Office (CBO) said yesterday (Tuesday).

The federal budget deficit for 2009 will reach a record $1.6 trillion, far higher than 2008's record deficit of $455 billion, according to both the OMB and CBO.

From 2010 to 2019, the deficit will balloon to $7.14 trillion, the CBO says, while the White House paints an even uglier, $9 trillion picture for the same period.

"While the danger of the economy immediately falling into a deep recession has receded, the American economy is still in the midst of a serious economic downturn," the OMB report said. "The long-term deficit outlook remains daunting."

The White House's cumulative deficit projection for the 10-year period replaces the administration's previous estimate of $7.108 trillion. Changes in budget projections - whether they result in a surplus or a deficit - are often refined as economic conditions change. This new projection was necessary because the recession has gone on for so long - causing federal tax receipts to plunge - and because the economic rebound will be prolonged and weak, resulting in lower forecasts for future federal revenue.

"This recession was simply worse than the information that we and other forecasters had back in last fall and early this winter," Obama economic adviser Christina Romer told The Associated Press.

One reason for the discrepancy between the White House estimate and the CBO's is the CBO projection is based on the assumption that all the tax cuts enacted by former U.S. President George W. Bush will expire on schedule, The AP reported.  However, President Barack Obama during his campaign vowed to keep the tax cuts in place for families earning less than $250,000 a year.

Both the White House and the CBO predict the national debt, the accumulation of annual budget deficits, will almost double over the next decade. The national debt is currently at an astonishing $11.7 trillion.

Congress will walk a thin line with fixing the economy. If it doesn't reduce the deficit, interest rates will likely rise and in turn hurt the economy, CBO Director Douglas Elmendorf told reporters. But acting too soon could thwart the recovery once it arrives.

"We face perils in acting and perils in not acting," Elmendorf told reporters.

One solution, Elmendorf said, is for Congress to pass measures today that would reduce the deficit in the future, after the economy recovers, or "out-years." Doing so could reassure bondholders that Congress is serious about cutting the deficit, without stifling the recovery, he said.

The Obama administration expects out-years deficits to hover in the range of 4% of U.S. gross domestic product (GDP) and said getting the out-year deficit under control is its top priority.

One of the biggest reasons the deficit is spiraling out of control is the soaring cost of healthcare, which makes Obama's effort to reform the healthcare system crucial.

"In addition to avoiding making the problem any worse, we need to address the key driver of our long-term deficits: healthcare costs," OMB Director Peter Orszag wrote in a blog. "The federal government simply cannot be put on a fiscally sustainable path without slowing the rate of health care cost growth in the long run. That is why the administration is insistent that health care reform not only be deficit neutral over the next ten years, but also incorporate changes that will help reduce the deficit thereafter."

The government's reports lend credence to Money Morning's "slow and gloomy, but could be worse" scenario for the economic recovery, first reported in March. While the housing market and asset prices are starting to show signs of life, job cuts continue. The rally in equities has been largely due to companies' cost-cutting measures.

While the latest earnings season has brought little in the way of actual growth in companies' revenue, when the growth returns it will likely be the much-talked about jobless recovery, similar to the one seen after the recession in the early 1990s. A jobless recovery entails companies reaping higher profits with fewer employees to make up for the ones lost during the recession.

Unfortunately for those without jobs, this recession is in its 21st month, longer than any before it since the Great Depression. That's a lot of profits to make up while job seekers wait on the sidelines.

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