Previews of a Mid-Session Review

There were two significant pieces of information this week regarding the likely Mid-Session Review of the Budget, to be formally released this summer.

First, as is now the custom, the Administration released an overview of its economic forecast as soon as it was finished. (The next step is for that forecast to be used by OMB and Treasury as they estimate expenditures and revenues.) This is a good move, because the Administration might otherwise be in the position of presenting this information six weeks or more from now as if it were current. The key changes since the last economic forecast six months ago are a reduction of the real GDP growth rate from 3.5 to 3.4 percent in the four quarters of 2005 and an increase in the CPI inflation rate from 2 to 2.9 percent over the same time period.

Both of these changes suggest a slight worsening of the future budget outlook for economic reasons. Lower real GDP growth suggests a lower future level of the tax base. Higher CPI inflation--when it is due to increases in the prices of energy, which is largely imported--raises the amount of government expenditures on things like Social Security benefits without an offsetting increase in revenues from the tax base, which is tied to the GDP price deflator. For 2005, the "wedge" between CPI and GDP inflation has opened up from a 0.1 percentage point forecast last December to a 0.6 percentage point forecast this week. I don't have a good feel for how large the impact of these two changes will be, and a lower interest rate forecast may offset some of the impact. We'll find that out when the MSR is released this summer.

Second, and much more importantly for the daily headlines and the near-term budget outlook, the Congressional Budget Office released its Monthly Budget Review for May. The deficit through the first eight months of fiscal year 2005 was $73 billion less than the comparable period of fiscal year 2004. This is attributed to revenues that are 15 percent higher than the same period last year and outlays that are 7 percent higher. As reported in the Wall Street Journal, forecasts of the deficit by CBO and others are now running about $350 billion, which is less than last year's $412 billion and earlier forecasts of this year's deficit.

So I'll take the good news, but I remain very concerned about the budget outlook, for three reasons:

1) We are in the fat part of the business cycle. A sensible fiscal policy is to run a balanced budget over the business cycle and to save Social Security surpluses for future Social Security benefits. So we should be running surpluses, not deficits, and that should be excluding the Social Security surplus.

2) The 7 percent increase in outlays compared to last year looks to be no smaller than the difference in nominal GDP across the two periods, so I guess I disagree with OMB Director Joshua Bolten's characterization (in the WSJ) of this as "spending discipline."

3) Baby boomers, lots of them, start retiring and collecting their entitlements soon. Full Social Security and Medicare starting in 2011. Early Social Security benefits starting in 2008. No preparations being made to lessen that financial burden on future taxpayers. Douglas Holtz-Eakin, Director of the CBO, summarized this well in the WSJ:

These are the good ol' days. These are the best of times. After this, it gets worse.

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