2013 US Budget Adheres to Debt Reduction Goal, but at Slower Pace

2013 US Budget Adheres to Debt Reduction Goal, but at Slower Pace

Last Monday, United States of America (Aaa negative) President Barack Obama released his fiscal 2013 budget proposal, which aims to reduce the federal government’s deficit to 2.8% of GDP in 2021, from 8.5% of GDP in 2012, and to stabilize the federal government debt level at around 76.5% of GDP over the next decade.

By adhering to the credit positive goal of debt and deficit reduction, the administration’s fiscal 2013 budget proposal underscores our view that all participants in this debate remain committed to fiscal consolidation, as evidenced in fiscal proposals from both parties over the past 18 months.9
Although the likelihood of this budget being adopted is small because of political differences on specific measures, it still serves as a basis for debate on fiscal policy. However, by omitting structural reforms in Social Security, Medicare and Medicaid programs, it neglects an essential aspect of fiscal consolidation.

The fiscal 2013 budget proposal includes measures to promote manufacturing and innovation, and invest in infrastructure. These aim to support economic growth by modestly decreasing the pace of deficit reduction. Medicare and Medicaid expenditure reductions are largely achieved through cost savings, while changes to Social Security were not included in the budget draft.

US Federal Government Fiscal Deficit Under Different Plans

As deficits will remain higher than expected in previous plans, the effect would be that the federal government’s debt ratios would rise to 78.4% of GDP by 2014 and will then decline to around 76.5% in 2018 (Exhibit 2). This contrasts with previous budget drafts that saw debt trending down faster and lower. The pace and magnitude of debt reduction will depend in part on how well the economy does over the next few years. Underlying the budget’s projections is the assumption that the economy will recover most of the loss from the 2008-09 recession, implying that over the coming years growth will be higher than normal and that this healthier pace of economic output will lead to an improvement in fiscal metrics beginning in 2014.

US Federal Government Debt Under Different Plans

Recent indicators show that the economic expansion is picking up speed at a moderate pace. Real GDP in the 2011 fourth quarter rose at an annual rate of 2.8%, the most rapid growth since the first half of 2010. The agreement between Congress and the administration to extend the temporary payroll tax reduction and unemployment benefits to the end of 2012 will likely benefit personal consumption, and therefore GDP growth. Should economic and labor market improvements persist over the next 12-18 months, the administration’s strategy of fiscal consolidation via improved growth would have a greater chance of success because tax revenues would rise.

The administration’s fiscal 2013 budget plan also includes measures to increase tax revenues by allowing the “Bush tax-cuts” to expire for all households with an annual income above $250,000. In addition, the proposal includes the “Buffett rule,” which stipulates that households making over $1 million annually should pay at least 30% in taxes. However, Republican representatives’ opposition to such measures was one of the reasons the Joint Select Committee on Deficit Reduction failed to reach an agreement last November. We expect an alternative Republican budget to be introduced in the House of Representatives soon.