Fri, 12 Jul 2013
Deficit reductions for the current fiscal year could lead to less government borrowing, but also less spending, which would weigh on GDP, says Morningstar's Bob Johnson.
Jason Stipp: I'm Jason Stipp for Morningstar. The Congressional Budget Office released a report this week that showed a dramatic decrease in the deficit over last year. Here to talk about those numbers and what they mean for the economy is Bob Johnson, our director of economic analysis.
Thanks for joining me, Bob.
Bob Johnson: Great to be here.
Stipp: We heard from the CBO; we got some data this week. It talked about the first nine months of the government's fiscal year in 2013 versus 2012. The deficit was reduced to about $500 billion in 2013, and that's down from the first nine months of 2012 which had a deficit of $900 billion, which is a pretty dramatic decrease. What was behind those numbers?
Johnson: It is a dramatic decrease in the deficit, and it's a really powerful set of numbers. And I think it's something that's really relatively unexpected and perhaps unrealized by the general public how well we have moved along on that deficit front. Really there are two or three key things. Obviously, two thirds probably of the deficit reduction was taxes and about a third of it was spending decreases. It wasn't all taxes, but that was about two thirds of it, and a third of it was spending-related things. Also the third factor I would say was Fannie Mae and Freddie Mac, the two government mortgage agencies that are now profitable paying a dividend, those monies were actually received in June.
Stipp: That may be more of a one-time effect that improved the deficit at least in the near term here. So it was the higher taxes, that's the higher payroll taxes that contribute to the number, that we saw kick-in in January. Is it also that the employment situation is maybe improving so tax receipts on income tax are better?
Johnson: Yes. As a matter fact, I found this interesting, too, that it was really income taxes that were the big driver of the deficit reduction. It was almost double the amount that came from the Social Security tax increase. So we keep on talking about the Social Security and the payroll tax weighing up because it's real measurable and it hits everybody. But the income tax number was actually probably a bigger number, and that's also not all driven by the tax increase, but also because the economy is doing better. People have more income and move into higher tax brackets, and that's also driving it. But income tax collections were the biggest contributor to the deficit reduction. The payroll tax was important, but not as big as income taxes.
Stipp: On the flip side, the lower spending, what areas were cut that resulted in lower spending for that one third portion of the deficit?
Johnson: Well, a nice portion of it was from the unemployment payouts because the number of people collecting unemployment benefits has gone down rather dramatically over the last year. So as that's rolled down, that's a less of an expense, and that made a meaningful differences this time around. Defense spending was the biggest single item that dropped off, and again as we wind down the various wars, I think that's really helped that number along.
I would say then the other thing is a little bit artificial, those Fannie and Freddie cuts that I talked about, because normally those are categories that absorb money and now they return money to the government. So, it came as a reduction in expense; not as an income tax receipt or something like that. So that kind of depressed the expenditures number a little bit, too.
Stipp: Let's talk about the full-year projections. So, there is a CBO report on those, but it also varies depending on who you're talking to and government on what the full year deficit is going to be.
Johnson: That's right. The CBO estimate, which is supposed to be a nonpartisan group and usually is, has estimated the deficit at $640 billion, and again that's down from $1,078 billion for the full year. So, that's really a very healthy reduction. There's another report out that may confuse the people from the Office of Management and Budget, which is an executive office branch. It says if President Obama got all his programs through the way he hopes too, their projection for the deficit is to be $780 billion, because there is going to be more expenditures in that budget. But none of that's been enacted into law yet. Frankly, it doesn't look like it's necessarily going to happen. But again, that number is out there, and it's still a nice reduction in the deficit, even if that turns out to be the number.
Stipp: So we are going to see a reduction in the deficit for this year versus last year, and you said there are kind of two ways to look at that, two ways to cut it. The first one has to do with the amount of capital that the U.S. needs basically to run the country, coming at a time that we're also seeing some Fed action potentially.
Johnson: Yeah. What's kind of interesting, what's happening now with all the deficit reduction is that we may not have to borrow as much money as a U.S. government as people had thought. And that less borrowing may end up to be the exact same amount that the Fed is not buying anymore. So I think they could turn out to be a little bit more offsetting factors than people think. In other words, if our deficits run lower, we need less bonds and obviously there is less need for bond buying.
In fact, as I talked to our bond team upstairs, they're telling me that there is actually now a shortage of some Treasury bonds. It's kind of hard to lay their hands on Treasuries because the Fed's still trying to buy some and there are not a lot new ones being issued because the deficit has come in so much. It's kind of an interesting situation, and it's not just government debt. I mean, it's interesting that mortgage debt has come down a lot, too, and that's another program where people have talked about the Fed going to cut buying mortgage bonds. Well, guess what, the amount of mortgages outstanding keeps going down.
Stipp: Another way to look at the data, however, is that it could weigh on GDP because there is less government spending. What impact do you think that will have?
Johnson: Well, it's hard to get the timing right and the seasonality that goes in the government number, and I haven't got enough time today to get it right. But I would tell you that it looks like the spending data didn't pick up a lot in the June quarter, at least the reported numbers that I'm looking at. It showed consistent downward pressure especially on the military side of the house, and I'm worried that's going to keep a lid on federal government spending in the second quarter, the June quarter. And that's the flip side of the coin. That's the bad news. We have got, believe it or not, one of the most incredibly tight fiscal policies right now than we've had in the long, long time.
Stipp: Just to review, your expectations for full-year GDP coming in at 2%?
Johnson: Yes, and it's interesting. With all the different reports recently, I was really surprised with the divergence. The Congressional Budget Office is thinking in the mid-1% range for GDP growth, I'm thinking around 2%. The Fed's thinking 2.3%-6.0%. The Obama administration is thinking about 2.4%. And this is for a year that's about half over, and there is wider disagreement than I might expect.
Stipp: So given that there is good news and potentially bad ways to look at the fact that we're seeing less government spending right now, do you think the deficit reduction that we're seeing is too big, too small, or about the right size for where the economy is right now?
Johnson: I think it's probably a little bit heavy. I think that we may need to back off a few things, and again it will be interesting to see if there is a few one-offs here in the fourth quarter like when we adjusted for the air-traffic controllers like we had to. I wonder maybe the student loan situation, where the rates just recently went up, if the [lawmakers] back away from that, and maybe there's a few things they agree on that will help bring it in. But it's a very interesting situation right now.
Stipp: All right, Bob, some great context on that deficit data that we got this week. Thanks for joining me.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.