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By Jason Stipp and Robert Johnson, CFA | 07-10-2013 12:00 PM

2 Sides of the Deficit Coin

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.

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