It’s amazing what some tax hikes coupled with spending cuts can do for a $1.1 trillion annual budget deficit (just kidding… actually, it’s pretty logical). The Congressional Budget Office (CBO), the leading group of nonpartisan budget number-crunchers, now projects that the U.S. federal budget deficit will shrink by an astounding 41% this year, from $1.087 trillion to $642 billion. The reason? Tax receipts are rising faster than expected. Couple that with budget cuts and the result is a huge dent in the annual funding gap for the federal government.
Even more important than a one-year annual decline is the trend CBO sees for the next decade. Here is a chart of their annual deficit projections through 2023:
As you can see, the deficit hits bottom in 2015, so this (falling deficits) is not a one-time 2013 event. Now, you may look at the rest of that chart and conclude that the good times will be short-lived, as the deficit climbs back to about $900 billion by 2022. If you are just looking at the absolute numbers alone, that would be concerning. However, we need to remember that the deficit as a percentage of GDP is what matters. Somebody making a $1 million a year, for instance, can afford a $10,000 per month mortgage payment. Somebody making $50,000 a year cannot. The ability to carry debt and service it adequately depends on how much money you have to work with, making the absolute numbers meaningless without context.
So what do the above numbers look like if we look at the deficit as a percentage of annual U.S. GDP? Here is that chart:
The key number here is the last bar, which shows that the average deficit over the last 40 years (1973-2012) has been 3.1% of GDP. All of the sudden those later years don’t look so scary, even though from 2015 to 2022 the deficit nearly doubles on percentage terms.
Now, it is certainly true that if we do nothing to adjust the long-term Social Security or Medicare payments we are scheduled to make, then the deficit will become a huge problem again down the road. However, it is very important to understand from an investing perspective (and possibly from a political one as well), that over the next decade we really will not have a debt problem as long as current law remains in effect and the CBO’s baseline assumptions about the economy are close to accurate. Although plenty of people hated the tax hikes and/or the budget cuts that took effect this year, they are doing wonders for our debt problem. Personally, I’ll take longer term gains with shorter term pains anytime, if the alternative is the exact opposite.