Federal Deficit Could Widen as Economy Slows, Borrowing Costs Rise

A cooling US economy and rising interest rates could widen the federal budget deficit, potentially undermining the White House’s message that a shrinking budget gap under President Biden shows fiscal responsibility at a time of high inflation.

The fiscal 2023 budget deficit, which began Oct. 1, is expected to be nearly flat from last fiscal year at more than $1 trillion, the White House and private sector economists say.

That would mark a pause from the fiscal year just ended, when an increase in revenue, particularly from individual income taxes, and reduced government spending on Covid-19 programs helped narrow the annual deficit. Higher income taxes have been driven in part by a strong labor market, which has brought pay increases to many workers.

The bipartisan Congressional Budget Office estimates the federal budget deficit shrank by about half to $1.4 trillion in fiscal 2022, which ended Sept. 30. The Treasury Department is scheduled to release its final figures for the fiscal year on Friday.

Some budget analysts say higher deficits and government debt pose threats to the country’s fiscal outlook. Running annual deficits require the government to borrow, often from foreign investors. The debt must then be repaid through either more borrowing, higher taxes, or less spending. The CBO forecast in May that the deficit will increase in most years over the next decade, topping $2 trillion in 2031 and 2032.

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High deficits and borrowing could limit the federal government’s ability to respond to public needs like nutrition and education programs, said Christina Skinner, an assistant professor at the University of Pennsylvania’s Wharton School.

“The result is that the revenue pie is no longer sufficient to fund government’s ordinary expenditures… so that deficits are growing in ways that are difficult to avoid,” Ms Skinner said.

The economy has shown signs of slowing down in recent months, which could hurt revenue and related tax revenues for businesses and individuals in the coming fiscal year. Meanwhile, government bond yields have risen as the Federal Reserve hikes interest rates to combat high inflation. This means that issuing debt becomes more expensive for the state.

About $9.8 trillion, or 40% of the national debt, will be shifted over the next two years and could therefore be subject to higher interest rates, according to the non-partisan Peter G. Peterson Foundation, which works to reduce the deficit.

“Between the traditional imbalance between spending and income and rising interest rates, which will play more of a role going forward, the headline deficit will gradually widen,” said Alec Phillips, chief economist at Goldman Sachs.

The 2022 deficit figure will include a $379 billion fee for canceling student loans. While these costs are required by law to be settled in a single year, they will be realized over many years of lower student debt payments.

Excluding student loan cancellation costs, the deficit would have been lower last fiscal year and is expected to rise this year.

Republicans campaigning ahead of next month’s midterm elections have argued that the Democrats’ spending agenda has fueled inflation, which is near its highest rate in four decades. The Biden administration and Democrats have responded that their policies have helped fuel a strong economic recovery and provide a financial buffer for families as the pandemic subsides.

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The Biden administration said recent legislation to strengthen domestic semiconductor and clean energy industries and its plans to ease student loans would increase the economy’s growth potential. The White House cited a smaller deficit in 2022 as justification for student debt relief.

“There are definitely dynamics in fiscal 2022 that are not prevalent in fiscal 2023,” said Jared Bernstein, a member of the White House Advisory Council. “But if you look at our budgets, they’re carefully constructed to produce fiscally responsible results.”

However, should the recent economic slowdown turn into a recession, deficits could widen more than forecast.

A recession could mean higher government spending on stabilizers like unemployment benefits, said Nancy Vanden Houten, senior economist at Oxford Economics. It forecasts a slight recession in the first half of next year.

“We don’t expect sharp revenue declines or steep spending increases, but the risks are greater that revenues will weaken and stabilizers will need to kick in given our outlook,” said Ms Vanden Houten.

write to Amara Omeokwe at [email protected]

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