The federal budget deficit is shrinking rapidly. …[I]n the 12 months through March 2013, the deficit totaled $911 billion, or 5.7% of GDP. In the first three months of calendar 2013–that is, since the increase in payroll and income tax rates took effect on January 1–we estimate that the deficit has averaged just 4.5% of GDP on a seasonally adjusted basis. This is less than half the peak annual deficit of 10.1% of GDP in fiscal 2009.
There are three main reasons for the sharp reduction in the deficit:
1. Lower spending. On a 12-month average basis, federal outlays have fallen by a total of 4% in the past two years, the first decline in nominal dollar terms over a comparable period since the demobilization from the Korean War in the mid-1950s.
2. Higher tax rates. The increase in payroll tax rates in January 2013 has boosted federal receipts by around $120 billion (annualized), or about 0.8% of GDP.
3. Economic improvement. Although real GDP has only grown at a sluggish 2%-2.5% pace since the end of the 2007-2009 recession, this has been enough to generate a sizable improvement in tax receipts, over and above the more recent impact of higher tax rates. Even prior to the tax hike that took effect in early 2013, total federal receipts had grown by 7% (annualized) from the 2009 bottom, nearly twice the growth rate of nominal GDP.
We expect the deficit to continue to decline and are forecasting a deficit of 3% of GDP or less in fiscal 2015. Some of this is policy-related. … But the more important reason, in our view, is that there is still a great deal of room for the economic recovery to reduce the deficit for cyclical reasons.