smra.com
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Stone & McCarthy (Princeton) -- The Treasury announced a July, 2005, budget deficit of $52.785 bln compared with a deficit of about $69.16 bln in July, 2004. The July data reflected receipts of $142.092 bln and outlays of $194.877 bln. The size of the deficit is a tad smaller than the $55 bln deficit projected by SMR. After the first ten months of the fiscal year, the fiscal year-to-date deficit is now $302.585 bln, and compares with a deficit of about $396.324 bln at the same point a year ago.
The improvement in the current year budget picture since the beginning of the year is quite significant, although we do not think that the preliminary OMB $427 bln deficit projection was unnecessarily pessimistic. Nonetheless, the 13.8% YTD growth in receipts is very impressive. The flip side is that the underlying causes of then surge in receipts are not well understood, so it is difficult to anticipate what will be the trajectory going forward. Also, the 6.1% growth in YTD outlays is more than twice the rate of inflation. In the absence of the type of strict fiscal discipline that was the consequence of the expired Budget Control Act and it's successors that proved to effective at limiting costs.
In January, OMB projected receipt growth of 9.2% and outlay growth of 8.2% for a deficit of $427 bln, so receipts are running well ahead of initial OMB projections. This faster-than-expected receipt growth is the primary cause of the improved budget picture, although outlays are also running below the initial OMB projections.
In July, the $52.785 bln deficit compared with a deficit of about $69.16 bln in July, 2004. Total June receipts of $142.092 bln were up 5.7% over the July, 2004, receipts of $134.415 bln. According to CBO, July receipts tend to be dominated by withheld income and payroll taxes, which were up by about $5 bln, or 4%. Neither individuals nor corporations make large amounts of quarterly estimated payments or final payments with their income tax returns in July. However, for the small group of corporations that pay income taxes in July, those payments continued to show impressive gains, up by almost 44%, or $2 bln.
Total receipts in the first 10 months of FY05 were about $211.6 bln, or 13.8%, higher than receipts in the same period of FY04. Individual income taxes have grown by $99.2 bln, the largest gain. Payroll tax receipts for Social Security grew by $46.2 bln.
According to CBO, income and payroll tax withholdings were up by about $69 bln, or 6% year-to-date. Since these tend to follow growth in wages and salaries in the economy, they are a good indication of the ongoing good health of the economy. Nonwithheld tax receipts are up by about $68 bln, an increase of about 30%. Again according to CBO, these receipts were especially strong after taxpayers filed their tax returns for calendar year 2004, and some of the strength probably reflects a shift in the timing of tax payments as a result of changes in tax laws rather than reflecting income growth. "Other factors contributing to the revenue growth, such as increases in certain types of income or the distribution of the income among taxpayers with different tax rates, should become clearer when tax return data become available next year."
Corporate income tax receipts have risen by over $60 bln year-to-date, a similar increase to a year ago, and are on track to be more than double their 2003 level, according to CBO, a good indication of growth in corporate profits during this period. The increase in receipts in 2005 reflects economic activity in calendar year 2004 and the first half of 2005.
As we have noted previously, the fact that nonwithheld receipts are a primary source of the larger-than-expected receipt flows reduces our confidence that the gush of receipts can be expected to persist. However, this is more of an issue for FY06 and beyond than it is for FY05. We also note, however, that we think that the insidious and rightfully despised Alternative Minimum Tax (AMT) has played a role in the strength of both nonwithheld and withheld individual income tax receipts. We think that the AMT was a large, if un-quantifiable, factor in the strength of nonwithheld receipts in April and May as the AMT reached more unsuspecting middle-income Americans than previously, many of whom expected to either receive larger tax refunds or expected to receive refund only to have to make payments by April 15.
We also think that this type of unpleasant April surprise probably caused many of these same middle-income Americans to increase their withholdings to avoid another unpleasant surprise in April, 2006. If we are correct in this assessment, withheld tax receipts will probably hold to the new and higher growth trajectory, but nonwithheld receipts in Q2, 2006, will fall short. Hence, the FY05 budget picture will probably remain rosier than previously expected, but it also creates legitimate concerns about FY06 and beyond.
Total July outlays of $194.877 compare with July, 2004, outlays of $$203.575 bln a decline of 4.3%. According to CBO, outlays were suppressed by the timing of certain payments. July, 2004, outlays were unusually high because august 1 fell on a Sunday, causing roughly $12 bln payments that would ordinarily have been made on August 1 to be made at the end of July. "Excluding the effects of that payment shift, outlays this year were about $7 billion higher than in July 2004, an increase of 4 percent, according to CBO's estimates."
Total outlays in the first ten months of fiscal year 2005 were 6.1% higher than in the same period last year. National defense outlays are up 5.6%, a deceleration from the average 14% during the military build-up between 2202 and 2004.
Net interest outlays on the public debt are up $17.1 bln or 9.4% from a year ago, but appear to be accelerating due to increases in short-term interest rates, the amount of public debt outstanding, and the rate of inflation used to calculate payments for TIPs.
Social Security and Medicare outlays have also been growing more rapidly, rising by 5.7% and 7.5%, respectively, through July after increasing by 4.5% and 8.5%, respectively, in 2004. Adjusted for shifts in payment dates, Medicare outlays in the first 10 months of the year were almost 10 % higher last year, according to CBO, the highest rate of growth in the program's spending since 1995. Medicaid spending has risen more slowly primarily because 2004 spending was bolstered by a temporary increase in the federal government's share of the program's costs.
The following table summarizes,
Earlier in the year SMR revised the FY05 budget projection down to $335 bln. Looking ahead to FY06, with outlays continuing to grow at about 7.5% and receipt growth probably slowing to about 8.5%, especially in Q2,2006, we expect the deficit to again be in a $325 bln to $350 bln range.
In OMBs' Mid-Session Review, the White House projects that the deficit will come in at $333 bln in FY05, edge up to $340 bln in FY06, then decline fairly rapidly to $233 bln in FY07, hold at $162 bln in FY08 and FY09, then decline to $170 bln in 2010. OMB trumpets the fact that the deficit will decline to 1.1% of GDP in 2008 and hold at 1.1% through 2010. Over the FY06 to FY10 time horizon, OMB projects average receipt growth of 6.2%, ranging from 5.4% to 6.8%. This is believable. Receipt growth since 1980 has averaged 6.2%, although this includes the gravy years of the late 1990s that kicked the budget back into a surplus, albeit temporarily.
However, OMB also projects outlay growth that averages 4.4% over the same time horizon, and that is very hard to swallow. OMB projects that outlay growth will slide to 5.7% in FY06, which is pushing the envelope, and plunge further to 1.8% in FY07. Since 1980, outlay growth has averaged 6.4% --including the Budget Control Act years of fiscal discipline-- so it is a stretch to understand why outlay growth will fall to below trend in the absence of fiscal discipline. Make no mistake, there is no fiscal discipline in Washington these days, nor is there any indication that a revival of fiscal restraint is imminent.
The bottom line is that we can be fairly confident that the deficit will be in a $325 bln to $350 bln range in FY05 and FY06 in the absence of unforeseen fiscal initiatives or changes in the economy. Looking beyond next year, the picture become much murkier. The OMB receipt projections are not unreasonable based on historical relationships, but the outlay projections. |
