Surprise: The Federal Budget Deficit Turns Sharply Lower

WE ALL KNOW that monetary policy will be restrictive until further notice, but there’s been little focus on fiscal policy — which also is becoming less accommodative as tax receipts surge and deficits plunge.

A SLOWDOWN IN SPENDING comes as Democrats are trying to persuade maverick Sen. Joe Manchin to support a scaled-back Build Back Better bill that would raise revenues. That could appeal to a deficit hawk like Manchin. Democrats think they can sell this to him (whether Democrat Kyrsten Sinema would go along is unclear).

AT THE LEAST, THIS TRIAL BALLOON seems to confirm that deficit reduction is back on the bargaining table. If Republicans capture the House this fall, which seems likely, huge new spending bills would be off the table and deficit reduction would be a major GOP goal.

IRONICALLY, OPPOSITION to more spending comes just as deficits are falling — from $3.1 trillion in fiscal 2000, to $2.8 trillion in fiscal 2021, to possibly something close to “only” $1 trillion in this fiscal year. Surging corporate and individual tax receipts have had a major impact.

BUT THIS SHARP DEFICIT REDUCTION has not satisfied deficit hawks like Manchin, who claim that the spending binge has exacerbated inflation. That’s far from certain; there are many reasons why inflation has surged. There was a $119 billion federal surplus in January, as inflation fears spooked the markets.

WITH MANCHIN CALLING FOR DEFICIT REDUCTION, could there be a scaled-back BBB bill, spending about $500 billion on climate provisions and $400 in new health care programs — while reducing the budget deficit? That would require a significant tax hike.

MANCHIN SUPPORTS RAISING the corporate tax rate to 25% from 21%, hiking the top capital-gains rate to 28% from 23.8% and increasing taxes on private-equity managers’ carried-interest income. He also could accept some increase in corporate foreign income. “Sounds like something we should be talking about,” Manchin says.

BOTTOM LINE: There’s probably enough monetary and fiscal stimulus in the pipeline to keep the economy in good shape this year. But with federal spending cooling and the Fed hiking interest rates, a GDP slowdown may be looming in 2023.

UKRAINE UPDATE: It’s way too early to declare victory, but signs of a possible Russian pull-back this morning are encouraging. Vladimir Putin may have concluded that the costs — Russian casualties, economic sanctions, etc. — would be too great. We think his fall-back might be cyberwarfare and an uneasy stalemate at the border that could persist for months.

Related: Inflation Surge Has Three Major Policy Implications

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