Deficit Outlook Darkens

Stark Warning for 2011 Fuels Battle Over Government Spending and Taxation

By DAMIAN PALETTA, JANET HOOK And JONATHAN WEISMAN

WASHINGTON—The federal budget deficit will reach a record of nearly $1.5 trillion in 2011 due to the weak economy, higher spending and fresh tax cuts, congressional budget analysts said, in a stark warning that will drive the growing battle over government spending and taxation.

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Republican Sens. John Cornyn, Orrin Hatch and Kelly Ayotte at a news conference Wednesday on a proposed balanced-budget amendment.

At that size, the deficit—up from $1.29 trillion in 2010—would be roughly $60 billion more than the White House projected last summer, the nonpartisan Congressional Budget Office said Wednesday. Last year's tax-cut package alone will add roughly $400 billion to the deficit, the CBO said. As a percentage of the nation's economic output, the 9.8% deficit would be the second-largest since World War II, behind only the 10% level in 2009.

The grim outlook landed a day after President Barack Obama outlined plans to push for new spending that he said would help keep the U.S. globally competitive in his State of the Union speech, and the data could complicate that effort. Republicans have dismissed the president's plans as ignoring the more pressing need to reduce the deficit.

Wednesday, the battle lines sharpened. "This report is a reflection of the gross mismanagement of our nation's finances," said Rep. Tom Price (R., Ga.). "It should make every American think twice about the latest calls by the president to increase spending at a time when Washington can clearly not afford to pay its bills."

Democrats argued that the bleak outlook for unemployment justified spending in a still-fragile economy, a line they intend to use to resist the GOP push for cuts. When asked whether current spending levels should be maintained, Sen. Patty Murray (D., Wash.), a member of the Senate Democratic leadership team, said: "We can't have a fire sale."

Next Steps

What happens now in Washington on spending plans:

Week of Feb. 14: White House Office of Management and Budget releases 2012 budget.
Week of Feb. 14: House of Representative begins debating continuing resolution (spending bill).
Late February: Government Accountability Office releases report on duplications in government programs.
March 4: Existing spending bill expires.
March 31: Treasury warns U.S. could hit $14.3 trillion debt ceiling by this point.

Alternate Plans

Neither the White House nor Republicans have offered many details about their spending plans.

President Barack Obama said in his State of the Union address Tuesday night that he would be proposing:

A five-year freeze on discretionary, non-defense spending, reducing the deficit by $400 billion over 10 years
A five-year plan proposed by the defense secretary to achieve an additional $78 billion in defense savings
Increased funding for research and development in to clean and renewable energy
Funding to recruit 100,000 science, technology, engineering and mathematics teachers over the next decade
A permanent tax credit of up to $10,000 for four years of college
A six-year plan to repair roads, bridges, and transit, to be fully paid for and including private capital
A "significant down payment" on a national rail network

House Republican leaders have said they want to slash spending to 2008 levels, cutting spending by $80 billion for the current fiscal year.

The Republican Study Committee, a conservative caucus of more than two-thirds of House GOP members, wants to cut $100 billion for the current fiscal year. It has also proposed a Spending Reduction Act which would end or cut funding for dozens of programs and agencies over 10 years including:

Federal control of Fannie Mae and Freddie Mac
Amtrak
U.S. Agency for International Development
Applied energy research
Corporation for Public Broadcasting
National Endowment for the Arts
Farm subsidies
Support for airline service to remote airports

Mr. Obama saw the dichotomy up close Wednesday in Wisconsin, on a post-speech trip to a state where Republicans made big gains in November's elections. Speaking to workers at Orion Energy Systems, an energy-efficiency and solar company, he said: "If we, as a country, continue to invest in you, the American people, then I'm absolutely confident America will win the future in this century as we did in the last."

But on arriving in the state, he was greeted by a skeptical letter in the Milwaukee Journal Sentinel from Wisconsin's newly elected Republican Sen. Ron Johnson. "We must pursue policies that will first limit and then begin to reduce the size, scope and cost of government," wrote the freshman senator, owner of a polyester and plastics maker.

And the state's new Republican governor, Scott Walker, who attended the event, reiterated his own stance on cutting spending after the speech. As one of his first acts in office, Mr. Walker rejected the stimulus-funded high-speed rail link that had been planned between Milwaukee and Madison. "The train has left the station in Wisconsin," he said. "We're going to focus on things we can afford."

The forecast will no doubt frame the coming months of debate. The first real tests of Mr. Obama's spending priorities will come when the White House releases its 2012 budget Feb. 15, spelling out proposed spending increases and cuts.

On the same day, House Republicans hope to begin debating a bill to extend government spending beyond the current expiration date of March 4. Less than a month later, Treasury officials predict the U.S. could hit the $14.3 trillion debt ceiling unless Congress raises it.

More State of the Union Video

The Big Interview: Paul Ryan

The Big Interview: Alan Greenspan

The deficit numbers do little to simplify a related thorny problem—what to do about the unwieldy U.S. personal tax code. The payroll tax holiday expires in a year, and extending it would add to the deficit. The possibility of a bigger revamp likely won't get taken up until after the 2012 elections.

Many of the budget-cutting proposals from Democrats and Republicans focus on a relatively small part of the U.S.'s $3.5 trillion budget: the roughly 15% that accounts for nonsecurity, discretionary spending. But the deficit is being driven by programs that are more politically difficult to cut, such as the Medicare health plan for seniors, military spending and Social Security.

"The United States faces daunting economic and budgetary challenges," CBO Director Douglas Elmendorf said.

The White House and Republicans could try to put together a package of changes that would raise the debt ceiling while cutting spending, though a deal could prove hard to reach and could trigger a backlash from rank-and-file lawmakers in both parties.

House Budget Committee Chairman Paul Ryan (R., Wis.), a key negotiator who delivered the GOP rebuttal to the State of the Union speech, plans to use the new CBO numbers to set a ceiling for discretionary spending for the remaining seven months of the 2011 fiscal year. Republicans are eyeing cuts of between $60 billion and $100 billion in federal spending. White House officials are pushing for mostly flat spending.

Mr. Obama proposed on Tuesday a five-year freeze on nonsecurity discretionary spending, a move officials say will save $400 billion over 10 years. But his State of the Union speech focused more on the need to continue investing in education and infrastructure than on the need to cut spending. He did, however, open the door for potential changes to some of the government's most costly programs—including Medicare, Medicaid and Social Security.

Republicans argue the White House isn't taking the country's fiscal problems seriously enough.

"To boost private-sector job creation and help the economy grow, we need to cut spending and enact serious budget reforms to ensure we keep cutting spending," House Speaker John Boehner (R., Ohio) said.

The CBO report offered a sobering look at both the short-term and long-term fiscal outlook. It projected the unemployment rate would fall from 9.4% now to 9.2% by the end of this year and then to 8.2% by the end of 2012. It projected the unemployment rate wouldn't fall to typical pre-recession levels—about 5.5%—until 2016.

Meanwhile, the U.S. debt is expected to increase rapidly in the coming years, compounded by rising health-care costs, the aging baby boomer generation and soaring interest payments. By 2017, the level of U.S. debt subject to the debt ceiling will hit $20.9 trillion, the CBO projected.

Democrats and Republicans are clamoring to introduce proposals to cut spending. Twenty Senate Republicans introduced a constitutional amendment to balance the federal budget. Meanwhile, 13 senators introduced a bill that would prevent lawmakers from receiving an automatic pay raise each year.

Several top Democrats on Wednesday said the CBO report was troubling, but warned Republicans against using the data to slash spending in the short-term.

"I don't think that's the way to solve the problem," Senate Budget Committee Chairman Kent Conrad (D., N.D.) said. He called for a fundamental overhaul of tax and spending rules that would address the long-term fiscal problems.

Write to Damian Paletta at damian.paletta@wsj.com and Jonathan Weisman at jonathan.weisman@wsj.com

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January 27, 2011