The federal budget deficit could approach $400 billion — or more if the economy enters recession — a Congressional Budget Office report revealed on Wednesday.

CBO officially forecast a $219 billion deficit for fiscal 2008. But the nonpartisan budget scorekeeper expects another $30 billion for the wars in Iraq and Afghanistan.

That would bring the deficit to about $250 billion. But that doesn't include any economic stimulus plan. President Bush has proposed a stimulus of 1% of GDP, or $140 billion-$150 billion.

"Our calculation is the deficit will be over $350 billion when you put in the stimulus and the war costs," Senate Budget Committee Chairman Kent Conrad said.

The CBO report highlights a risk that the past three years of deficit-cutting progress will give way to an era of deeper shortfalls, just as the baby boomers begin to retire and fiscal pressures mount.

"I think we've seen the last of deficits under $200 billion for quite some time," said Robert Bixby, executive director of the nonpartisan Concord Coalition, which advocates fiscal responsibility.

The 2007 deficit of $163 billion, or 1.2% of GDP — down from 2004's deficit of $413 billion, or 3.6% of GDP — is likely to be "the low-water mark," Bixby said.

CBO projects a $198 billion deficit in fiscal 2009, but that would rise by $75 billion if Congress once again extends relief from the Alternative Minimum Tax.

Much uncertainty is built into the CBO numbers, both with respect to policy changes and the state of the economy.

While several Wall Street forecasts call for recession, CBO expects modest GDP growth of 1.7% this year vs. 2.2% in 2007. It expects unemployment to rise to 5.3% at year-end from 5% now.

"A more severe downturn could significantly decrease projected revenues and increase projected spending," CBO director Peter Orszag told the House Budget Committee Wednesday.

In past recessions, lower revenue and automatic spending hikes on programs such as jobless benefits have raised the deficit by 1.1% to 2.5% of GDP, CBO says.

The CBO still projects surpluses from 2012 to 2018, but relies on a highly questionable assumption.

CBO expects a $223 billion surplus in 2018 — if all the Bush tax cuts were to expire, including those for lower earners — and Congress subjected taxpayers to the full force of the AMT.

But if current tax relief is extended, CBO sees a $617 billion deficit.

The CBO also has to assume that discretionary spending will grow at the rate of inflation.

Last year, spending on discretionary programs from defense to education equaled 7.6% of GDP. But under current trends, discretionary spending would fall to 6.1% of GDP by 2018 — the lowest in more than 40 years.

Even if such a shift were to occur, surging entitlement spending would more than offset the savings.

Medicare, Medicaid and Social Security are on track to cost 10.8% of GDP in 2018, up from 8.9% this year.

"A substantial reduction in the growth of spending, a significant increase in tax revenues relative to the size of the economy, or some combination of the two will be necessary to maintain the nation's long-term fiscal stability," Orszag said.

The Concord Coalition's Bixby says the 2018 deficit could hit $950 billion if discretionary spending keeps up with GDP growth and all tax relief is extended.

Bixby expects the return of big deficits to play a role in the presidential campaign — and beyond.

"If the government reports a $400 billion deficit in September, people are going to notice," he said.

An uncomfortably large deficit "is going to make it difficult for any new president to enact a big policy agenda," he said. "Big deficits could constrain the appetite for even-bigger deficits."

Source: http://www.investors.com/editorial/IBDArticles.asp?artsec=16&issue=20080123