US fiscal deficit shows surprise fall

America’s fiscal deficit has fallen this month, contrary to many previous predictions. The cut in the 2005 budget deficit by $94bn (53bn) to $333bn has been attributed to rising tax receipts.

Federal tax receipts are expected to grow by 14.6% in the fiscal year that ends in September. Republicans have hailed this as a sign of the success of two rounds of tax cuts by President George W Bush’s administration.

There are predictions that the fiscal deficit could fall to $162bn by 2009 compared with its peak of $521bn. If this were correct, it would bring the deficit down to 1.1% of GDP against an average of 2.5% over the past 40 years.

Whether this prediction is correct will depend largely on future economic growth and whether the improvement is the result of cyclical or structural changes.

Gabriel Stein, chief international economist of Lombard Street Research, says the decline is the result of two main factors. “All the states have to balance their budgets over a two-year cycle and we are in the second year of this process.

“The other factor is the strong economic growth being seen in the US. This creates greater tax receipts and a reduction in social security spending.” Stein, therefore, says the fall in the deficit at the Federal level is the result of an improvement in the business cycle rather than a structural change.

Lombard Street Research says American economic growth will continue to be strong this year. It will then slow in 2006 after the continued raising of interest rates to counter inflationary pressures. This scenario would support the ongoing improvement in the deficit during 2005.

But an improving budget deficit has disadvantages, says Stein. “The economy comprises four sectors – household, corporate, public and foreign. The surpluses and deficits of these four sectors must add up to zero by definition.

“If the budget deficit is improving at the expense of households saving less then some might argue this is not a positive development. The answer to whether you want an improving budget is not straightforward and depends on how that is being achieved.”