Earlier this month, the Congressional Budget Office released revised projections for fiscal year 2013. The CBO now expects a deficit of $643 billion for the year. This marks a $203 billion reduction from the CBO's $846 billion estimate in February.

The improvement comes from three main sources. Individual income taxes are running $69 billion above prior estimates. The CBO hypothesizes that taxpayers rushed to realize income -- particularly capital gains and dividend income -- in calendar 2012 before the 2013 tax rates took effect. This resulted in unexpectedly large estimated tax payments. The CBO believes this is temporary.

The second source is $95 billion in additional payments from Fannie Mae and Freddie Mac. These are the mortgage financing entities bailed out by the Treasury during the financial crisis. With the recovery in the housing market, the companies are repaying some of the money advanced by taxpayers.

Finally, corporate taxes are $40 billion above expectations for unknown reasons.

The $643 billion deficit for 2013 is a gargantuan $445 billion below the $1.087 trillion recorded in 2012. Beyond those cited above, factors include $185 billion from increasing income tax rates on top earners and eliminating the Social Security tax holiday. Meanwhile, discretionary spending is projected to decline $82 billion primarily due to the sequester.


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Overall, CBO estimates tax revenue equaling 17.5 percent of GDP in 2013. This is slightly less than the 40-year average of 17.9 percent of GDP. CBO expects spending to equal 21.5 percent of GDP versus the long-term average of 21 percent.

Continuing on the path toward lower deficits is problematic. An aging population will inevitably result in higher Social Security and Medicare spending. CBO sees mandatory spending -- which includes those two programs -- increasing from $2 trillion in 2013 to $3.6 trillion in 2023. Interest rates will eventually rise from today's rock-bottom levels. CBO sees interest expense increasing from $223 billion in 2013 to $823 billion in 2023. Added expenses in these areas will put the squeeze on discretionary spending which the CBO sees increasing from $1.2 billion to $1.4 billion over the ten years. In relative terms, discretionary spending would fall from 7.6 percent of GDP to 5.5 percent of GDP, a near 30 percent reduction.

In the CBO's estimation, revenue will climb from $2.8 trillion to $5 trillion, rising to 19 percent of GDP. Revenue figures are always highly suspect as the CBO is required to base its estimates on "current law." Current law assumes that the "temporary" tax provisions that Congress regularly extends on a year-by-year basis will, in fact, expire. CBO also must "guesstimate" how the recent tax increases will affect revenue. If history is any guide, capital gains realizations will plummet more than the CBO expects taking tax revenue down with them.

Beyond the factors above, the budgetary effects of the Affordable Care Act are highly uncertain.

The good news is that the federal debt problem may be stabilizing. The bad news is that it may be stabilizing at 70 percent of GDP rather than the historical norm of 39 percent, leaving the country with greatly reduced flexibility to react to the crisis next time.

Jeffrey R. Scharf is chairman of Scharf Investments. Contact him at jeffrey@scharfinvestments.com.