Con­gress is on hol­i­day, rest­ing up for the next round of bud­get wars that will resume after Labor Day. The issues they will face when they return are famil­iar: the fed­er­al gov­ern­ment is about to lose author­i­ty to do what it does best (or, at least, most nat­u­ral­ly) – bor­row and spend. 

Absent a fresh appro­pri­a­tion of funds, gov­ern­ment agen­cies will close Octo­ber 1; and unless Con­gress agrees to raise the government’s cred­it card lim­it, Trea­sury will default on its debt at a yet-to-be-deter­mined date in Octo­ber or November.

The posi­tions tak­en by the two par­ties also are famil­iar. The Pres­i­dent wants a straight increase in the debt ceil­ing, while Repub­li­cans insist on pair­ing new bor­row­ing with spend­ing reduc­tions. The Pres­i­dent says that he will not nego­ti­ate with Repub­li­cans on this point. On appro­pri­a­tions, House Repub­li­cans favor steep cuts in domes­tic spend­ing pro­grams, but pre­fer a soft­er approach to Pen­ta­gon spend­ing. A fac­tion of Repub­li­cans wants to up the ante, argu­ing that Con­gress shouldn’t fund any gov­ern­ment agency unless the Pres­i­dent agrees to a pro­vi­sion that would pre­vent the imple­men­ta­tion of Oba­macare.  It is unclear whether GOP lead­ers will join in mak­ing this demand.

The Pres­i­dent advo­cates what he calls a “bal­anced” approach to deficit reduc­tion – bal­anced because it includes a mix of spend­ing cuts and tax increases.

A snap­shot of fed­er­al spend­ing released ear­li­er this month by the Con­gres­sion­al Bud­get Office (CBO) shows that the deficit is com­ing down faster than it ever has, though hard­ly in a bal­anced way. The deficit will be sub­stan­tial­ly low­er this year than last large­ly because of tax increas­es, low­er unem­ploy­ment ben­e­fits, and the return to prof­itabil­i­ty of Fan­nie Mae and Fred­die Mac.

CBO now pre­dicts that this year’s deficit will be $642 bil­lion, down from $1.09 tril­lion last year. If they’re right, that would be the first year since 2009 that the gov­ern­ment bor­rowed less than $1 tril­lion and the biggest one-year decline in the deficit ever.

The chart above (click on it to enlarge) shows how that deficit reduc­tion is being achieved.

• Rev­enues are high­er. Through the first ten months of this fis­cal year (Octo­ber 1 – July 31), we’ve paid lots more in tax­es of every kind. Some of that is mere­ly due to an econ­o­my that is grow­ing, albeit slow­ly. But some of it, too, is because the Pres­i­dent won his stand­off with Repub­li­cans last win­ter, get­ting the tax hikes he’d long sought. Pay­roll tax­es are up for every­one, income tax­es are up for the high­est earn­ers, and cor­po­rate tax­es have risen as well, as the Fed­er­al Reserve’s bond pur­chas­es and zero inter­est rate pol­i­cy have helped boost equi­ty mar­kets and cor­po­rate prof­its.
• Spend­ing is flat.  With the excep­tion of unem­ploy­ment insur­ance (UI), which I’ll dis­cuss below, fed­er­al spend­ing is pret­ty close to what it was last year. The three biggest enti­tle­ment pro­grams (Social Secu­ri­ty, Medicare and Med­ic­aid) con­tin­ue to grow robust­ly; the gov­ern­ment has so far spent $1.3 tril­lion on those three pro­grams alone, $58 bil­lion more than last year. But that increase is off­set by cuts in domes­tic ($25 bil­lion) and mil­i­tary ($36 bil­lion) spend­ing, much of that due to across-the-board cuts (seques­tra­tion) that took effect this past March. That nets to about $4 bil­lion less in spend­ing this year, neg­li­gi­ble when com­pared to the near­ly $2.9 tril­lion the gov­ern­ment has so far spent.
• UI spend­ing is down. Gov­ern­ment spend­ing on unem­ploy­ment ben­e­fits is down by $20 bil­lion, a 24 per­cent drop over last year. That’s to be expect­ed since the unem­ploy­ment rate is low­er. It’s also because the max­i­mum length of time that a per­son can col­lect those ben­e­fits has been reduced by 6 months – from 99 weeks to 73 weeks – whether they find work or not.
• Fan­nie Mae and Fred­die Mac are “prof­itable.” Remem­ber when the gov­ern­ment took over mort­gage giants Fan­nie and Fred­die back in 2008?  For near­ly five years, tax­pay­ers ate their loss­es, as the two firms bled $187 bil­lion. This year, they start­ed to make mon­ey. Their prof­its now go to the Fed­er­al Trea­sury, account­ing for an esti­mat­ed $87 bil­lion in deficit reduc­tion over last year.

If that seems a lit­tle gim­micky, well, it is. But it’s not the only gim­mick con­tribut­ing to this year’s his­toric drop in the deficit. Recall that the Fed­er­al Reserve has been buy­ing up $45 bil­lion per month in Trea­sury bonds. In all, the Fed held near­ly $2 tril­lion in fed­er­al debt (and anoth­er $1.3 tril­lion in mort­gage-backed secu­ri­ties) as of last week. The Trea­sury pays inter­est on this debt to the Fed which – you guessed it – returns those inter­est pay­ments to the Trea­sury.  Last year, the Fed paid a record $88.4 bil­lion to the Trea­sury Depart­ment, mon­ey that also helps reduce the deficit. Here’s how it works: 1) the Fed­er­al Reserve “prints mon­ey” to buy Trea­sury debt; 2) the Trea­sury pays inter­est on that debt to the Fed; 3) the Fed gives the inter­est pay­ments back to the Trea­sury. Voila! $88.4 bil­lion in gov­ern­ment “receipts” that help tamp down the deficit.

In a sep­a­rate but relat­ed action, the Fed also has held down inter­est rates, enabling the gov­ern­ment to bor­row at very low cost. As a result, the Trea­sury has so far made about $5 bil­lion less in inter­est pay­ments than it did last year, despite hav­ing to ser­vice hun­dreds of bil­lions of dol­lars of more debt. The gov­ern­ment has bor­rowed more, but paid less in inter­est. Go figure.

Togeth­er, that com­bi­na­tion of high­er tax­es, flat spend­ing, reduced unem­ploy­ment ben­e­fits and a strange brew of gim­micks are on track to pro­duce sub­stan­tial deficit reduc­tion. And while it includes some­thing to offend every­one, the poli­cies behind that reduc­tion are much clos­er to those of the Pres­i­dent than to those of Republicans.

That’s cer­tain­ly true of tax­es, which account for over 70 per­cent of the deficit reduc­tion. Anoth­er 23 per­cent derives from gim­micks that nei­ther par­ty nec­es­sar­i­ly advo­cates but both are hap­py to accept. The UI cuts are cycli­cal by design, ris­ing and falling with the unem­ploy­ment rate, a pol­i­cy that has had bipar­ti­san sup­port since the 1930s. Enti­tle­ment spend­ing has fol­lowed the tra­jec­to­ry favored by the Pres­i­dent, with those pro­grams con­tin­u­ing to grow auto­mat­i­cal­ly at uncon­trolled rates. With the imple­men­ta­tion of his health care law, that spend­ing will go high­er still begin­ning next January.

Seques­tra­tion is the only pol­i­cy that reflects the Repub­li­can com­mit­ment to reduce spend­ing, although the across-the-board approach is by no means their ide­al option. They want to replace some of those cuts, par­tic­u­lar­ly in defense spend­ing, with enti­tle­ment sav­ings, some­thing that the Pres­i­dent has so far suc­cess­ful­ly resist­ed. Fail­ing that, Repub­li­cans pre­fer across-the-board cuts to no cuts at all.

Although he is win­ning on tax­es and enti­tle­ment spend­ing, the cuts in domes­tic dis­cre­tionary spend­ing con­tin­ue to trou­ble the Pres­i­dent.  He signed a “stim­u­lus” bill on his first day in office that dra­mat­i­cal­ly increased that spend­ing.  By 2010, it had reached $658 bil­lion, 26 per­cent high­er than in 2008.  In nom­i­nal terms, spend­ing has not reached that lev­el before or since; it rep­re­sent­ed 4.5 per­cent of GDP, high­er than in any year since 1981.  The GOP vic­to­ry in the 2010 Con­gres­sion­al elec­tions pro­duced a sharp rever­sal in for­tunes.  The Bud­get Con­trol Act caps domes­tic dis­cre­tionary spend­ing at $469 bil­lion in 2014, below its 2008 lev­el, and House Repub­li­cans want to push it low­er still.

The Pres­i­dent will fight to dri­ve that spend­ing high­er this fall and push for more tax increas­es.  He will meet stiff resis­tance from Con­gres­sion­al Repub­li­cans, who want to hold the line on tax­es, pare enti­tle­ment spend­ing, and delay imple­men­ta­tion of Oba­macare.  All of which makes for enter­tain­ing spec­ta­cle whose out­come remains uncertain.

To this point, though, the Pres­i­dent has pre­vailed on enti­tle­ment spend­ing and tax­es.  Repub­li­cans are get­ting their deficit reduc­tion but the Pres­i­dent is get­ting his way.