The Deficit Is Falling! What It Means for a Debt Fight in Washington

May 10, 2013 — -- There's no denying it: things are looking a little better for the economy.

More money is coming into the Treasury, the government is spending a little less, the unemployment rate is slowly moving down, and Wall Street is doing great. And the cherry on top: On Thursday, the once-embattled mortgage giants Fannie Mae and Freddie Mac announced that they would return a combined $66.4 billion to the U.S. Treasury.

"I think it's great news," said Moody's Analytics' chief economist Mark Zandi. "It reflects the steadily improving economy, but also the tax increases and government spending cuts that have been implemented."

But good economic news is tantamount to a loosening of the proverbial noose around the necks of Washington lawmakers, potentially postponing a deadline that could force quicker action on some major issues including tax reform and entitlement reform.

For their part, Republicans hope that an upcoming debt ceiling fight will force a broader conversation about tax and entitlement reform and additional spending cuts.

Democrats have said that the debt ceiling should be raised no matter what, and lawmakers should discuss long-term deficit reduction separately.

There's no official date yet for when the Treasury Department will run out of emergency borrowing authority, but the Bi-Partisan Policy Center predicted the added boost of the Fannie-Freddie windfall could push off another debt ceiling fight between the White House and congressional Republicans to October.

On May 19, the official debt ceiling would have been reached, but the Treasury Department is expected to employ some financial jujitsu that allows it to pay the bills for some time after that date.

With more time, it's almost certain that Congress will do what it has done nearly every time in the past: wait until the last minute to cut a deal.

"The pressure to do more deficit reduction is reduced as a result of the better budget picture," Zandi said. "Without that Damocles' sword, it's less likely that policymakers are going to come together and come up with future spending cuts."

The slightly rosier forecast stems from a complex combination of rising revenue from higher taxes after January's budget deal, a slow-but-steady economic recovery, and deep automatic spending cuts in military and discretionary spending, known as the "sequester."

In a report this week, the Congressional Budget Office said that the federal budget deficit in the last seven months of 2013 is $231 billion less than it was in the same period a year ago, mostly because the government is collecting far more tax revenue after the payroll tax cut and the Bush tax cuts for high income earners were allowed to expire.

For the month of April, the government actually ran a surplus of $112 billion. That's right, a surplus.

All of that seems to fulfill a prediction made months ago, in January 2013, by a private research firm, Potomac Research. It predicted that economists might end up revising their economic forecasts to show the U.S. debt becoming a smaller and smaller percentage of GDP sooner than anyone thought.

That doesn't mean that the country's economic problems are solved, only that the measures Congress has already taken are having some, perhaps moderate, effect.

Republicans have made it clear that in exchange for a debt ceiling increase they'll ask for concessions that could jump-start deficit reduction.

But with the debt ceiling deadline coming as late as this fall and the deficit getting smaller already, Republicans may hit a wall when it comes to how much they can extract from Democrats in terms of tax or entitlement reforms and spending cuts.

Separating the issue of the debt ceiling from reforms, Democrats believe, works to their advantage.

"The Republican strategy of holding the economy hostage and trying to push this budget conference to when we have a crisis again is absolutely the wrong approach," said Sen. Patty Murray, D-Wash., the fourth-highest-ranking Democrat in the Senate, at a press conference this week. "It is not sustainable. It needs to stop. We are ready to sit down, we're ready to negotiate, we're ready to make some tough decisions, we're ready to go to work and in the conference and we see no reason to wait until the next crisis."