Video: Managing debts, and expectations

updated 1/7/2009 7:16:11 PM ET 2009-01-08T00:16:11

The federal budget deficit will hit an unparalleled $1.2 trillion for the 2009 budget year and the U.S. economy will likely contract by more than 2 percent, according to a new Congressional Budget Office report.

The eye-popping estimates reflect plummeting tax revenues because of the recession and about $400 billion spent to bail out the financial industry and take over mortgage finance companies Fannie Mae and Freddie Mac. Last year's deficit was $455 billion.

The CBO estimate released Wednesday also sees the U.S. economy shrinking by 2.2 percent this year and recovering only slightly to grow by 1.5 percent in 2010. It foresees the unemployment rate eclipsing 9 percent early next year unless the Obama administration steps in.

"The recession — which began about a year ago — will last well into 2009," the CBO report says. The agency said that "ongoing turmoil in the housing and financial markets has taken a major toll on the federal budget."

The dismal figures come a day after President-elect Barack Obama warned of "trillion-dollar deficits for years to come."

CBO's figures don't account for the huge economic stimulus bill Obama is expected to propose soon to try to jolt the economy.

The shrinking economy has led to a sharp drop in estimated tax revenues of $166 billion from 2008 levels, which is largely responsible for the deficit, along with big outlays from the Wall St. bailout.

The agency expects the $700 billion bailout to actually cost taxpayers $189 billion, with the costs reflected in its estimates for this year and next. CBO estimates take into account the net value of the assets the government holds from financial institutions.

Under Treasury Department accounting, the bailout spending is reflected only as the government makes the payments; as of mid-December, those disbursements totaled $238 billion. Exposure to the taxpayer stemming from the Federal Reserve Board's extensive interventions in the financial markets — such as acquiring 80 percent control of insurance and financial giant American International Group Inc. — are not reflected in the estimates.

The CBO report also said the federal takeover of Fannie Mae and Freddie Mac last year added $240 billion to this year's deficit.

Obama and Congress are promising quick enactment of the economic recovery plan, which will blend up to $300 billion in tax cuts with big new spending programs and could cost up to $775 billion over the next few years.

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Obama said the flood of red ink probably won't affect that measure but could crimp other items on his agenda.

"Despite the record deficits facing us, our number one task is an economic recovery package," said House Budget Committee Chairman John Spratt Jr. "With Americans concerned about their jobs, their homes, their retirement and their children's future, our economic situation is so severe that stabilizing the economy must take precedence over short-term deficits."

The $1.19 trillion 2009 figure shatters the previous record of $455 billion, set only last year. It also represents more than 8 percent of the size of the economy, which is higher than the deficits of the 1980s. The 2009 budget year began last Oct. 1.

Just in September, CBO predicted a 2009 deficit of $438 billion, but revenue projections have dropped by $362 billion on top of the approximately $400 billion federal intervention in the financial system.

Senate Republican Leader Mitch McConnell called the budget figures "a stunning and sobering reminder that Congress must strengthen its efforts to be good stewards of the taxpayers' money."

CBO predicts the deficit will come under relative control within a few years, dropping to the $250 billion range by 2012. But such predictions depend on the expiration of President George W. Bush's tax cuts at the end of next year; Obama has promised to renew most of them except for those aimed at people making more than $250,000 a year.

Fully renewing the Bush tax cuts, as well as indexing the alternative minimum tax for inflation, would add $380 billion to a deficit otherwise projected at $327 billion for 2012, CBO says.

At the same time, Democrats are expected to increase domestic agency budgets as they complete the leftover 2009 spending bills, and Obama is likely to recommend further increases in next month's budget submission.

While expected, the deficit numbers will give lawmakers second thoughts about creating new spending programs without finding ways to pay for them. And it is likely to prompt a debate about whether tax increases are necessary after the economy recovers from the current recession.

On Wednesday, Obama said, "Unless we take decisive action, even after our economy pulls out of its slide, trillion dollar deficits will be a reality for years to come."

"I'm going to be willing to make some very difficult choices in how we get a handle on this deficit," Obama said Tuesday.

Economists warn that large and sustained budget deficits put upward pressure on interest rates. In the short term, however, efforts to restrain the deficit could have a contracting effect on the economy.

"As we address our economy, it is vital that we simultaneously take steps to put our budget back on a sound long-term fiscal path," said Senate Budget Committee Chairman Kent Conrad.

© 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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