The CBO’s latest report on the federal budget and the economy needs a giant asterisk next to it. Because it was prepared during the month of July, it doesn’t take into account the changes in the economic outlook that have cropped up in August. CBO fully admits that:

“CBO initially completed its economic forecast in early July, but it updated the forecast in early August to reflect the policy changes enacted in the Budget Control Act [the debt limit deal],” the report reads. “However, the forecast described here does not reflect any other developments since early July, including the recent swings in financial markets, weakness in certain economic indicators, and the annual revision to the national income and product accounts. Incorporating that news would have led CBO to temper its near-term forecast for economic growth.”

Therefore, this forecast is inherently over-optimistic. However, one thing is clear from the report, right from the first graph. If we just follow current law, deficits will stabilize at 3.2% of GDP by 2013, and down to an average of 1.2% of GDP over the next decade. In other words, letting the Bush tax cuts expire, implementing the Affordable Care Act and ending the wars will bring the budget into primary balance, less expenses from debt service. Because the wars are an extra trillion dollars in savings not even accounted for here, you may be able to extend certain policies like the AMT patch or the doc fix and still get to that balance (on page XII, you can see the table showing that keeping the doc fix would cost a pittance compared to extending the Bush tax cuts).

And the more economic growth you can muster, the more this dynamic changes. The forecast is over-optimistic because it views economic growth too highly. If job creation measures were undertaken now to boost growth and build a foundation for better growth in the future, the deficits shrink. We’ve had largely crappy growth in FY 2011, and yet the deficit has shrunk (albeit slightly, to $1.3 trillion). But this is clearly not the most government can do. CBO, even with their sunny forecast, has unemployment still over 8% until 2014. Chuck Schumer got at this a little in his reaction:

This analysis reveals two productive trends—reduced long-term deficits and gains in economic growth—but neither is as robust as is needed to get our economy going again. This makes the case for immediate jobs measures to boost growth, and for ending tax breaks for millionaires in order to keep us on the path towards a balanced budget. It’s clear from this report that the Republican approach to the economy is harmful to both growth and deficit reduction, and is holding back the recovery.

Not sure about the latter (as a political economy strategy yes; but it can wait until the Bush tax cuts expire in 2012), but immediate jobs measures would boost growth AND reduce the deficit.

Broadly speaking, this is not a projection that should strike anyone as an example of out of control, runaway spending. We need a stronger economy. The rest will take care of itself.