Tax hikes larger than I thought, says $185 billion below:

Commentary for Thursday: For the past four years, the annual federal budget deficit has exceeded $1 trillion. However, due to a combination of improving economic conditions, tax increases and fiscal austerity, the deficit is poised to shrink considerably in 2013 and 2014. In fact, it already appears to be ahead of target for 2013 relative to the Congressional Budget Offices estimates from earlier this year. Previously, most of the fiscal improvement was due to stronger tax revenue as the economy mended; however, more recently outlay reductions have caught up- revenues were up $72 billion in Q1 versus yearago levels, while outlays were down $78 billion. Revenue is being propelled by a combination of hiring gains, as well as the tax increases implemented at the start of the year. The expiration of the payroll tax holiday was worth about $135B, and higher tax rates for upper income brackets totaled roughly $50B. Individual income taxes, corporate income taxes and social insurance/ retirement receiptsaccount for the vast majority (92%) of federal receipts, and all three sources are highly cyclical. Thus, the best prescription for higher tax revenue is a sustained improvement in the pace of economic growth. If the economy accelerates along the profile we project for 2013 (thereby pushing year-on-year real GDP growth from +1.7% to +2.8%), the CBOs projected deficits for fiscal years 2013 and 2014 should prove to be too large. This makes sense since the CBO only projected 2013 real GDP growth at +1.4% (half of our projected rate). The figure below shows the difference between the 12-month rolling sums of federal receipts and outlays, which is a useful proxy of the federal deficit. As of March, it was running at -$911 billion, and as the chart illustrates, the deficit is shrinking rapidly. Over the past six and twelve months the rolling deficit estimate improved by an average of $28-$30 billion per month. Thus, if this pace is maintained through the end of the fiscal year, the deficit is likely to shrink to approximately -$735 billionconsiderably better than the CBOs deficit projection of -$845 billion. (CBO projects -$616 billion for fiscal year 2014.) However, since the budget sequestrations are only beginning to take hold, the pace of outlays will probably shrink more quickly in the months ahead. Outlays are down 2.8% on a 12-month rolling average basis, but Q1 was down 8.1% (year-on-year) and March was down 20.8%. Receipts also appear to be strengtheningthey rose +14.2% in Q1, compared to +10.0% on a 12-month rolling average basis. In light of these trends, we trimmed our 2013 deficit projection to $700 billion