BY PAUL HANDLEY

THE huge US budget deficit, which earned the country its first credit rating downgrade, will drop dramatically by 2013 if planned spending cuts are implemented and temporary tax breaks end, a government report said Wednesday.

But with a tough budget regimen ahead, the unemployment rate is expected to remain above eight percent for the next three years, the Congressional Budget Office said in a new forecast of the US budget and economic outlook.

The CBO warned that the economy confronts strong headwinds that could undermine efforts to reform.

“The economy remains in a severe slump. Recent turmoil in financial markets in the United States and overseas threatens to prolong the slump,” the CBO said.

The report said that the budget deficit could fall from US$1.284 trillion this year, or 8.5 per cent of gross domestic product, to just $510 billion, or 3.2 per cent of GDP, by 2013 under certain key conditions.

Those include implementing a new $2.4 trillion austerity plan, letting a handful of tax breaks expire, and cutting payments to doctors in the public Medicare health service.

If all were put in place, and if economic growth hits 2.3 per cent this year and 2.7 per cent next year, the result could be a sharp contraction of the government deficit that would put it at around 1.7 per cent of GDP by 2018.

That outcome would counter the arguments made by Standard & Poor’s when it cut Washington’s credit rating one notch from the top-line AAA grade on August 5, citing high debt and deficits and expressing doubts that the country’s politicians could agree on a credible deficit-cutting programme.

The CBO’s assumptions are that the August 2 Budget Control Act, passed by Congress amid deep rancour in a rush to avoid forcing the country to avoid defaulting on its debt, is implemented.

The austerity plan mandates $900 billion in spending cuts and that a panel of Democrats and Republicans in Congress agree by November additional measures to reduce the deficit by $1.5 trillion.

S&P and others expressed doubts that the panel will be able to agree: Democrats already have signalled they want to end tax breaks and raise some taxes, while Republicans have adamantly refused any tax hikes.

Economists also worry that sharp spending cuts will restrain the economy and job creation; many have already cut their forecasts for growth this year to less than 2.0 per cent.

“If some of the changes specified in current law did not occur and current policies were continued instead, much larger deficits and much greater debt could result,” the CBO warned.

White House spokesman Josh Earnest said the report “validates the progress that’s been made” by the government on cutting the deficits.

“The report also makes it clear that there is a lot more that we have to do,” he said.