The nation's budget situation is challenging. In fiscal year (FY) 2008, the budget deficit reached $455 billion or 3.2% of gross domestic product (GDP), up from $161 billion or 1.2% of GDP in FY2007. New deficit projections provide a picture of what the United States faces over the next decade. In February 2009, the Congressional Budget Office (CBO) projected that the deficit in FY2009 will reach more than $1.4 trillion, which includes the deficit impact of the American Recovery and Reinvestment Act (ARRA; H.R. 1 , P.L. 111-5 ). Between FY2010 and FY2019, cumulative deficits could reach as high as $10 trillion. CBO projects deficits in each fiscal year of this period. These deficits are largely a result of federal financial intervention and fiscal stimulus legislation designed to alleviate the credit crunch and to bolster the economy. Current economic conditions have also led to increases in outlays for certain government social programs and declines in revenue collections, leading to further deterioration in the budget balance. Economists generally agree that when an economy is in recession, running deficits by increasing government spending or cutting taxes can stimulate growth. However, once growth returns, they advise paying down debt. Though the economy is currently in recession and running deficits may be appropriate, the accumulated deficits will increase federal debt held by the public and will generally increase the portion of the budget devoted to future interest payments. Larger deficits today and in the future would add additional pressure to the long-term budget outlook, hampering the ability of Congress and the President to address other priorities like healthcare and entitlement reform. This report will define deficits and will explain the appropriate way to measure them. It will also describe how current economic conditions and federal financial interventions have increased the deficit over time. Deficits can serve as a powerful instrument of fiscal policy. Differences between revenues and outlays determine whether or not the budget is in surplus or deficit, which often serves as a measure of the federal government's fiscal health. Annual budget deficits or surpluses determine, over time, the level of federal debt and affect the amount of annual interest paid to finance the debt. Occasional deficits, in and of themselves, are not necessarily problematic. Deficit spending allows governments to smooth outlays and taxes to shield taxpayers and program beneficiaries from abrupt economic shocks. Persistent deficits, on the other hand, lead to growing accumulations of federal debt that may lead to higher interest payments, tax increases, or spending cuts. Changes in economic conditions can cause movements in outlays (spending) or revenues and can lead to changes in the budgetary outlook. These can occur simultaneously or as a result of each other. Economic growth can stimulate employment and individual income, generally reducing certain types of spending and increasing revenue levels. During a recession reductions in consumption and increased reliance on government programs have the opposite effect. For example, in a strong economy, new jobs are often created. If the unemployed become employed and earn higher incomes, additional tax revenue would be generated. In contrast, in a weak economy, people may lose their jobs, which could lower tax revenue and increase government expenditures on programs such as unemployment insurance and food stamps. Economists refer to these changes as automatic stabilizers. Policy changes by the federal government to change spending or revenue levels (i.e., through the creation of new programs or through tax cuts) would also affect the size of the deficit. The dollar value of the budget deficit (or surplus), however, may give a partial and potentially misleading picture of the government's true fiscal condition. Deficits and debt levels are often measured as a percentage of GDP, rather than in dollar amounts. Measurement of deficits and debt as a percentage of GDP provides adjustments for inflation and relates the size of the deficit or debt to the size of the economy. The CBO baseline is an estimate of federal spending and receipts and resulting levels of surplus or deficit during a fiscal year, under existing law. Congress set forth specific rules for calculating direct spending, receipts, and discretionary spending baselines in Section 257 of the Balanced Budget and Emergency Deficit Control Act of 1985 (Title II of P.L. 99-177 ), as amended. A baseline provides a benchmark for comparing proposed budget policy changes to existing policies and indicating changes that may be necessary to meet certain budgetary goals. Therefore, the calculation of a baseline can be instrumental to the evaluation of budget policies. However, there are numerous uncertainties surrounding the baseline projections, especially in the out-years, and they cannot be thought of as absolute certainty of the government's fiscal condition. According to CBO, "[t]he baseline is intended to provide a neutral, nonjudgmental foundation for assessing policy options. It is not 'realistic,' because tax and spending policies will change over time. Neither is it intended to be a forecast of future budgetary outcomes." The proper way to use a baseline is as a rule-of-thumb estimate for the budgetary ramifications of current policy. This offers the policymaker a means to measure the relative effects of proposed legislation in the context of the overall budget. The deficit in FY2008 was $455 billion, or 3.2% of GDP, sharply higher than the FY2007 deficit of $162 billion (1.2% of GDP). In January 2009, CBO projected that the deficit would reach nearly $1.2 trillion (8.3% of GDP) in FY2009, which did not include the effects of the American Recovery and Reinvestment Act of 2009 (ARRA). At the request of Speaker of the House Nancy Pelosi and House Budget Committee Chairman Spratt, CBO released three alternative budget scenarios in February 2009. Under all of the scenarios, CBO projected a deficit of $1.4 trillion in FY2009, with the majority of the deficit increase from the January to February projections occurring as a result of ARRA. CBO also projected the continuation of deficits well into the future. This budgetary outlook is largely attributed to the effects of the economy as well as the significant federal financial interventions and stimulus legislation already passed by Congress. Additional actions may increase the deficit further. CBO also projects that the recession, probably the longest and deepest since World War II (WWII), will likely last well into 2009. The current condition of the economy will likely result in increases in outlays for mandatory programs, such as food stamps and unemployment benefits, also known as "automatic stabilizers," and increases in the deficit. Revenue collection is also projected to be lower largely due to declines in personal incomes and corporate profits. The deficit impact of these increases in outlays and decreases in revenues is accounted for in the CBO baseline. The projected deficit for FY2009 is high relative to historic standards. The deficit reached its peak in 1943 at 30.3% of GDP. After WWII, deficits remained relatively low until the mid-1980s. In FY1985, the deficit reached 6.0% of GDP. If the deficit in FY2009 reaches the projected level, it will likely be the highest deficit as a percentage of GDP since FY1946. Several significant federal financial interventions were enacted in 2008 and early 2009 in an effort to relieve the credit crisis and mitigate the economic affects of the recession on Americans. These include the enactment of economic stimulus in early 2008, the Housing and Economic Recovery Act (HERA) in July 2008, the Troubled Assets Relief Program (TARP) and its components in October 2008, the extension of unemployment benefits in November 2008, and the American Recovery and Reinvestment Act (ARRA) in February 2009. Other actions, such as interventions by the Federal Reserve (Fed) and the Federal Deposit Insurance Corporation (FDIC), have largely utilized existing or expanded authority. The long-term impact of these programs on the budget deficit is somewhat uncertain. The size, variety, and complexity of federal responses to financial and economic turmoil present many challenges to budget analysis. The ultimate costs of these responses will depend on how the economy recovers, how well firms receiving federal assistance weather future financial shocks, and whether or not the government receives positive returns on its asset purchases. Estimating how much these responses will cost the federal government is difficult, both for conceptual and operational reasons. In February 2008, Congress enacted the Economic Stimulus Act of 2008 ( P.L. 110-185 ) aimed at promoting consumption and investment by sending rebates to taxpayers and allowing firms to depreciate new capital investments more quickly. The costs of these provisions increased the deficit by $152 billion in FY2008 and by an estimated $16 billion in FY2009. The Housing and Economic Recovery Act (HERA, P.L. 110-289 ) provided new authority to address issues in the mortgage markets by allowing banks to write down the balance of existing loans so that borrowers can refinance and avoid foreclosure. The act also contained other provisions to help local communities acquire and redevelop vacant and foreclosed properties and created a new regulator for the government-sponsored enterprises (GSEs), Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The act gave Treasury the temporary authority to purchase debt and equity securities of the GSEs. The provisions of HERA increased the deficit by $1.4 billion in FY2008 and are expected to increase the deficit by $36.7 billion in FY2009 and $3.6 billion in FY2010. CBO's deficit estimate for FY2009 includes the addition of Fannie Mae and Freddie Mac, previously not accounted for in the budget. They have been included by CBO in their budget baseline because they were placed under direct control of the federal government on September 6, 2008. This action added $238 billion to the deficit in FY2009, an amount which represents CBO's estimate of the net present value of the current outstanding obligations and securities of the GSEs. These transactions are being recorded by CBO on a net present value basis rather than a cash basis.