The state of the federal government’s finances is an important factor for the health of the nation’s housing markets. Federal fiscal policy can affect interest rates, if for example the government runs large fiscal deficits over a long period of time. Tax policies, necessary to pay for government spending, can also influence housing and small business decisions.

With that in mind, the Congressional Budget Office has published its new baseline forecasting the state of the nation’s finances over the next decade (Budget and Economic Outlook: Fiscal Years 2011 Through 2021).

The CBO predicts that fiscal year 2011 will see the largest federal budget deficit of the Great Recession – approximately 9.8% of Gross Domestic Product or nearly $1.5 trillion. Total debt held by the public will equal nearly 70% of GDP (many economists believe that when the debt level approaches 90% of GDP, the probability of a fiscal crisis increases substantially).

CBO’s predictions for economic growth are in line with other forecasters; 3.1% GDP growth for 2011. They also see little changes in unemployment (moving from 9.6% in 2010 to 9.4% for 2011) and interest rates (the 10-year Treasury note rate moving from 3.2% in 2010 to 3.4% in 2011).

It is worth noting that the CBO baseline must assume present law over the budget window (10 years). Thus, CBO assumes that the 2001 and 2003 tax cuts, which were extended in December for another two years, expire as currently scheduled. If CBO used a present policy baseline, which would assume current policy is extended indefinitely, some of their projections would change.

For example, CBO forecasts that in 2021 federal debt held by the public will total approximately 77% of GDP; a high level but likely short of crisis levels. But under a present policy baseline, the federal debt in 2021 would total 97% of GDP, according to the CBO.

The reasons for this increase in debt are multiple, but two stand out. Extending the tax cuts adds a little less than 2% of GDP to the deficit each year. Extension of current Medicare reimbursement rates (the so-called “doc fix”) adds 2.4% of GDP to the deficit.

Regardless, under present law CBO forecasts, total Social Security, Medicare and Medicaid spending is set to increase from $1.5 trillion in 2010 to $2.9 trillion in 2021. Even with the sunsetting of the 2001/2003 tax cuts, CBO forecasts a structural gap between federal spending and federal revenues of 3.2% of GDP in 2021.