By Brian Faler

Jan. 7 (Bloomberg) — The U.S. budget deficit will more than double this year to at least $1.18 trillion, driven up by the federal bailout of the financial industry, Fannie Mae and Freddie Mac, according to the Congressional Budget Office.

Next year’s shortfall will reach at least $703 billion, the nonpartisan agency said in a biannual report today. Those estimates don’t include the cost of President-elect Barack Obama’s pending economic stimulus package, which will likely add at least $750 billion to the total over the next two years.

The 2009 shortfall, also fueled by sagging tax revenue and increased costs due to the recession, would represent at least a 160 percent increase from last year’s $455 billion deficit. The estimate is for the fiscal year that ends Sept. 30.

As a share of the nation’s economy, which economists say is the best measure of a deficit’s size, this year’s shortfall would amount to 8.3 percent of the nation’s gross domestic product, the report said. That would be the biggest of the post-World War II era, topping the previous record set in 1983 when it reached 6 percent of the economy.

“The federal fiscal situation in 2009 will be dramatically worse than it was in 2008,” the report said. “The ongoing turmoil in the housing and financial markets has taken a major toll on the federal budget.”

The agency said it expects the recession to continue into the second half of this year, estimating the economy will shrink in 2009 by about 2.2 percent. It said it expects a “slow” recovery to begin later this year before the economy grows by a “modest” 1.5 percent in 2010. The report projected the unemployment rate will top 9 percent next year.

National Debt

The deficit, the annual difference between government spending and tax receipts, is financed by money borrowed from investors here and abroad. That money is tacked onto the national debt, which now stands at approximately $10.6 trillion, and must be paid back with interest.

The CBO said it expects the government’s interest payments to shrink this year by more than 20 percent to $195 billion, despite the growing debt, because of plummeting interest rates. Those costs will likely increase in coming years, though, doubling by 2014, the agency said.

“CBO’s deficit projections are jaw-dropping,” said Senate Budget Committee Chairman Kent Conrad, a North Dakota Democrat. “This is one of the worst budget forecasts I have seen in my lifetime. President-elect Obama is being handed an absolute fiscal disaster.”

Similar Shortfalls

The estimate comes one day after Obama warned he expects to inherit the first-ever trillion-dollar deficit and that similar shortfalls are in store as the government grapples with recession and other spending demands.

“Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on,” Obama said. Today he named Nancy Killefer, a former Clinton administration official, as chief performance officer to “scour” the government’s budget in search of potential savings.

The government is seeing increased costs on a number of fronts. The takeover of Fannie Mae and Freddie Mac added $200 billion to this year’s deficit while the financial industry bailout added another $180 billion. Unemployment compensation costs will nearly double to $79 billion because of growing joblessness and expanded benefits approved by Congress while public nutrition assistance costs will grow by 27 percent to $50 billion, the agency said.

World War II

The increased spending means the size of the government, with federal expenditures amounting to 24.9 percent of the nation’s economy, will be bigger than any time since World War II, the agency said.

Meanwhile, CBO said, the flow of tax receipts into the Treasury will slow because of the recession and the slump on Wall Street. It estimated revenue will be down this year by $166 billion or about 6.6 percent, with corporate receipts down by 27 percent and individual income tax revenue dropping by 8 percent. Overall, revenues are projected to drop to 16.5 percent of the economy.

Lawmakers favor pushing ahead with Obama’s stimulus package in the face of the record shortfall because experts warn the economy is in such bad shape that the alternative would be much worse.

“Despite the record deficits facing us, our number one task is an economic recovery package,” said House Budget Committee Chairman John Spratt, a South Carolina Democrat. “With Americans concerned about their jobs, their homes, their retirement and their children’s future, our economic situation is so severe that stabilizing the economy must take precedence over short-term deficits.”

New Budget Rules

The CBO estimate is likely to spur calls in Washington for new budget rules that might help stanch the flow of red ink once work on the stimulus package is complete. That could make it harder for Obama to make good on some of his campaign promises.

Senate Majority Leader Mitch McConnell called the report a “stunning and sobering reminder that Congress must strengthen its efforts to be good stewards of the taxpayers’ money.”

Senator Judd Gregg, the top Republican on the Budget Committee, said “it is time for the Democratic leadership in Washington to tighten its belt and find savings where it can so that we safely weather this economic storm and put the nation back on sound fiscal footing.”

To contact the reporter on this story: Brian Faler in Washington at