RED A COUN­TRY IN THE

Bush deficits likely to mount, CBO says

The Washington Times Weekly - - National - BY DAVID M. DICK­SON

As the U.S. gov­ern­ment em­barks on a fi­nan­cial-res­cue mis­sion — whose cost is im­pos­si­ble to pre­dict — the na­tion is al­ready headed for a sus­tained pe­riod of bud­get deficits on a scale never seen be­fore, said Peter R. Orszag, di­rec­tor of the Con­gres­sional Bud­get Of­fice.

Mr. Orszag re­cently out­lined a sce­nario in which $7 tril­lion in cu­mu­la­tive deficits could be piled up over the next 10 years.

The so-called “on-bud­get deficits,” which ex­clude So­cial Se­cu­rity sur­pluses, would ex­ceed $9 tril­lion over the next 10 years, CBO data re­veal.

Un­der the plau­si­ble fis­cal-pol­icy sce­nar­ios detailed in CBO’s lat­est “Bud­get and Eco­nomic Out­look,” which was re­leased ear­lier this month, the bud­get deficits for 2017 and 2018 could ex­ceed $1 tril­lion each year.

Tril­lion-dol­lar deficits would be arriving just as the cash-flow sur­pluses from So­cial Se­cu­rity turn into cash-flow deficits, a de­vel­op­ment that would re­quire the fed­eral gov­ern­ment to use gen­eral rev­enues to meet So­cial Se­cu­rity ben­e­fit pay­ments.

If the pro­jec­tions hold true, th­ese deficits would be­come the pri­mary force that would add $10 tril­lion to the na­tional debt, more than dou­bling it by 2018.

“Un­for­tu­nately, that’s the good news,” Mr. Orszag said, “be­cause there­after we start to ex­pe­ri­ence the longer-term bud­get pres­sures that are at the heart of the long- term fis­cal prob­lems the na­tion faces.”

David M. Walker, the for­mer comp­trol­ler gen­eral of the United States, said, “It is very pos­si­ble that the num­bers could be worse” than the 10-year, $7 tril­lion deficit pro­jected by the CBO di­rec­tor. Mr. Walker, who, as head of the Gov­ern­ment Ac­count­abil­ity Of­fice, con­ducted a na­tion­wide Fis­cal Wake-Up Tour chron­i­cled in the doc­u­men­tary “I.O.U.S.A,” re­cently be­came pres­i­dent and CEO of the Peter G. Peter­son Foun­da­tion, which was es­tab­lished to alert Amer­i­cans about the forth­com­ing fis­cal cri­sis.

The im­pact of $700 bil­lion deficits

If the deficits un­fold as Mr. Orszag projects, “it would clearly have an ad­verse long-term ef­fect on our eco­nomic po­si­tion, but the scarier thing is that it is just the beginning. Baby boomers don’t be­gin re­tir­ing in big num­bers un­til af­ter 2018, when a fis­cal tsunami could swamp our coun­try,” Mr. Walker said.

It is worth not­ing that none of th­ese fig­ures in­cludes a dime of costs that the tax­payer might be forced to bear af­ter the gov­ern­ment’s re­cent takeover of mort­gage-fi­nanc­ing giants Fan­nie Mae and the Fed­eral Home Loan Mort­gage Corp. (Fred­die Mac) and other bailouts.

Mr. Orszag es­ti­mated deficits av­er­ag­ing $700 bil­lion per year would “hover” in the 4 per­cent to 5 per­cent range of gross do­mes­tic prod­uct (GDP).

Ex­cept dur­ing the 1940s, when bud­get deficits dur­ing World War II av­er­aged 22 per­cent of GDP, the 1980s was the only decade since the beginning of the 20th cen­tury when deficits av­er­aged more than 4 per­cent of GDP. Ac­cord­ing to a study by Lawrence H. Sum­mers, the Har­vard econ­o­mist who served as Sec­re­tary of the Trea­sury un­der Pres­i­dent Clin­ton, real (inflation-ad­justed) in­ter­est rates for short-term busi­ness loans av­er­aged 4.1 per­cent dur­ing the 1980s, a level higher than any other decade since 1900.

In the near term, the U.S. bud­get deficit will likely ex­ceed half a tril­lion dol­lars for the first time ever in fis­cal 2009, which be­gins Oct. 1, Mr. Orszag said. That’s more than three times the $162 bil­lion bud­get deficit for 2007.

Com­pared with the $236 bil­lion sur­plus in 2000, Amer­ica’s an­nual fis­cal sit­u­a­tion will have de­te­ri­o­rated by three-quar­ters of a tril­lion dol­lars in 2009.

The sober­ing deficit num­bers would se­ri­ously com­pli­cate the tax and spending poli­cies of the in­com­ing ad­min­is­tra­tion, re­gard­less of who is elected. “The next pres­i­dent, who­ever he is, will be forced to tackle this prob­lem,” said Maya MacGuineas, pres­i­dent of the non­par­ti­san Com­mit­tee for a Re­spon­si­ble Fed­eral Bud­get.

“Deficits of that mag­ni­tude or even smaller mag­ni­tude do im­pose eco­nomic costs be­cause they slow the rate at which we’re ac­cu­mu­lat­ing cap­i­tal over time for the fu­ture and thereby im­pair our fu­ture in­come,” Mr. Orszag said.

“Most economists would say that bud­get deficits of that scale would tend to push up in­ter­est rates in the United States,” said Robert E. Scott, a se­nior in­ter­na­tional econ­o­mist at the Wash­ing- ton-based Eco­nomic Pol­icy In­sti­tute. The ris­ing in­ter­est rates would ap­ply to gov­ern­ment bor­row­ing, to mortgages for home buy­ers, to bonds fi­nanc­ing busi­ness in­vest­ment and to loans for in­ter­est-rate-sen­si­tive con­sumer pur­chases, such as au­to­mo­biles, Mr. Scott said. As a re­sult, “ris­ing in­ter­est rates could slow the U.S. econ­omy,” he said.

“For the past decade, there has been tremendous de­mand for U.S. fi­nan­cial as­sets, and we haven’t seen a big run-up in in­ter­est rates de­spite re­cent large bud­get deficits,” Mr. Scott ac­knowl­edged. “But the hous­ing de­ba­cle could change that by rais­ing the risk pre­mi­ums.”

If an­nual deficits were sus­tained at a $700 bil­lion level, they would dam­age the U.S. econ­omy in both the short term and long term by push­ing up in­ter­est rates and crowd­ing out in­vest­ment, which would lower fu­ture pro­duc­tiv­ity gains, ex­plained Brian A. Bethune, chief U.S. fi­nan­cial econ­o­mist at Global In­sight.

Diane Lim Rogers, chief econ­o­mist at the Con­cord Coali­tion, a non­par­ti­san grass-roots or­ga­ni­za­tion ded­i­cated to elim­i­nat­ing the bud­get deficit, agreed that cur­rent and on­go­ing fis­cal ir­re­spon­si­bil­ity would ex­act a price in terms of fu­ture eco­nomic growth.

“We are go­ing to see higher in­ter­est rates be­cause even the world cap­i­tal mar­kets have lim­its, and we are test­ing those lim­its,” Ms. Rogers said. “We have been lulled into the sense that bor­row­ing is cheap, but that is about to change as we bump up against the world’s cap­i­tal con­straints.”

If Amer­ica post­pones clos­ing to­day’s fis­cal gap by mak­ing it even larger by run­ning deficits av­er­ag­ing $700 bil­lion per year, it sim­ply means that the cost of clos­ing the gap to­day will be­come three times as high af­ter we dig the fis­cal hole deeper and deeper, she es­ti­mated.

“Such a large, sus­tained bud­get deficit would usu­ally be ex­pected to put up­ward pres­sure on in­ter­est rates, es­pe­cially in an econ­omy with such a low sav­ings rate — at least if it is not off­set by large in­flows from abroad on very gen­er­ous terms,” said Brad W. Setser, a fel­low for geoe­co­nomics at the Coun­cil on For­eign Re­la­tions and the au­thor of the “Fol­low the Money” blog. “Run­ning sus­tained, large, long-term deficits in a coun­try with such a low pri­vate sav­ings rate is risky.”

Mr. Setser also said that re­ly­ing on the rest of the world, es­pe­cially for­eign gov­ern­ments, to pre­vent up­ward pres­sure on U.S. in­ter­est rates would re­quire a huge in­flow of fi­nan­cial cap­i­tal from the rest of the world and likely from cen­tral banks in­ter­ven­ing in the mar­ket to keep their cur­ren­cies down. More­over, the at­ten­dant ex­ter­nal trade deficits would be un­healthy for the U.S. econ­omy, would ex­ac­er­bate

trade-pro­tec­tion­ist sen­ti­ments in the United States and would worsen the cur­rency con­flicts the United States has with China, he said.

Bud­get deficits for the pre­vi­ous 40 years have av­er­aged 2.4 per­cent of GDP. The 2009 deficit of $530 bil­lion would be 3.6 per­cent of GDP, and that as­sumes the econ­omy grows by 0.8 per­cent in fis­cal 2009. The en­act­ment of a sec­ond eco­nomic-stim­u­lus pack­age could eas­ily tip the 2009 deficit above $600 bil­lion, and a re­ces­sion could shift it above $700 bil­lion, or more than 5 per­cent of GDP.

The largest post-World War II deficit in re­la­tion to GDP — 6 per­cent — occurred in fis­cal 1983, when un­em­ploy­ment av­er­aged more than 10 per­cent. In con­trast, CBO projects the un­em­ploy­ment rate will av­er­age 5.1 per­cent for the 2009-2018 pe­riod, when deficits would “hover” in the range of 4 to 5 per­cent of GDP. Worth not­ing is the fact that from 1983 through 1987, when bud­get deficits av­er­aged 4.8 per­cent of GDP, real in­ter­est rates were ex­cep­tion­ally high.

In­ter­na­tional di­men­sions of U.S. debt

Deficits in the range pro­jected by Mr. Orszag al­most cer­tainly would re­quire the United States to be­come in­creas­ingly in­debted to for­eign coun­tries, which owned 45 per­cent of Amer­ica’s pub­licly held debt at the end of fis­cal year 2007 (up from 15 per­cent in 1985).

“The fed­eral debt will grow at an un­sus­tain­able rate, which means more bor­row­ing from China, more bor­row­ing from Ja­pan and more bor­row­ing from oil ex­porters like Saudi Ara­bia,” said Sen. Kent Con­rad, North Dakota Demo­crat, who chairs the Se­nate Bud­get Com­mit­tee. As for­eign in­vestors hold larger shares of U.S. gov­ern­ment debt, in­ter­est pay­ments on that debt would in­creas­ingly go abroad.

Years ago, a stan­dard Eco­nomics 101 ar­gu­ment held that the na­tional debt was not a prob­lem be­cause we owed nearly all of it to our­selves and Amer­i­cans re­ceived the in­ter­est pay­ments. If that was true in 1970, when for­eign­ers owned 5 per­cent of pub­licly held debt, it can­not be true to­day, with for­eign in­vestors own­ing 45 per­cent of that debt.

If for­eign in­vestors balk at fi­nanc­ing ever-larger U.S. gov­ern­ment debts, per­haps be­cause they fear a de­pre­ci­at­ing dol­lar, then the deficits would have to be fi­nanced in­ter­nally. This, too, would tend to raise in­ter­est rates be­cause the U.S. econ­omy has so lit­tle sav­ings to­day.

Pres­i­den­tial prom­ises

Just as Pres­i­dent Clin­ton felt com­pelled to break his cam­paign prom­ise to en­act a mid­dle-class tax cut in or­der to con­cen­trate on re­duc­ing a bud­get deficit that av­er­aged 4.6 per­cent of GDP dur­ing 1990 and 1991 and 4.8 per­cent through­out the 1980s, the next pres­i­dent may be forced to re­ar­range pri­or­i­ties in the face of the un­end­ing on­slaught of red ink that will greet him on Inau­gu­ra­tion Day.

In­her­it­ing an an­nual bud­get deficit nor th of $500 bil­lion, which is far more likely on its way to $1 tril­lion than to zero, a Pres­i­dent Obama could feel con­strained by the mar­kets, if not by a Demo­cratic Congress, in his ef­forts to dra­mat­i­cally ex­pand gov­ern­ment-sub­si­dized health-in­sur­ance cov­er­age ($65 bil­lion per year) and to elim­i­nate the “dough­nut hole” in the Medi­care pre­scrip­tion-drug pro­gram ($43 bil­lion per year). Those are only the health pro­grams.

Just as Mr. Clin­ton deep-sixed his mid­dle-class tax cut in 1993, will Mr. Obama feel obliged to can­cel or de­lay his re­fund­able “Make Work Pay” tax credit ($72 bil­lion per year), his re­fund­able “Saver’s” tax credit ($21 bil­lion per year), his re­fund­able col­lege tax credit ($13 bil­lion per year) and his re­fund­able “Uni­ver­sal Mort­gage” tax credit ($13 bil­lion per year)? What will be­come of his $15 bil­lion per year green-tech­nol­ogy pro­gram, his $6 bil­lion per year in­fra­struc­ture-rein­vest­ment bank and his $15 bil­lion per year in­crease in ba­sic re­search? (The cost es­ti­mates were pro­vided by the Com­mit­tee for a Re­spon­si­ble Fed­eral Bud­get.)

In an en­vi­ron­ment of half-tril­lion-dol­lar deficits on their way to be­ing dou­bled, where might a Pres­i­dent McCain find the funds to fi­nance the re­duc­tion in the top cor­po­rate in­come-tax rate from 35 per­cent to 25 per­cent, which could cost $68 bil­lion per year?

Im­pact on the na­tional debt

Large bud­get deficits will, of course, raise the na­tional debt, which was $5.6 tril­lion at the end of fis­cal 2000. It is now $9.6 tril­lion. Be­fore con­sid­er­a­tion of any costs from the Fan­nie and Fred­die takeover, the na­tional debt would in­crease by $10 tril­lion dur­ing the next 10 years un­der the plau­si­ble sce­nario that Mr. Orszag out­lined.

The na­tional debt, which ex­ceeded 120 per­cent of GDP at the end of World War II, reached its post­war low of 33 per­cent of GDP in 1981. It is 67 per­cent to­day. Un­der Mr. Orszag’s fis­cal sce­nario, the na­tional debt would reach 87 per­cent of GDP in 2018. That also as­sumes no re­ces­sions, which al­ways cause the deficit and the na­tional debt to rise faster than oth­er­wise.

CBO’s plau­si­ble sce­nario

To ar­rive at the 10-year, $7 tril­lion deficit, CBO made sev­eral as­sump­tions, which mostly ex­tended cur­rent pol­icy. For ex­am­ple, CBO as­sumed the Bush tax cuts, which are sched­uled to ex­pire at the end of 2010, would be ex­tended through at least 2018.

In ad­di­tion to ex­tend­ing vir­tu­ally all of the Bush tax cuts, Repub­li­can pres­i­den­tial nom­i­nee Sen. John McCain, as noted, would also cut the top cor­po­rate in­come tax rate from 35 per­cent to 25 per­cent. Sen. Barack Obama, the Demo­cratic nom­i­nee, would ex­tend all the Bush tax cuts for those earn­ing un­der $250,000, while giv­ing sub­stan­tial tax re­lief to lowerand mid­dle-in­come house­holds.

CBO also as­sumed the rou­tine ex­ten­sion of other tax pro­vi­sions, such as the pop­u­lar re­search and de­vel­op­ment tax credit, which both candidates sup­port. CBO as­sumed Congress and the White House would con­tinue to ad­just the al­ter­na­tive min­i­mum tax (AMT) for inflation, a po­si­tion each pres­i­den­tial can­di­date em­braces. In fact, Mr. McCain has promised to elim­i­nate the AMT.

CBO as­sumed that the num­ber of troops in Iraq and Afghanistan would be re­duced from about 175,000 to­day to 30,000 by 2011. Given that the United States al­ready has more than 30,000 troops in Afghanistan and that both pres­i­den­tial candidates want to ex­pand that force, this as­sump­tion seems very rea­son­able, if not overly op­ti­mistic.

Fi­nally, CBO as­sumed that dis­cre­tionary spending, ex­clud­ing fund­ing for the global war on ter­ror­ism, would grow at the same rate as nom­i­nal GDP. That would mean dis­cre­tionary spending would re­main at the same per­cent of GDP that it is to­day.

Notwith­stand­ing both candi- dates’ pledges to con­tinue in­creas­ing U.S. mil­i­tary forces and the need to re­place much of the equip­ment lost in Iraq and Afghanistan, this last CBO as­sump­tion still might seem overly gen­er­ous on the spending side, ac­cord­ing to James R. Hor­ney, the di­rec­tor of fed­eral fis­cal pol­icy at the Wash­ing­ton, D.C.-based Cen­ter on Bud­get Pol­icy and Pri­or­i­ties.

If dis­cre­tionary spending, which ex­cludes in­ter­est pay­ments and en­ti­tle­ments such as So­cial Se­cu­rity, Medi­care and Med­i­caid, were to grow only by the rate of inflation, CBO projects that the 10-year cu­mu­la­tive deficit would to­tal $5.75 tril­lion, or $575 bil­lion per year. Mr. Hor­ney es­ti­mates a deficit that size would av­er­age about 3.1 per­cent of GDP, com­fort­ably above the av­er­age for the past 40 years.

Looking at the past, Ms. MacGuineas of the Com­mit­tee for a Re­spon­si­ble Fed­eral Bud­get be­lieves CBO’s as­sump­tion about dis­cre­tionary spending is re­al­is­tic. Since Democrats would be very ag­gres­sive in meet­ing their per­ceived pent-up spending needs, the pur­suit of “a faster growth rate of spending is not at all out of the realm of the pos­si­bil­ity, and seems likely to oc­cur if Democrats con­trol both the White House and Congress,” she said.

“Deficits av­er­ag­ing $700 bil­lion per year are cer­tainly out­side the com­fort zone,” Ms. MacGuineas said. “Given that this is the first year baby boomers have be­come el­i­gi­ble for So­cial Se­cu­rity, there is no ex­cuse for not sav­ing in ad­vance.”

“If you think th­ese num­bers are bad,” said Mr. Walker, the for­mer GAO head, “you ain’t seen noth­ing yet. We are headed for un­prece­dented deficit and debt lev­els that threaten our fu­ture econ­omy, our stan­dard of liv­ing, our in­ter­na­tional stand­ing and our na­tional se­cu­rity.”

UNITED PRESS IN­TER­NA­TIONAL

Pres­i­dent Bush makes a state­ment on the econ­omy out­side the Oval Of­fice ear­lier this month. He has been meet­ing with ad­vis­ers con­cern­ing the bank­ing de­ba­cle.

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