4:48 pm
Tue February 3, 2004

Balancing the Federal Budget

Taxes may be a partisan issue but in an election year everyone is talking about spending.

Wilmington NC – [Click the LISTEN button to hear Dennis' commentary.]

It is hardly newsworthy to note that the Federal budget is sharply in the red. Most are aware that the Federal government?s finances have swung from a surplus in 2000, equal to 2.5 percent of gross domestic product, to this year?s deficit equal to 4.5 percent of GDP. While this is not the first time the budget has been deep in deficit, it is relevant to ask, what is being done to correct it?

At this point, it seems as if there is a bipartisan conspiracy to ignore the widening deficit. In the first three years of the Bush Administration, taxes were cut three times. This sharply lowered Federal revenue, much as early in the Reagan Administration. Back then, in 1983, tax cuts resulted in a record deficit, 6 percent of GDP.

This time around, however, there has also been a sharp increase in public spending. This is not only on war and homeland security, but also on domestic programs. For example, federal spending on education has increased by three-fifths since 2000, and spending on transportation programs has nearly doubled.

In 1983 Mr. Reagan and Congress worked together to reduce the deficit. Now, there appears to be no one with political influence willing to seriously address the situation. To some degree or another, all the presidential challengers want to roll back Mr. Bush?s tax cuts. Yet, none aim to lower the deficit ? all would increase public spending. The president?s own new program to pay prescription drug costs under Medicare adds 400 billion dollars to federal spending. Other new spending initiatives ? space exploration and marriage training to mention a couple ? are in the pipeline.

Some might wonder, what is the problem? After all, a couple years of large tax cuts and high Federal spending early in the Bush presidency did stoke the country?s economic fire. But, even as growth becomes robust, budget prospects look bleak. A recent report by the Congressional Budget Office shows that the costs of Social Security, Medicare, and Medicaid will claim a significantly larger share of the nation?s economic output over coming decades. An aging population and higher health care costs are principle causes.

Currently, payroll taxes for social security and medicare run a surplus. But by 2015 ? just 11 years away ? this surplus will swing to a deficit. Based on current benefit entitlements, outlays for these programs will increase from about 8 percent of GDP this year to about 20 percent by the year 2030. With these entitlement obligations, holding back the growth in so-called discretionary spending, that is, things such as defense and education ? even if it could be done ? would not ensure a sustainable budget.

This creates a problem of market confidence. If investors loose confidence in the ability of the government to manage its budget, they will demand higher returns for assuming government debt. This means higher interest rates ? and not just by a point or two, but a substantial turn up toward the double digit level. This would spread economic hardship to virtually everyone with debt ? mortgage holders, credit card users, business borrowers and more.

The Administration claims that it is preparing a budget committed to fiscal restraint. But, this is an election year, after all, and spending cuts for programs such as housing for the poor and job training seem unlikely, even if they would help the fundamental problem.

More realistically, it will take a serious commitment to cuts in corporate welfare such as subsidized insurance and loans, devolution of even more fiscal responsibilities to the states, and higher taxes to resolve the budget dilemma. As far as I can see, such initiatives do not yet appear on the political horizon.