LACK OF ACTION ON DEFICIT SIGNALS UNDUE COMPLACENCY
The budget deficit continues to ratchet upward, and there is no
consensus on what, if anything, to do about it. At best, Washington
policymakers seem content to tread water in the rising
tide of red ink. At worst, they are cynically professing concern
about the deficit while pursuing tax and spending policies they
know will only dig the fiscal hole deeper. One thing is clear:
specific plans to actually reduce the deficit are not on the
agenda. Such complacency is not warranted.
Federal Reserve Board Governor Edward M. Gramlich summarized
the challenge at a recent Concord Coalition forum
where he admonished policymakers, “now that the recovery is
well under way, it is important to concentrate on longer-run
fiscal policy. Specifically, it is time to bring the budget deficits
under control. Doing so will, of course, require action in the
political arena.”
Unfortunately, fiscal policy this year has featured wishful
thinking and creative accounting rather than actions to control
the deficit. The President’s budget claims to cut the deficit in
half over five years but omits the likely cost of ongoing military
operations in Iraq and Afghanistan, assumes a freeze on nonsecurity
appropriations and pretends that relief from the growing
alternative minimum tax (AMT) will be temporary. Moreover,
its 5-year window ignores the 10-year revenue loss of
making the President’s tax cuts permanent.
In Congress, deficit reduction talk has produced actions that
only make it more difficult to close the gap. A sensible proposal
to reinstate “pay-as-you-go” rules (PAYGO) for both tax cuts
and entitlement expansions was rejected. House appropriators
rejected the idea of statutory spending caps. A bipartisan plan
in the Senate to offset the revenue loss from extending three
expiring “middle class” tax cuts was brushed aside, as was a
similar proposal by the House Blue Dog Democrats. Efforts to
offset the new spending and tax cuts in the transportation
reauthorization bill, and the corporate tax bill have come up short
as demonstrated by the fact that $43 billion in identical offsets
have been claimed for both bills. Negotiators on the defense
authorization bill are considering plans to increase personnel,
expand benefits and delay a new round of base closures.
Meanwhile, the appropriations process appears headed for
its now routine debacle a massive omnibus bill that simply
delays inevitable hard choices on spending priorities.
The deficit cannot be dismissed as a self-correcting problem.
Even assuming strong economic growth, plausible
projections for the 10-year outlook show deficits of about
$5 trillion. The longer-term outlook is worse. If policymakers
want to get out of this hole, they are going to have to stop
digging and start climbing. Deficits matter.
SHORT-TERM GRADE: C-MINUS
In the short-term, the most promising fiscal policy development
may be that some politicians in both parties are beginning
to recognize the danger of rising deficits and demanding
offsets for the costs of new initiatives. It remains to be seen,
however, whether this good intention will translate into
actions that actually get the deficit under control.
By most projections, the deficit will peak this year and then
decline in 2005 and 2006. Yet the desire of many policymakers
to extend expiring tax cuts, with or without offsets, and the
need to fund military operations abroad and security needs at
home will likely keep the deficit at unusually high levels.
Earlier this year, the Congressional Budget Office (CBO)
projected a fiscal year 2004 deficit of $477 billion a record
in dollar terms and tied for the third worst in over 40 years
when adjusted for the business cycle and other temporary
factors (see chart above). Since then, however, revenue
growth has been stronger than expected and the actual deficit
for 2004 will likely be closer to the $445 billion deficit that the
Bush administration (OMB) now projects.
Does that mean that current policies are bringing the deficit
down? No. For one thing, the deficit is going up, not down.
It is true that when CBO issues its next forecast, the
projected deficit will be lower than it wasjust as the
OMB's projected deficit has declined since February. What
matters, however, is the bottom line and there can be no
denying that a deficit of $445 billion, or close to it, is
considerably larger than last year’s deficit of $375 billion.
Policymakers bear direct responsibility for correcting this
situation but they seem willing to let the economy do all the
heavy lifting. It is a strategy with limited potential. While
the economy can probably be counted on to produce a
budgetary boost in the short-term, this alone will not be
nearly enough to close the gapparticularly if policymakers
use the proceeds of a growing economy to raise spending
and cut taxes.
Meanwhile, not a single piece of legislation has been
enacted this year that makes any hard choices designed to
cut the deficit. It cannot be said, therefore, that fundamental
progress has occurred even if the deficit projections
change slightly for the better. Assisted by the growing
economy and political gridlock, Washington policymakers
get a polite C-minus on their short-term fiscal stewardship.
It is important to note, however, that this grade is better
than last year’s failing grade. One reason is that Congress
and the President appear willing to hold the line on, or even
cut, discretionary programs unrelated to national security.
The potential savings are modest, however, because these
programs account for less than 20 percent of total federal
spending. Indeed policymakers would have to virtually
eliminate these programs next year if they wanted to close
the budget gap. Moreover, there is the very real threat of
a lame duck Congressional session in which policymakers
will turn to a large omnibus bill, encompassing all discretionary
spending except defense. The past has shown that
such legislation could include billions of last-minute spending
increases under circumstances that can shield Congress
from accountability.
Another short-term plus is that Congress is starting to push
for a more complete and accurate accounting of the costs
to fight the global war on terrorism. As this endeavor will
last longer than the next six months, it is disingenuous for
the Administration to only request funding in short-term
increments. The CBO estimates that the war costs may
increase by up to $35 billion over the amount requested so
far by the administration for 2005. The Government Accountability
Office (GAO) reports that the military has
already gone through its supplemental funds for the war
this year and will have to cannibalize other accounts
causing a “bow wave” of deferred costs to hit the budget
later on. Congress is right to put its foot down in insisting
on more information and a longer-term perspective.
Congress can also be complimented for its renewed
interest in budget enforcement rules intended to help rein
in the deficit. While such rules will not balance the budget
on their own they can help reluctant lawmakers to “do the
right thing.” To be effective, however, there must be a
consensus about what the rules are supposed to accomplish
and the political will to stick with them. That crucial part
of the equation is still missing
MEDIUM TERM GRADE: D
The ten-year outlook remains as worrisome as ever. Absent
a change of course, deficits totaling $5 trillion are likely under
plausible assumptions. Most problematic in this bleak picture
are expiration dates, or "sunsets," embedded in the tax cuts
passed over the last three years. While the official 2005-2014
revenue loss of $1 trillion is a significantly large amount, the
actual cost of the tax cuts explodes to around two-and-a-half
times that when not hidden by sunset gimmickry. The cost is
even larger if one assumes Congress will be forced to fix the
AMT. Even a partial fix will cost over $500 billion.
No consensus has developed over how the sunsets should be
dealt with. When Congress reconvenes in September, it will
try again to reach agreement on extending three popular
"middle class" tax cuts that expire this year. Earlier talks
broke down over whether to extend them for two years or five
years and whether to find offsets for the revenue loss.
Whatever Congress decides in this regard, the revenue loss
will be offset. The only question is whether the offset will be
LONG-TERM GRADE: F
Washington has been consumed this year with reports of
intelligence failures leading up to the September 11 attacks
and the war in Iraq. Many have concluded that the official
agencies entrusted with giving policymakers timely warnings
about developing problems failed in that mission. No such
charge can be leveled against those who are entrusted to
provide warnings about our fiscal future. Here, the warnings
have been timely, loud and clear. Any “intelligence failure”
rests squarely with policymakers who hear the warnings and
choose to ignore them.
From the Social Security and Medicare Trustees to Federal
Reserve Chairman Alan Greenspan to the GAO, CBO, and
OMB, those in charge of the programs and those who analyze
the programs have consistently informed policymakers that
Social Security and Medicare promise far more in future
benefits than they can afford to deliver. The multi-trillion
dollar long-term shortfalls are well documented and well
known. There is no shortage of “actionable intelligence” on
this subject. For example, U.S. Comptroller General David
Walker has warned, "Absent reform, the nation will ultimately
have to choose between persistent, escalating budget deficits,
significant tax increases, and/or dramatic budget cuts...Taken
together, Social Security, Medicare, and Medicaid represent
an unsustainable burden on future generations."
Similarly, the Congressional Budget Office cautioned in a
recent report, "If taxation is restricted to the levels that
prevailed in the past, the growth of entitlement spending will
have to substantially reduced. Restricting the growth of
outlays for defense, education, transportation, and other
discretionary programs would not be enough to ensure fiscal
sustainability. Likewise, economic growth alone is unlikely to
bring the nation's long-term fiscal position into balance.
Moreover, issuing ever-larger amounts of debt or dramatically
raising tax rates could significantly reduce growth."
In spite of these clear warnings, Washington policymakers
have chosen to avoid taking any action to rein in the long-term
cost of Social Security and Medicare. With the baby boom
generation poised to retire in a few short years, Washington
has rallied around the “Do Nothing Plan” for Social Security,
added to the long-term liabilities of Medicare, and set off on
a fiscal path that is likely to add trillions to our National Debt
over the next ten years. This is a “hat trick” of thoroughly
irresponsible fiscal policy, and earns an F.
in the form of more borrowing, rather than spending cuts, or
revenue increases elsewhere in the budget.
Circumstances have changed dramatically since 2001. The
tax cuts can no longer be justified as “refunding a surplus” and
whatever short-term stimulus the tax cuts provided has
already helped the economy grow out of the recession. The
country now faces endless deficit spending that, if left
unchecked, will reduce national savings and private sector
investment, potentially suppressing future economic growth.
An added complexity is that Congress is considering another
large tax bill, this one masquerading as an international tax
system reform. In reality, the corporate tax bill is a boondoggle
of special-interest corporate welfare with costs hidden
by unrealistic sunsets. The House version officially costs
$35 billion, however, the non-sunset cost hovers around $200
billion. By infusing this bill with budget gimmickry, instead of
workable revenue neutrality, policymakers have made it
incredibly difficult to control vote-buying through special
interest fiscal giveaways and have reduced a necessary bill
to Congressional pork-barreling at its worst.
Policymakers are also considering an expensive 6-year reauthorization
of the TEA-21 transportation spending bill. While
the proposals from the Senate, House and President have
provisions for raising some revenue to offset increased
spending, each would add from $12 to $32 billion to the federal
budget deficit, according to the Senate Budget Committee.
However, a fiscally responsible solution is not impossible. If
the revenue proposals from the Senate bill were combined
with the restrained spending the President has proposed, the
bill would not add to the deficit. Unfortunately, the overall
environment in Washington these days makes such a compromise
the least likely outcome.
The debate about the middle class tax cuts, the corporate tax
bill, and the transportation bill is laudable in one sense. There
are supporters of each who admit that offsets and deficit
neutrality are worthy goals. The problem is that proponents
of all three bills use some of the same offsets. This is a game
of musical chairs: once one is passed, the others’ costs will
immediately jump. Worse yet, the negotiations necessary to
find more offsets might prove to be so difficult that Congress
will avoid offsets altogether. A responsible strategy would be
to first use the package of offsets for the middle class tax cuts
that are already in place, before enacting wholly new tax cuts
or expanding transportation programs without raising fuel
taxes. While spending on war has historically been unpredictable
and deficit financed, there is no excuse for deficit
financing transportation’s planned multi-year projects, especially
at a time when the fiscal situation has deteriorated.
Policymakers get a D for their medium-term actions. Perhaps
their most notable recent accomplishment is that they
have not done anything as irresponsible as simultaneously
passing a prescription drug benefit while enacting another
large tax cut, as in 2003. There have also been some small
victories. Attempts to convert certain veterans programs and
special education funding from discretionary to mandatory
spending have been turned aside for now. The problem is not
that these programs are unworthy—but that turning them into
an entitlement shields them from any fiscal scrutiny.
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