Federal deficits: a brighter picture for now

When you are borrowing to pay your bills, the less debt you run up in a year, the better.

So it was good news when the nonpartisan Congressional Budget Office predicted Monday that the federal budget deficit would drop sharply for the year ending Sept. 30. CBO said the gap between government income and spending would be $331 billion in fiscal 2005.

The federal budget deficit the CBO is projecting for this year is the third largest in history, but nonetheless down sharply from last year's record $412 billion worth of red ink. In 2006, CBO says the deficit will fall a bit more to $314 billion.

A key question raised by the improving short-term budget picture is whether it will make it harder for Congress to control spending. "It is safe to say budgetary restraint has not been a high priority either for Congress or the Bush administration," says Gus Faucher, senior economist at the consulting firm of economy.com.

One example: before the summer recess, Congress embraced its spending side and approved the most expensive public works legislation in US history.

The $286.5 billion transportation bill signed by President Bush included some 6,371 earmarks for legislators' pet projects.

"Lawmakers who allow themselves to be lulled into thinking that the economy is growing its way out of the deficit are unlikely to support the painful measures needed to reach a more lasting solution," Goldman Sachs economist Edward McKelvey recently wrote to clients.

Some reaction to the CBO report had predictably partisan overtones.

"The strong economy, higher revenues, and falling deficit projections are all results of the successful leadership and policies of the Congress and president," stated House Budget Committee Chairman Jim Nussle. "We are clearly on the right track."

Kent Conrad of North Dakota, the top Democrat on the Senate Budget Committee, said "While this year's deficit will be lower than last year's record shortfall, the improvement is likely to be short lived. Declarations of victory over budget deficits only distract from the disturbing long-term budget outlook."

The new CBO report assessed both the short- and long-term outlook for the government's financial health.

The federal government's finances have "improved noticeably for this year" CBO Director Douglas Holtz-Eakin told a press conference. A 42 percent hike in tax payments by corporations has been a major factor in the improvement.

The CBO director said "we really don't know" if the increase will continue but added that it "doesn't look likely."

The CBO report cautioned that "the fiscal outlook for the coming decade remains about the same" - in a word, challenging. Among the tough financial issues the nation faces are higher Social Security, Medicare, and Medicaid spending as baby boomers prepare to retire.

By CBO estimates, federal spending for Social Security, Medicare, and Medicaid will increase from about 8 percent of the economy's total output (gross domestic product) in 2005 to between 12 and 17 percent of economic output in 2030. y 2050, those social programs, unless changed, would consume between 13 and 28 percent of GDP.

"Over the long term, then, growing resource demands for these programs will exert pressure on the budget that economic growth alone will not eliminate," the CBO said. Translated from economic speak, the message is that either programs will have to be cut or taxes raised.

The improved shorter-term budget figures are welcome news for the White House, which endured three years where each CBO report brought word of more red ink. "The president is committed to the combination of strong economic growth and spending restraint that will keep us on track to cut the deficit in half by 2009," said White House spokesman Scott Milburn.

But the CBO estimates actually show how hard it will be for the president to cut the deficit in half while at the same time accommodating tax proposals dear to the hearts of congressional Republicans.

The CBO estimates the deficit in 2009 would be $321 billion, some $60.5 billion above the president's goal. When the president said he would halve the deficit, it stood at $521 billion, so the presidential goal is $260.5 billion. Even with a phaseout in spending on Iraq and Afghanistan, the likely deficit would exceed $300 billion based on CBO data.

And the CBO baseline "does not include a lot of the president's priorities," says Economy.com's Faucher. "It kind of artificially makes the number look better than it otherwise would be."

For example, the CBO figures do not include the cost of overhauling the Alternative Minimum Tax (AMT), which affects more and more middle-income Americans.

Also not included is the cost of making permanent the cuts in dividend and capital-gains tax rates that Mr. Bush championed and are slated to expire in 2011.

"When you take into account the president's proposed extension of expiring tax cuts, continuation of current Alternative Minimum Tax relief, and a conservative estimate of future funding for the wars in Iraq and Afghanistan, projected deficits never dip below $330 billion over the next 10 years," said Richard Kogan, senior fellow at the Center on Budget and Policy Priorities.

Mr. Kogan estimates deficits would total $4.0 trillion over the 2006-2015 period.

The risk, Kogan says, is that the nation's debt could begin growing faster than the economy, a trend that, "is by definition unsustainable. Neither an individual nor family nor nation can increase borrowing by more than income. Sooner or later, creditors shut it down."