Cost of Katrina to hit budget hard

Think of it as the financial equivalent of another Iraq war.

Relief efforts for the storm-ravaged Gulf Coast throw a huge fiscal burden onto a US Treasury that is already deep in the red.

Spending tied to hurricane Katrina has hit as much as $2 billion per day, or about 10 times the amount the United States is spending on military operations in Iraq. The pace will slow, but the recovery effort could easily cost the federal government $150 billion, experts say. Spread over a couple of years, that would roughly match the $6 billion a month being spent in Iraq.

As staggering as these numbers are, the question is not whether America can absorb this shock but whether it will alter the mind-sets of policymakers and financiers on other budget matters.

Already, for example, some US law- makers cite the storm as a reason to reconsider plans to cut entitlement programs, which would shrink government assistance to the poor by $35 billion over five years. At the least, the looming tab for everything from road repairs to business loans is a reminder that America's current budgetary path is not sustainable.

"It just compounds the problems we're already in," says Linda Bilmes, a Harvard University economist. "Any money that we spend on Katrina is more money that we have to borrow and pay interest on. There's less money ... for doing all the other things we want to do."

The magnitude of Katrina's devastation and the government's slow initial response argue in favor of generous spending to help the Gulf region recover. The danger is if investors who finance America's debts begin to worry about a profligate Congress.

"If foreigners took this as a leading indicator that we were going to become irresponsible in the budget in a great variety of ways ... you could have a negative psychological effect," says Rudolph Penner, a former director of the Congressional Budget Office.

Interest rates could tick upward if demand for US Treasury bonds ebbs. That danger is, for now, hypothetical. Readiness of investors to buy US debt is one reason long-term interest rates remain low today.

But the storm-surge of spending does weaken Washington's balance sheet. Even as spending rises, tax revenues from Gulf workers and businesses will fall. The fiscal 2006 budget deficit could shoot from $314 billion to $400 billion or more.

"It really depends crucially on how many people you want to compensate," says Mr. Penner, now with the Urban Institute in Washington. "If you include farmers in Iowa [whose grain shipments have been disrupted], then it could expand mightily."

The tally could include costs such as:

• Strengthening New Orleans' defenses against future floods.

• Promoting the return of businesses to the almost-vacant city. Making the Big Easy a big tax-free zone is one idea on the table.

• Making low-interest loans to small businesses along the Gulf Coast.

• Providing aid to evacuees, which could include costs for education, healthcare, and unemployment insurance that would be paid by states under normal circumstances. States could also be reimbursed for providing temporary shelter.

• Covering rebuilding and cleanup costs. These could range from highway and bridge repair to removal of environmental hazards.

• Giving financial assistance to homeowners who lacked flood insurance. Of perhaps 150,000 flooded homes in New Orleans, about 40 percent don't have coverage. The level of such aid could become a source of controversy, with critics arguing that it's a bailout that simply encourages future irresponsibility.

• Compensating storm-affected industries such as farming.

With these and other provisions under consideration, this relief effort promises to set a record for disaster spending. Congress has already approved $62.3 billion in emergency spending on the storm.

"While some people are talking about $200 billion, a number like $100 [billion] to perhaps $150 billion might be a better guess as to what's really needed," says Richard Kogan, an economist at the Center for Budget and Policy Priorities.

Recovery costs will represent only about 1 percent of America's $12 trillion annual economic output. By that standard, and because these are one-time costs, the impact on the budget is manageable, economists say.

Still, because every dollar of new spending expands the federal deficit, Katrina will add $5 billion or more in annual interest costs long after relief efforts are complete.

A potentially positive outcome, Mr. Kogan says, would be "if Katrina encourages people to think more about the long term" budget outlook.

Current trends, with entitlement costs poised to rise and with proposed tax cuts outstripping spending cuts, are not sustainable, many economists say.

Now, given the temporary post-storm political climate, President Bush's tax-reduction agenda may be in jeopardy. GOP leaders plan to delay a vote on extending tax breaks on dividends and capital gains, The Wall Street Journal reported Tuesday.

Meanwhile, some lawmakers question a pre-Katrina budget plan to scale back entitlements for the poor. "It makes no sense to consider such a bill at a time when the massive needs of those affected by hurricane Katrina are still being assessed," Sen. Harry Reid (D) of Nevada and Rep. Nancy Pelosi (D) of California wrote last week to Republican leaders in Congress.