Don't let America's red ink scare you

America is running a hefty budget deficit but fret not. The deficit sky is not yet falling.

David R. Francis

When President Obama presents his budget for fiscal 2011 on Feb. 1, the cries of fiscal alarm over his projected deficit will be loud.

After all, last fiscal year's deficit surged to a record $1.42 trillion, more than three times the fiscal 2008 level. This year's is almost certain to set a new record for red ink.

But don't despair for the nation yet.

"It's absolutely not as hopeless as some of the deficit hawks would have you believe," says Josh Bivens, an expert at the left-leaning Economic Policy Institute in Washington and author of a 24-page paper defending the present need for a huge deficit to counter current economic weakness.

Lack of political consensus means deficit reduction will be "extremely hard," says James Horney, one author of a lengthy study by the Center on Budget and Policy Priorities. But "it can be done."

A key hurdle for politicians is that many taxpayers regard themselves as overtaxed. Here are some numbers to put that view in perspective.

•The federal tax burden is at its lowest level in the postwar period. As a proportion of gross domestic product (GDP), revenues stood at 15.8 percent in fiscal 2009, calculates the Congressional Budget Office (CBO). That postwar record reflects the combination of already low tax rates with the deep recession's impact on profits and earnings, which has further cut tax revenues.

•Federal spending, on the other hand, reached a new modern high of 26.8 percent of GDP, the nation's output of goods and services. The result: the massive deficit. The CBO projects revenue will rise to 18.7 percent of GDP in fiscal 2011, as the economic recovery progresses. Spending will decline in terms of GDP to 22.8 percent, a bit above usual.

•Compared with citizens of other industrial nations, Americans pay relatively low taxes. Federal, state, and local taxes together amounted to 26.9 percent of GDP in 2008. The average for 19 European member nations of the Paris-based Organization for Economic Cooperation and Development: about 38.8 percent.

One reason for Europe's higher tax burden is the cost of government-paid healthcare for all citizens. Indeed, the future trajectory of government healthcare costs is a key – perhaps the key – determinant of whether politicians can rein in deficits.

In a limited way, the US fiscal deficit will be self-correcting as the recovery progresses. The big banks will perhaps reduce the deficit by paying new fees, and they won't be adding to the red ink. Key mortgage guarantors Fannie Mae and Freddie Mac will suffer reduced losses. Any new stimulus package will probably be less than the $787 billion approved last year.

Further, if Congress can't agree on what to do about the 2001 and 2003 Bush tax cuts before they expire at the end of the year, revenues will rise about $210 billion a year. If Obama's proposal to not harm anyone making less than $250,000 a year prevails, only a third of that extra revenue will flow to Washington.

Over the past 30 years, Congress has balanced the federal budget only four times, notes Mr. Horney. Full balance isn't necessary, figures Mr. Bivens.

Both agree that the real key to avoid skyrocketing deficits in the longer run means sharply restraining the growing costs of healthcare – Medicare, Medicaid, and any new health scheme.

That won't be easy. The insurance industry will fight to hold onto profits. The medical industry will resist real income cuts.