Semi-Daily Journal

The Rout of the Administration's Deficit Hawks

Back at the beginning of November, 2000, former Bush-the-First Council of Economic Advisers Chair Michael Boskin was very optimistic about fiscal policy in a Bush-the-Second administration. "You'll see Brad," he said. And he went on to outline how there were very good chances that a Bush-the-Second administration would greatly reduce the country's debt-to-GDP ratio and put Social Security and Medicare on a balanced long-run financial footing.

Alas! It has not worked out that way. Here David Rogers of the Wall Street Journal characterizes yet another stage in the rout of the Bush-the-Second administration's deficit hawks.

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POLITICS AND POLICY
FIGHTING DEFICITS: Congress Faces a Budget Crisis as Spending Plan Gets Stalled

As Elections Near, Daniels and GOP Struggle to Address Federal Deficit
By DAVID ROGERS, Staff Reporter of THE WALL STREET JOURNAL

WASHINGTON -- At the height of their revolution in 1995, House Republicans refused to extend the Treasury's borrowing authority unless President Clinton acquiesced to budget cuts. Now the same issue is back in the GOP's lap, only this time the debts have been incurred on the party's own watch. By a 68-29 vote, the Democrat-controlled Senate voted to raise the government's debt ceiling by $450 billion, the first increase in five years. The Treasury warned the House must do the same by June 28, but the vote poses a dilemma for Republicans, reminding them -- and voters -- how much their priorities have changed and their tactical differences with their own president.

As revenues fall, this year's deficit could exceed $150 billion, and White House Budget Director Mitchell Daniels Jr. says Congress must "get about the business of flattening" the rate of increased appropriations. But with Republicans relying on spending as a political tool to retain power in the House, the director often appears to be reduced to picking small budget fights because the big ones already are lost.

President Bush signed a costly farm bill last month without complaint, and Defense Secretary Donald Rumsfeld has proved his ability to get around Mr. Daniels and win more money for the soaring Pentagon budget. The White House is left to threaten a veto of an emergency spending bill to which the Senate wants to add $4 billion more than the president does for homeland defense. But the GOP never mounted an effective effort to pare the costs in floor debate last week, and the White House had to scramble just to get 22 votes in opposition.

Long before this year's farm bill, the GOP pumped billions into the agriculture economy, and government payments to farmers soared to more than $33 billion in fiscal 2000 -- the most recent election year. It was a Republican, former House Transportation Committee Chairman Bud Shuster of Pennsylvania, who led the way in accelerating spending from the highway trust fund. The National Institutes of Health budget, which has doubled in size in recent years, is a favorite GOP cause, and the political pressure to compete for swing independent voters makes it harder to live with the marginal spending increases Mr. Daniels wants for sensitive areas such as education.

Even as they struggle with the debt issue, House Republicans are preparing an election-year Medicare package, including a prescription-drug benefit, that will cost $350 billion over the next 10 years -- or near double what the administration budgeted. Mr. Daniels's goal is to get the budget back into balance by 2005, but that would appear to rule out any substantial new commitment for prescription drugs before then.

"The issue is not really where we are now but where we are headed," says Mr. Daniels, who was caught off guard by the drop in capital-gains revenues in the dismal stock market. He says it is "very iffy" now whether the government can be brought back into balance before 2005, and an increasing number of budget analysts predict next year's deficit could approach $200 billion.

Going into the November elections, Republicans had hoped to slide by the issue, using the soured economy and war against terrorism as an excuse for the return of large deficits. But Democrats are working hard to hold them accountable, and President Bush will find it even harder to duck in 2004, when he is likely to face opponents' attacks for rolling up -- not reducing -- the nation's debt.

By the end of the decade, "we will have paid down all the debt that is available to retire," Mr. Bush had predicted last year. The deficits now have emboldened Democrats to make more of an issue of the revenue loss that has resulted from last year's tax cuts, and a showdown vote is slated Wednesday in the Senate on a House-passed bill to permanently repeal the estate-tax.

The weaker economy certainly has contributed to the reappearance of the deficit. The Congressional Budget Office estimates that if growth falls by just 0.1 percentage point, it would reduce anticipated revenues by $1 billion the first year and $3 billion the second. But looking back, Mr. Daniels says he in fact used such conservative economic projections for the current fiscal year to build a revenue cushion even in the event of a downturn. Instead, he found his budget undercut by the stock market's impact on capital gains.

"We now know the models that we have been using are obsolete," Mr. Daniels says. "Individual income-tax revenue has become heavily dependent on trends in the stock market." A year late, Mr. Daniels concedes all the optimistic surplus projections last summer implicitly assumed an unrealistic steady growth in the same markets.

Economist John Youngdahl of Goldman Sachs & Co. agrees the shortfall so far this year largely has been due to a drop-off in capital gains last year. He notes that reported mutual-fund distributions of capitals gains fell to $69 billion in 2001 from $325 billion in 2000 -- a drop of almost 80%. Based on those numbers and other data, Goldman Sachs estimates net capital-gains income overall could have plunged by as much as 65%, or $400 billion, in 2001, he said.

The other side of the coin is that the deficit would be that much worse but for today's low interest rates and the debt already paid down. Government interest payments are almost $56 billion less than that just two years ago -- a 25% drop -- and represent enough savings to offset all the increased spending in the same period for education, transportation, veterans medical care, for example.

But as debt piles up again, and if interest rates increase, the same math will work in reverse and leave that much less room in a balanced budget for these priorities.

Posted by DeLong at June 11, 2002 09:37 PM