The $62.5 billion voted last week for relief of the sufferers from Hurricane Katrina throws light on an important budget truth. The games Congressional budget-busters have been playing since 1999 and the George W. Bush administration since 2001 are about to come to an unpleasant end. The Federal budget is becoming boxed in by reality.
The greatest structural problem with the U.S. budget is on the spending side. Under the 1990 Byrd Rule tax cuts cannot be made permanent, but must be re-authorized at fairly frequent intervals, thus giving tax raisers the chance to oppose them on economic or policy grounds, or to demand new spending in return for their acquiescence. Thus the abolition of the estate tax passed in 2001 may never take effect, since it costs too much to make it permanent.
On the spending side, on the other hand, additional spending items such as Katrina relief and Iraq war spending fall outside the budget process in the year they are authorized, but are then included in the spending base from which the following year’s budget is calculated, thus permanently raising the level of federal spending as a percentage of the economy.
It is this, not President George W. Bush’s tax cuts, that makes it likely that the federal budget deficit of $331 billion (2.7 percent of Gross Domestic Product) in the year to September 30 2005 (according to the August 15 Congressional Budget Office projections) will increase rapidly over the next decade. Officially, the Congressional Budget Office, responding to a request from Rep. John Spratt (D.-SC) predicted September 8 that the budget deficit, assuming that the 2001-2003 tax cuts are made permanent and the President’s Social Security reform is enacted, will widen moderately over the next decade to $640 billion in the year to September 30 2015, 3.2 percent of GDP. Revenues will remain at or a little below their current level, close to the post-1960 historical average, of 17.5 percent of GDP (17.4 percent in 2015) while expenditures will rise slightly from 20.2 percent of GDP in 2005 to 20.6 percent of GDP in 2015.
However, as Congressional Budget Office Director Douglas Holtz-Eakin explained to the National Economists Club Thursday, the August 15 projections, and their September 8 refinement to Rep. Spratt, rest on a number of assumptions, mandated by legislation, that are unlikely to be valid. On the revenue side, they assume a gradual increase in the share of government revenues produced by the federal income tax. This is because under the mandated assumptions corporate taxes are projected to decline as a share of revenues, for two reasons.
First, corporate tax payments have been exceptionally high in 2005, producing $269 billion compared to $189 billion in 2004. Holtz-Eakin’s staff believe this to be temporary, caused partly by exceptionally cheap money inflating operating profits, and partly by legislative changes such as the 6.5 percent excise tax on repatriation of foreign profits, which has produced a one-time surge in tax payments. The CBO assumes that corporate profitability and taxes thereon will be at their long term average in 2015; this assumption seems reasonable, provided the U.S. economy remains in good shape.
Second, corporate defined benefit pension plans are currently hugely underfunded (by $354 billion at December 2004, according to the Pension Benefit Guaranty Corporation.) The CBO assumes that this underfunding will be corrected by 2015, producing tax writeoffs. This seems unlikely, given the political pressures on the pension funding legislation. More likely, pension underfunding will continue, or be corrected by a rise in interest rates (reducing the necessary funding) rather than by a surge in corporate pension funding contributions. In that event, corporate pension contributions may increase somewhat, as the CBO predicts, but this effect will be swamped by the pension fund defaults that will occur, swelling the deficit in the PBGC’s own funds (already $23.3 billion at the end of 2004) and forcing a commensurately large federal bailout of the PBGC.
Overall, therefore, the CBO’s revenue projections may be somewhat conservative. It is likely if policies continue on their present track that federal revenues will increase modestly as a percentage of GDP over the next decade.
The real holes in the CBO projections are on the expenditure side. By law, the CBO has to assume that discretionary spending (excluding items such as Social Security and Medicare that are mandated by prior law) will increase only at the rate of inflation, and that “supplemental” items such as Iraq and Katrina will be only temporary. However, the last year that discretionary spending increased only at the rate of inflation was 1999, not coincidentally the last year for which former Speaker Newt Gingrich (R.-GA), who took spending control seriously, held overall responsibility in the House of Representatives.
Since Dennis Hastert (R.-IL) took over the Speakership in December 1998 (the first budget year for which he was responsible being 2000) discretionary spending has consistently increased faster than inflation, and the Budget finally passed by Congress in each year has consistently exceeded that proposed by the White House (of either party) for that year by at least $25 billion.
Both Hastert’s tenure as Speaker and the Bush administration’s propensity to propose large supplemental items seem likely to remain part of the landscape until at least 2009. Consequently, the CBO’s expenditure assumptions seem highly optimistic. In the six years 1999-2005, federal discretionary spending increased by 68.2 percent, compared to a 34.4 percent increase in nominal GDP or by 9.05 percent per annum compared to 5.06 percent per annum. Should discretionary spending continue to increase until 2015 at this rate of roughly 4 percent per annum faster than GDP, then total federal spending in 2015 will be 26.0 percent of GDP, not 20.6 percent of GDP as projected by the CBO in the Spratt letter. The federal budget deficit (excluding increased interest costs on the extra deficits incurred in 2006-2014) will be 8.6 percent of GDP, or 1,562 billion.
If you believe that in 2015 the world will be happy to absorb $1.5 trillion per annum of new U.S. government debt, I don’t!
Things could change; indeed, they will have to. First, we could have a big recession, which would throw off the CBO’s baseline deficit projection in the wrong direction and make everything much worse.
Ignoring that doom-laden projection (which I regard as extremely likely) we can consider more hopefully the possibility that Bush, Hastert and their successors may “get religion” and start tailoring their programs to reflect the budgetary realities:
- No more expensive foreign wars
- No more generous new Medicare entitlement programs
- No more pork-barrel highway and transportation bills
- No more huge new federal departments created, like the Department of Homeland Security.
- No more exciting new social spending initiatives, like the education “No Child Left Behind Act.”
- No more supplemental appropriations to deflect political blame after natural disasters
- No more gigantic increases in agriculture subsidies, to protect GOP Congressmen from the farm belt.
Hastert has recently shown himself keen to cut spending, even if this meets with political opposition – by not rebuilding New Orleans! This makes perfect sense economically – leave in place only the tourist attraction of the original “French Quarter,” which has remained above the flood, and move everything else to higher ground in the suburbs, where it is safe from the Mississippi’s depredations. Politically, it makes no sense at all, and is unlikely to be carried out.
Guess what, Dennis – public spending restraint means restraint on Republican pet projects as well as Democrat ones, and austerity in Illinois as well as Louisiana!
One thing is completely clear. Once the capital markets wake up to the true size of the federal deficit problem, being President or Speaker of the House of Representatives will be no fun at all.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.