T Nation

Cutting the Deficit

There were many deficit hawks who came out of hiding during the campaign to bemoan the size of the deficit – I wonder if they are going to support Bush in his attempts to reduce it?

Sharpening the Knife
As Bush Vows to Halve Deficit,
Targets Already Feel Squeezed
Less Budget Funding for Aid,
Education, Cities, Science;
Bracing for the Boomers
Republican Governors Resist

December 21, 2004

WASHINGTON – In his first term, President Bush’s domestic policy focused on creating winners, through tax cuts, a new prescription-drug-benefits plan for seniors, large farm subsidies, big homeland-security contracts and increased spending for education, scientific research and more.

Now, with worries about the size of the deficit widespread, get ready for a second Bush term about identifying losers.

“This cannot afford to be a guns-and-butter term,” says Sen. Judd Gregg, the New Hampshire Republican who will be the Senate Budget Committee’s new chairman. “You’ve got to cut the butter.”

With guns – or military spending – growing, the butter is likely to include some of the most visible areas of domestic spending, including the Medicaid health program, subsidies to Amtrak, agricultural research and even some federal education programs.

In the just-finished fiscal 2005 budget, which came in 10 weeks late, big cities received less federal aid to comply with anti-pollution laws and job training requirements. The National Science Foundation, which underwrites the country’s basic research saw its funding cut from 2004 levels.

Funding for the National Aeronautics and Space Administration came in below Mr. Bush’s request, despite House Majority Leader Tom DeLay delaying a vote to get more money for the space program, which has major installations in his district. Even spending on the president’s own initiatives for education, health research and the promotion of economic and political change overseas were cut to levels below his requests or last year’s spending. A similar fate befell Laura Bush’s program to sponsor cultural events in local communities.

The resulting budget “was the wake-up call,” says Douglas Holtz-Eakin, a former Bush White House economist who heads the Congressional Budget Office.

Fights over what gets cut, and by how much, will likely become a defining feature of Mr. Bush’s second term. The president has pledged to halve the deficit, a promise that will likely clash with some of his pet policy initiatives. His vision of a Social Security overhaul requires more borrowing. Mr. Bush will also likely face opposition from cash-strapped Republican governors.

California’s Arnold Schwarzenegger, Jeb Bush in Florida and George Pataki in New York, among others, will likely resist attempts to shift the funding of major programs, such as Medicaid, to the states. Of the 38 governorships up for grabs in 2006, 22 are now held by Republicans. “All the Republican governors were pretty reserved because they wanted Bush to get re-elected,” says former Republican Rep. Vin Weber. “But they’re not going to keep quiet now.”

The Republicans who control Congress will also fight to avoid deep cuts in popular programs and to maintain their ability to bring home funds for local projects. So difficult were this year’s choices that Congress’s initial cuts weren’t deep enough to bring the budget within pre-set limits. In the end, lawmakers opted to cut all programs across the board. They even put off a highway-construction bill – a surefire way for Congressmen to find money for their states – until next year.

“I think you will see the emergence of George Bush the deficit hawk in the second term,” says Rep. Tom Cole, an Oklahoma Republican. The president’s prey, he adds, will be “the very spending Congress loves most.”

In Mr. Bush’s first two years, domestic spending – not including defense and entitlement programs such as Social Security and Medicare – grew roughly 10% annually. It grew 6.4% in his third year. The President and Congressional Republicans, for all their anti-spending rhetoric, have shown themselves to have big appetites for splurging on matters such as roads, farms, education and business subsidies.

In fiscal 2004, which ended Sept. 30, the U.S. registered its biggest-ever deficit in dollar terms: $412 billion. At 3.6% of gross domestic product, that deficit was proportionally smaller than those of the mid-1980s, which surpassed 5% of GDP. With economic growth, good weather, stricter spending discipline and a favorable turn in Iraq, the 2005 deficit could shrink. But the imminent retirement of the baby boomers and the inexorable rise in health-care costs makes the question of government spending more pressing.

Tax revenues now represent 16% of GDP, the smallest since 1959. Government outlays are at nearly 20%. By 2008, Mr. Bush’s final year in office, the oldest of the baby boomers will qualify for early Social Security benefits. That sets in motion a demographic tidal wave that will overwhelm that program – as well as Medicare and Medicaid – unless they’re changed.

Extra Demands

Meanwhile, big political and economic forces are putting extra demands on the Treasury. Overhauling Social Security, for example, will raise costs in the short term. The administration plans to borrow as much as $2 trillion over a decade to divert a slice of workers’ payroll taxes into private accounts. As for health care, administration officials say Mr. Bush has no intention of revisiting Medicare after the bruising 2003 fight to introduce health-saving accounts and add a prescription-drug benefit for seniors.

Mr. Bush has ruled out raising taxes and is widely expected to win an extension of his first-term income- and dividend-tax cuts, moves that will reduce revenues flowing into the Treasury beyond his presidency. Moreover, both Mr. Bush and Congress are committed to changing the alternative minimum tax, a levy designed to prevent rich taxpayers avoiding taxes altogether, which is about to ensnare about 30 million mostly middle-class Americans. Fixing the AMT will cut projected tax revenues by hundreds of billions of dollars.

As a result, deficit hawks including conservative Republicans, Federal Reserve Chairman Alan Greenspan and foreign investors who hold U.S. government bonds, have pressed Mr. Bush to practice the fiscal restraint he preaches. Their concerns have been buttressed by the weakening dollar, which raises the possibility that investors are losing confidence in U.S. economic policy.

The president campaigned for re-election on a promise to cut the deficit in half by the time he leaves office. The White House is basing its target on a 2004 deficit estimate it made last February of $521 billion, or 4.5% of GDP. A number of independent analysts said that number was inflated; at about the same time, the CBO predicted a deficit of $477 billion.

But finding areas to cut isn’t easy. Of the government’s $2.3 trillion spending this year, about 85% is almost untouchable by public consensus. About 20% of the total goes toward defense. Spending in that area has increased 55% on Mr. Bush’s watch. The war and reconstruction efforts in Iraq and Afghanistan are running about $5 billion a month, congressional analysts say. Mr. Bush has also embarked on ambitious plans to modernize the armed forces through the use of advanced technology.

Cutting Social Security benefits, which represent another fifth of the budget, is also off-limits – for now. An additional fifth is spent on Medicare and Medicaid health-insurance programs. A thinner slice goes to unemployment compensation, farm subsidies and other benefit programs.

Interest on the nation’s borrowing is a big and growing budget item, one that cannot be cut except by slashing the debt itself. The $168 billion in annual payments, much of it to overseas holders of Treasury bonds, represents just over 7% of the federal spending. That’s more than the government will spend on education, housing, transportation, science, space and technology combined.

The remaining discretionary funds – and the area Mr. Bush has targeted for shrinking – cover much of what many Americans typically think of as government work, including breast-cancer research, aid to rural and inner-city schools, veterans’ medical care, weather forecasting and park rangers. These annually appropriated activities accounted for about 18% of the federal budget in fiscal 2004.

For fiscal 2005, the growth in that domestic spending was held to just 0.8%. At that rate, spending in this area will decline as a portion of the overall budget. Yet the president aims to shrink this piece even further. In February, Mr. Bush will call for a spending freeze for fiscal 2006, according to people familiar with administration’s deliberations.

“It’s going to be a tough budget, no question about it, and it’s a budget that I think will send the right signal to the financial markets and those concerned about our short-term deficits,” Mr. Bush said yesterday at a White House news conference.

The cut in the National Science Foundation’s 2005 funding will mean about 1,000 fewer federal research grants. That will affect perhaps 2,000 senior university researchers and 1,000 science and engineering graduate students, estimates Joel Widder. A longtime NSF official, he now works for Lewis-Burke Associates, a company that helps universities navigate the government’s grant-approval process. Two years ago, the law that re-authorized the program promised that the NSF’s budget would double by 2007.

Pell grants, the main source of federal funding for disadvantaged college students, are frozen at $4,050 for the third consecutive year. During the same period, the cost of tuition at four-year public colleges has risen 28%, according to the College Board, the nonprofit administrator of the SAT, a national college-admissions test. The number of Pell recipients has also risen by over one million in that time, to more than five million, resulting in smaller average grants. The president received nothing for his proposed pilot program to give extra Pell funds to poor students who take college-preparatory courses in high school.

Funds for heating assistance to low-income households increased because of pressure from Northeastern Republicans, but it’s not enough to match the spike in energy costs. The final tally of almost $2.2 billion is $164 million below what’s needed, estimates the liberal Center on Budget and Policy Priorities.

Easier to Cut

This discretionary spending, which is about the same size as the deficit, isn’t the fastest-growing part of the budget by far. Why target that almost exclusively? White House Budget Director Joshua Bolten says this spending is easier to cut than entitlement programs such as Social Security, Medicare and Medicaid because it’s approved each year rather than mandated by legislation. “That is a lot of money that’s in that portion of the budget. It’s almost $400 billion,” he adds. Moreover, Mr. Bolten says, “in a time of war, there will be a priority for making sure that our defense needs and our homeland-security needs are met.”

With cuts in the domestic appropriations, and economic growth ahead, “we will be in very low deficit territory” by Mr. Bush’s exit, he predicts. Mr. Bolten says the president will declare victory if he gets the deficit down to 2.2% of GDP.

Governors of both parties are poised to fight any move to shuffle expenses in their direction. The White House is likely to target the joint state and federal Medicaid program for the poor, which increasingly goes to middle-class seniors who have exhausted their assets on nursing-homes costs. Mr. Bush is expected to propose changes that eventually move more costs to the states.

“That would be a disaster for us,” says Arkansas Gov. Mike Huckabee, the Republican vice chairman of the National Governors Association. “You can’t mask the deficit by cost-shifting.” With states only now emerging from their worst fiscal downturn in 50 years, and with Medicaid their fastest-growing cost, Mr. Huckabee says any such shift will force them to cut services, especially for rural residents and those needing long-term care.

Rep. David Price, a North Carolina Democrat, sits on the House Appropriations subcommittee where housing funds compete with popular veterans, space, science, community-service and environmental programs. Already, he says, officials in his district of Durham, N.C., have stopped taking low-income applicants for federal housing vouchers because the waiting list is too long. This year, Congress used a one-time accounting change to save $1 billion on public-housing costs, but that gimmick won’t be available for 2006.

Ultimately, some budget-watchers predict that Congress and the president will be forced to cut from the budget’s more intractable parts before the end of Mr. Bush’s term. Some even believe the option of raising taxes might be up for consideration.

“The pressures on [discretionary spending] is what, in the long-run, may force action,” says Eugene Steuerle of the Urban Institute think tank and a former Treasury official in the Reagan administration. Otherwise, he says, “ten years from now, there’s no revenues left for anything but defense.”

–David Rogers contributed to this article.

Write to Jackie Calmes at jackie.calmes@wsj.com

This is a long post but please read it! I put a lot of time into gathering the facts for it. (Evidently I have no life)

You are right Boston that the same individuals who complained about the growing deficit are going to be right there complaining when the Republicans try to fix it. Here’s a little story to back up that prediction.

Four years ago the BC Liberal party won a landslide victory over the long ruling (and extremely left-wing) NDP party. People were tired of the waste, the alarming deficit, and the long economic slide that had left our province in shambles and rated the worst performing economy in Canada.

The Liberals (who aren’t liberal at all, or affiliated with the federal Liberals - Canadian political parties are confusing) campaigned on a platform that centered on eliminating the deficit. Well guess what? Much to everyone’s horror they got to work right away and did everything they said they were going to do. They laid out a plan to eliminate the deficit in three years and then they worked backwards from there. They did this in conjunction with personal and corporate tax cuts.

I can go into all sorts of details but the major move was to immediately cut every ministry (I think you guys say department) other than health care and education by 25%. Before they took office, powerful labor unions were controlling the budgets of many provincial ministries. The Liberals looked the unions square in the eyes and would not back down. They also immediately set out to reduce the total regulatory burden by 1/3 during their first term.

The same people who gave this party all but three seats in the Legislative Assembly (a historically unprecedented victory) instantly turned on them. As soon as the government actually started to cut, their support dropped off the chart. For a while the hatred seemed almost unanimous. People were and continue to be outraged at the cuts and over the past four years have not been passing up a chance to make this outrage known. The polling has consistently looked bleak.

Their first term is almost up and I am terrified of what is going to happen come election day. Being a Liberal in BC is like being a Republican in California. I have a picture of me with the Premier (similar to your term governor) on my desk and I often consider hiding it when I have visitors. I know it is asking for trouble. Think about how incredible that is, that this party to go from being so hugely popular to so utterly despised just by doing exactly what they said they were going to do.

Of course, these policies take time to translate into tangible results, but are those results ever coming in now! It has been two decades and in some cases much longer since our province could make the following claims:

We a running a fiscal surplus and are about to make a large debt payment.

Our economy is experiencing strong growth, outpacing the national average.

We have the second strongest investment climate in Canada.

Housing starts in B.C. during the first ten months of the year have increased 24%.

B.C. is expected to have the highest percentage growth in housing starts in Canada this year.

Consumer confidence is ahead of the national average and up for the fifth month in a row.

Employment in B.C. has increased 9.4% since Dec. 2001, the strongest growth of all provinces and well ahead of the national average of 6.8% over the same period.

We are experiencing our fifth consecutive double-digit increase in exports.

Our provincial credit rating has been upgraded to AA by Standard and Poor’s.

The value of building permits in B.C. has increased 27.9% year-to-date - 3.5 times the national average of 7.9%.

B.C. also leads the provinces with the highest year-to-date increase in the value of residential building permits, a 37.6% increase, compared to the national increase of 16.3% over the same period.

We have posted the third largest increase in retail sales.

We lead the county with the largest gain in wholesale trade.

We have just experienced the largest quarterly net inflow of new residents (10,249) in a decade.

I could go on, but you get the picture.

Our province has achieved these things in spite of some of the biggest challenges we have ever faced, including crippling U.S. softwood lumber tariffs, export bans due to mad cow disease, the pine beetle epidemic that is destroying our forests, the worst forest fires in history, and SARS.

Guess what? In spite of all of these acheivements, I am near certain, and current polling shows, that the people of British Columbia are not going to re-elect this government. Why? Because people are stupid. No actually, people are fucking brain dead. I don’t like to swear very often, but I’m making an exception for this.

JPBear –

Yeah, lots of people are for decreasing spending on everything – except anything that benefits them or sounds as if it could benefit them.

People decried the rise of the deficit during Bush’s first term, but it was pretty classic Keynesian economics – do deficit/stimulus spending during an economic downturn. The flipside is that you turn around and cut spending and pay down that debt when the economy turns back around. The main fights will be over what is “cut” (realize that in Washington budgetary parlance, a “cut” means not increasing spending as fast as whoever is complaining wants it increased – very few programs are actually “cut” in terms of actual dollar -amount spending – or even in terms of the real (inflation-adjusted) value of the spending).

Hey JPBear. That sounds just like another country I read about. Unfortunately I cannot remember which one. They cut everything to the bone, completely dumping their previous socialist style economy. And the last I heard they are not only booming economically, but their federal debt is shrinking.

Too often people are fooled by shallow thinking. They cannot see beyond the week, if even the day. This ignorance is what keeps infomercials for things like the ab lounger in business.

How can you get people to understand the benefits of government spending cuts when most people live on credit cards with little or no investments?

This is similar to how many people are fighting against the privatization of social security. Yet a simple look at the math shows how much better it would be to privatize social security. (This will annoy a few people here.)

People pay more then 12% into social security. (Including employer matching.) If you take a person making $6 an hour, he pays $1,500 into social security each year. If invested at 10% annually, he would have over $1 million in less then 40 years. And remember that includes 40 years of no raises.

Anybody expect even half of that from the current system?

Now Bush is only suggesting 2%, so that same person would only have about $244,000 after 40 years. (Again with 40 years of no raises.) Then again if his wife also worked for 40 years at $6 an hour, she would have the same amount, so they would have about $488,000 between the both of them. Not too shabby.

This combined with little or no government debt could bring about an era of prosperity never imagined.

Oh yeah, before people start complaining about all the debt created by taking that little 2% out of the social security, just imagine what happens when those with the 2% invested start retiring, and the remaining 10+% starts going into social security. Any debt will be wiped out in no time.

Don’t tell anyone, but our budget deficit is shrinking…


January 13, 2005, 2:20 p.m.
Psst, the Deficit?s Shrinking
Why won?t anyone say it?

Here?s one story you won?t find on tomorrow?s front pages: ?The U.S. Budget Deficit Is Shrinking Rapidly.? The headline would be accurate, but the mainstream media is much more interested in talking down this booming economy than telling it like it is.

This week?s Treasury report on the nation?s finances for December shows a year-to-date fiscal 2005 deficit that is already $11 billion less than last year?s. In the first three months of the fiscal year that began last October, cash outlays by the federal government increased by 6.1 percent while tax collections grew by 10.5 percent. When more money comes in than goes out, the deficit shrinks.

At this pace, the 2005 deficit is on track to drop to $355 billion from $413 billion in fiscal year 2004. As a fraction of projected gross domestic product, the new-year deficit will descend to 2.9 percent compared with last year?s deficit share of 3.6 percent.

Wire reports are loaded these days with accounts of an expanded trade gap (driven mostly by slower exports to stagnant European and Japanese economies, along with higher oil imports from the peak in energy prices). But there?s not a single report I can find that mentions the sizable narrowing in U.S. fiscal accounts. Behind this really big budget story is the even-bigger story: The explosion in tax revenues has been prompted by the tax-cut-led economic growth of the past eighteen months.

With 50 percent cash-bonus expensing for the purchase of plant and equipment, productivity-driven corporate profits ranging around 20 percent have generated a 45 percent rise in business taxes. At lower income-tax rates, employment gains of roughly 2.5 million are throwing off more than 6 percent in payroll-tax receipts. Personal tax revenues are rising at a near 9 percent pace.

Meanwhile, in the wake of strong stock market advances over the last two years, non-withheld revenues from individuals ? including investor dividends and capital gains that are now taxed at only 15 percent ? have jumped by over 14 percent.

Following the Clinton cap-gains tax cut and savings expansion bill of 1997, investment-related tax collections led to bull-market budget surpluses in the pre-9/11 period of 1997-2001. However, despite the flood of new revenues, this year?s federal budget is still overspending. Domestic spending on non-entitlement programs (excluding homeland defense) is rising at a 4.1 percent rate. That?s more than twice the pace of core inflation. But this may be changing.

According to the Washington Post, the Bush budget totals planned for fiscal year 2006 may be essentially unchanged from the totals for fiscal year 2005 (excluding defense and homeland security). According to reporter Jonathan Weisman, the administration?s first really tough budget request (due out next month) ?would freeze most spending on agriculture, veterans and science, slash or eliminate dozens of federal programs, and force more costs, from Medicaid to housing, onto state and local governments.?

The rapid growth of federal health care and other entitlements would also be slowed markedly. Though the numbers are not yet available, this sounds a bit like Ronald Reagan?s tax-cutting budget of 1981. In addition to reducing the top personal tax rate to 50 percent from 70 percent, the Gipper proposed budget cuts that would be worth nearly $100 billion in today?s dollars.

Of course, the political screaming over the forthcoming budget has already begun. A passel of Democrats and at least one Republican, Sen. Craig Thomas of Wyoming, have written a protest letter to Josh Bolten, director of the Office of Management and Budget. Former-Gov. John Engler of Michigan, a Republican and the current president of the National Association of Manufacturers, has pledged to fight the elimination of various protectionist subsidies to his member firms.

However, Sen. Judd Gregg, the New Hampshire Republican who is the current chair of the upper chamber?s budget committee and a long-time Bush ally, is set to support the administration?s new budget discipline. This includes, by the way, Bush?s plan to reduce Social Security benefits by replacing wage indexing with a price-level formula and extending the retirement age ? one or the other, or both ? in return for personal saving accounts.

By the way, Treasury Secretary John Snow just completed a Wall Street tour where leading bond traders told him not to sweat the transitional costs for personal accounts. The traders said that an additional $100 billion a year over the next decade for transitional financing will be easily manageable. ?A rounding error,? one senior trader told Snow.

A supply-side tax-reform movement, a shrinking budget deficit, newfound spending discipline, and a determination to confound conventional wisdom by reforming Social Security has George W. Bush?s second term off to a roaring start ? even before he is officially sworn in.

? Larry Kudlow, NRO?s Economics Editor, is host with Jim Cramer of CNBC?s Kudlow & Cramer and author of the daily web blog, Kudlow?s Money Politic$.

I love it when Supply-Side Economics works - which is every single time it’s applied.

I wonder if the left will still stand by their pat ‘we can’t afford a tax cut’ mantra.

How dare you insert facts into this discussion? Oh wait, none of the liberals are discussing this.

But I hope Bush keeps his promises and actually slashes spending. Something that has been foreign to him in the past. He got half of it right, but he needs to get the other half right also.

I like the sound of that deficit falling.

But, to reiterate a point Mage made, supply-side economics do not entail drunken spending, nor does it necessarily entail wild deficits.

For true fiscal conservatism to work its practical magic, not only must taxes be kept low, but government spending as well. The pork in the last budget was shameful.