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Dizzying Dive to Red Ink Poses Stark Choices for Washington By DAVID FIRESTONE
ASHINGTON, Sept. 13 — When President Bush informed the nation last Sunday night that remaining in Iraq next year will cost another $87 billion, many of those who will actually pay that bill were unable to watch. They had already been put to bed by their parents.
Administration officials acknowledged the next day that every dollar of that cost will be borrowed, a loan that economists say will be repaid by the next generation of taxpayers and the generation after that. The $166 billion cost of the work so far in Iraq and Afghanistan, which has stunned many in Washington, will be added to what was already the largest budget deficit the nation has ever known.
With a force that has surprised even critics of the administration, the Iraqi occupation has pushed to the forefront a budget deficit that had previously existed mostly as an abstract red stain on Democratic bar charts. With no extra money available for the foreseeable future, real choices are being illuminated on Capitol Hill — choices between electronic bombs and electrical grids, between low taxes now and lower retirement payments later.
Should Washington reconstruct Iraq's schools and hospitals, lawmakers are asking, or America's? Should it pay for more than 100,000 American troops to stay in Iraq, or for 40 million seniors to be offered prescription drugs through Medicare? And if it tries to do it all, should it keep cutting taxes?
The Bush administration says it can do all of the above, once the tax cuts inaugurate a burst of economic growth. Democrats and virtually every mainstream economist say that something will have to give, very possibly the government's retirement promises to millions of aging baby boomers.
These questions have emerged as the most fundamental political issue dividing the two parties, affecting almost every vote on Capitol Hill and every speech in the current presidential campaign. The deficit, once confined to Congressional committee rooms and Washington research organizations, has become a constant refrain among all the Democratic candidates, who use it to attack the administration's tax cuts and financial stewardship. (None, however, have proposed a cutback in spending or a serious rethinking of big-ticket entitlement programs.)
The bleak choices now facing politicians and policy makers were hard to imagine when George W. Bush was inaugurated just 32 months ago, before the drastic turnabout of the federal budget. As the decade opened, the overheated economy of the 1990's had left the government with a flush of cash that seemed never-ending. There were 281 billion extra dollars in the budget that year, and the Bush administration, looking a decade ahead, predicted that a cumulative $5.6 trillion surplus would build up by 2011.
It seemed to be the brink of a golden era for Washington, "an unprecedented moment in history," in the words of the administration's first budget plan, issued a month after Mr. Bush was inaugurated. He vowed that almost all the national debt would be paid off and that retirement and health plans would be strengthened for the future by setting aside trillions in savings. Balanced budgets, so long in arriving, seemed to promise an end to wasteful interest payments and years of arguments pitting military spending against domestic programs.
And then, within months, the glittering promises crumbled. The budget was upended by what economists now say were three independent forces gathering in power at once: a steep economic decline, a political consensus to slash taxes and the effects of the 2001 terrorist attacks. The surplus disappeared, replaced the next year with a budget deficit that has since grown to a record size. The $5.6 trillion surplus once predicted for the 10 years ending in 2011 is now a $2.3 trillion cumulative deficit under the best-case prediction issued by the Congressional Budget Office two weeks ago.
The $8 trillion difference between those numbers has little precedent in American history. The long-term budget forecast has declined as much in the last two years as the total revenue collected by the United States government from 1789 to 1983.
A Fall Worthy of Milton
"It really has been a Miltonian experience, from the heights to the depths," said Robert D. Reischauer, a former director of the Congressional Budget Office, invoking "Paradise Lost" as a metaphor for the budget's fall.
The current fiscal year, which ends this month, was supposed to have ended with a surplus of $353 billion, the Congressional Budget Office predicted two years ago; today, the office says the year will end in a $401 billion deficit. Next year's deficit was projected to be $480 billion, but the new Iraq spending will bring that to $540 billion or higher — close to the 5 percent of the gross domestic product that many experts warn is a serious danger zone for the economy.
And now the painful effects of the budget's free fall are beginning to emerge. Though the deficit hardly spells ruin for the federal government, it already means spending battles over a variety of popular nonmilitary programs, from education to space flight to veterans hospitals. To make room for the initiatives the administration favors — like $1.5 trillion in tax cuts and at least $100 billion in new defense spending — other programs are being squeezed more tightly than they have been in years.
Disputes have broken out in Congress this year on spending items that used to be routine, like construction of housing for military families, which the administration proposed cutting by 6 percent. The administration invoked the deficit earlier this year in explaining the size of its proposed 2004 budget for the Environmental Protection Agency, which was 5.5 percent less than this year's spending. (Congress is likely to restore some of those funds.) And next year's budget could fall short of paying for more than 100,000 housing vouchers now used by low-income families, said a study by the liberal Center for Budget and Policy Priorities; it would be the first time in 30 years that existing vouchers were not renewed.
The pressure is likely to get worse, particularly if the occupation of Iraq continues to consume $4 billion a month. Joshua Bolten, the White House budget director, said in a recent interview that this coming year's 4 percent increase in discretionary spending might well be reduced below 4 percent in 2005, which would be far below the average recent increase for programs that are not entitlements. Congressional Republicans deny the Democratic charge that the deficit was deliberately created to shrink government, but nonetheless acknowledge that it will be a useful tool to achieve that goal.
"There's no question that annual federal deficits have been the only effective check on Congressional spending in the modern era," said Representative Mike Pence, an Indiana Republican and a member of a conservative House caucus pushing for big cuts in spending. "There's been a lot more willingness on the part of our appropriators to exercise discipline in the last eight months than in the previous Congress. It doesn't justify all that red ink, but it's kind of a silver lining in that cloud."
Mr. Pence was referring to cuts in existing programs, but both the administration and the Democrats have proposed dozens of new spending items, from the occupation of Iraq to combating AIDS in Africa to improved domestic security. For the foreseeable future, every major new program now under debate in Congress, including a $400 billion prescription drug benefit for the elderly sought by both parties, will be paid for with borrowed money.
There is no sign yet, however, that either overall spending or tax cutting is changing course. The conservative Cato Institute noted tartly last month that Mr. Bush had never vetoed a spending bill, had advocated huge farm and Medicare programs and had presided over double-digit increases in spending each year of his term. Barely a month goes by when House Republican leaders do not propose a new form of tax cut, and Congressional Republicans join the administration in saying they fully intend to extend the tax cuts that are now scheduled to expire in 2005, which would add another $1.6 trillion to the cumulative deficit by 2013.
This course prompted the Congressional Budget Office to issue an unusual warning in its forecast last month: If Congressional Republicans and the administration get their wish and extend all the tax cuts now scheduled to expire, and if they pass a limited prescription drug benefit for Medicare and keep spending at its current level, the deficit by 2013 will have built up to $6.2 trillion. Once the baby boomers begin retiring at the end of this decade, the office said, that course will lead either to drastically higher taxes, severe spending cuts or "unsustainable levels of debt."
The long-term effect of the budget's imbalance was the reason the deficit was the leading concern in a survey of economists last month by the National Association for Business Economics, topping even unemployment. Deficits can be useful in stimulating a lethargic economy, but if they persist for years, they could push up interest rates and impose huge costs on Social Security and Medicare at precisely the moment that the baby boom generation will begin expecting its retirement benefits. The Committee for Economic Development, a group of business executives, warned earlier this year that persistent deficits could lead, for the first time in the nation's history, to a lower living standard for future generations.
A Surplus Smaller Than It Seemed
Economists in and out of government have begun studying the budget's plunge as a significant phenomenon in financial history, and reject the partisan contentions in Washington that the deficit can be blamed on any single factor, like the tax cuts or the 9/11 attacks. The biggest reason for this year's deficit, they say, has been the recession, while the tax cuts and military-related spending will have a much greater effect on the long-term deficit. Tax cuts alone will grow from 26 percent to 44 percent of the decline in 2011, according to the Brookings-Urban Tax Policy Center. What has been remarkable, economists say, is that all three forces combined at once beginning in 2001 to utterly change the government's financial outlook.
"It really was the perfect fiscal storm," said Joel Prakken, chairman of Macroeconomic Advisers, an analytical company in St. Louis that developed the economic model of the country in use by many government agencies, including the Treasury Department. "So many different things all seemed to happen at once."
The initial problem, several economists said, was that the surplus was never as large as it seemed. The economy of the late 1990's was operating beyond its capacity, Mr. Prakken said, and the stock market boom generated so much quick wealth at the highest levels that the resulting tax revenues were bound to return to earth.
"The reality of the surplus projections was never really as good as it looked," Mr. Prakken said. "Because the surplus was essentially ephemeral, it declined at a much faster rate than the economy did, really breathtaking in its reversal."
It was essentially a forecasting error, parallel to the "irrational exuberance" that Federal Reserve chairman Alan Greenspan saw among investors during the 1990's. Mr. Reischauer said that even the Congressional Budget Office did not appreciate how much of its forecast was based on unrealistic expectations; in fact the legal constraints on the office have occasionally led to projections that were far from their mark. But before the mirage disappeared and the downward direction of the economy was clear, a consensus developed in Washington that the surplus justified a major change in tax policy.
Mr. Bush had campaigned on the promise of returning the surplus in the form of a big tax cut, and Democrats disagreed only on the size and distribution of the cut, preferring to direct more to middle-class taxpayers. (Democrats proposed a tax cut of $750 billion that year.) The budget had been balanced in the late 1990's using a combination of spending controls and higher taxes on the wealthy. But by 2001, the controls had expired and seemed unnecessary. Mr. Bush's election, giving Republicans control of both Congress and the White House, broke a stalemate that had long prevented the adoption of major tax legislation.
"Once the gridlock was broken, it was hard when staring at the surplus to argue that there shouldn't be a tax cut," said Mr. Reischauer, now president of the Urban Institute. "Of course there was debate about who should get what share of it. But because there seemed so much certainty about the persistence of these surpluses, there wasn't a proper caution that would have led lawmakers to say, `We don't know what the situation will be in the next downturn, we don't know the priorities of future Congresses, so we should not have a set of tax cuts that phase in over a 10-year period.' "
Mr. Bolten, previously the president's deputy chief of staff, challenged the notion that the administration had been hypnotized by the surplus numbers. He said the White House was aware of the economy's direction at the time of the first tax cut, and intended it in part as a brake against further decline.
"The concept of an insurance policy was very much on the president's mind at that point," Mr. Bolten said. "And it turns out to have been one of the best, if not the best, timed tax cuts ever."
But by the summer of 2001, the economic slide was too swift to be stopped by a tax cut that would take years to become fully effective. In August of that year, after the $1.35 trillion tax cut passed, the Congressional Budget Office revised its estimate of the cumulative surplus to $3.4 trillion from the $5.6 trillion forecast in January.
The Ramifications of 9/11
A month later, the World Trade Center and the Pentagon were attacked, and the budget outlook worsened. The attack not only exacerbated the downturn, but it also brought heavy increases in domestic security spending, and eventually led to costly wars in Afghanistan and Iraq. The budget office estimated that another $300 billion in military spending would result (long before Iraq entered the picture), and by January 2002 had taken its projection of long-term surplus down to $1.6 trillion.
It was clear by then that the 2003 budget would be in deficit, although the full amount was not known until just a few weeks ago, after the passage of two more tax cuts: a $30 billion cut in 2002 and a $350 billion cut in May of this year. The most recent cut was made in full knowledge that the nation was looking ahead to several more years of deficits, and it was that cut that brought the loudest criticisms.
"Once it was clear that the confident predictions had blown up and the picture was frightening, they still refused to step on the brakes," said Robert Greenstein, executive director of the Center on Budget and Policy Priorities. "Instead, the administration pushed the accelerator down closer to the floor. It's flabbergasting."
Mr. Bolten, however, said concern about the deficit was secondary to reviving the economy.
"I think we were always aware of what the budget projections were," he said. "But in hindsight, I would not have argued that we should have done something different, and I don't think any of the economic advisers would. The priority was properly placed on getting the economy back to growth. And if that meant larger deficits in the short run, well, if there was ever a time to run deficits, this is it."
He argued that the current-year deficit was still reasonable by historical standards as a percentage of the nation's economy, and said the administration believed the long-term deficit would be cut in half in five years. President Bush said the same thing a few days ago, saying that goal could be achieved "if Congress holds the line on discretionary spending."
It is hard to find an independent economist who agrees with that optimistic forecast, barring a nearly miraculous return to extremely high growth or draconian cuts in spending. Economists at the Wall Street firm of Goldman Sachs, for example, have said all year that their forecast was far gloomier than the administration's, and issued a statement last month saying the new numbers confirmed their warnings.
The numbers make it hard to see how Mr. Bush's goal can be reconciled with his intention of extending the tax cuts when they expire. The deficit could be cut in half by 2006 if the tax cuts expire on their current schedule and spending is held to an average increase of 2.7 percent a year — far below its current level of increase — numbers in the budget office's forecast say. But if the tax cuts are extended, even assuming that low level of spending increase, the deficit would not be cut in half until 2012, by which time the nation would have accumulated more than $3 trillion in new debt.
When Mr. Bush's political spending priorities, like the Medicare drug benefit, are added to the tax cuts, the deficit is extended even further. For that reason, many conservatives are beginning to bridle at the administration's proposals. As the conservative Heritage Foundation recently put it in arguing against the drug benefit, "In the future, as lawmakers examine the need to extend those tax cuts and make them permanent, they will be haunted by budget projections showing an enormous expansion in Medicare spending."
The conservatives, of course, are arguing against expanded government spending because it might endanger the future of the tax cuts. The liberals are arguing the reverse. Both sides, however, are in rare agreement with the economists that their two goals cannot be pursued at once, without resorting to borrowing that will make life in America a very different experience for generations to come.
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