<DIV> The Truth About the Reagan Deficits<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /><o:p></o:p> Washington Post <o:p></o:p> By Linda Bilmes Tuesday, February 10, 2004; Page A23 The Bush budget announced last week shows revenue falling some $500 billion short of projected spending. Is this a cause for alarm, or is it true that, as Vice President Cheney reportedly asserted, "Reagan proved that deficits don't matter"? Fans of Reaganomics note that former President Ronald Reagan's spending spree followed a formula similar to President Bush's: tax cuts combined with a major boost in defense spending. The current Bush deficit is equal to 4.5 percent of gross domestic product. The Reagan deficits grew beyond 5 percent. The aftermath in the 1990s was not a fiscal train wreck but rather a sustained economic boom that enabled President Bill Clinton to balance the budget and even to generate a surplus by 2000. Bush is hoping the nation will outgrow its recent deficits as we did last time around. Unfortunately, history is not about to repeat itself. The ability to recover from the 1980s deficits was the result of three historical "flukes" that happened at the same time: a huge demographic bulge, an extremely strong dollar and a sudden peace dividend. The first fluke was the baby boom. When Reagan took office, the boomer generation had already entered the workforce and was approaching peak earning years. Those peak earning years turned into peak spending years. Savings dropped, consumer credit rose and boomers snapped up new cars, cool appliances and second homes as if the good times would never end. While the affluent workforce swelled, the percentage of the population aged 65 and above stayed steady. By 2000 it had inched up to 12.4 percent of the population from 11.3 percent 20 years earlier. Consequently, there were more high-earning workers to support a fairly stable number of retirees. This enabled Congress to increase the amount of "entitlement" payments (Social Security and Medicare) and to leave eligibility criteria intact. The contrast with the upcoming 20 years is stark. By 2020 the over-65 percentage of the population will have grown to more than 16 percent while the working-age population will have declined. The fastest growth is among the very elderly (those over 85). Social Security, Medicare and other entitlement programs (such as veterans' benefits) already account for more than half of federal spending. On top of this, the Bush administration has added a hugely expensive prescription drug benefit for the elderly. If no changes are made to eligibility for the programs, they will, by 2020, gobble up virtually all federal tax revenue. The extremely strong dollar during the post-Reagan era also is unlikely to be repeated. Reagan's tax cuts in 1981 came at a time of double-digit interest rates and tight monetary policies. In the 1990s overseas investors had a voracious appetite for U.S. stocks and bonds that fueled demand for the dollar and made it easy to finance the deficit. The stock market soared, making boomers feel they could have it both ways -- swelling 401(k) plans and a new Mercedes in the driveway. Today the mood is more sober. Foreign investors' love affair with the United States is over. With short-term interest rates lower than they have been in a half-century, the dollar is weak and getting weaker. At the same time the Treasury will have to find buyers for an ever-increasing supply of bonds to fund the deficit. Finally, the nature of the military buildup under Reagan was very different from the current war on terrorism. There is one similarity in that, then as now, U.S. intelligence failed to predict events. In 1980 almost no one outside the Soviet Union foresaw the coming collapse of the "evil empire." But it happened -- presenting President Clinton with the opportunity to cut back the size of the military and to plow that "peace dividend" into balancing the budget. Looking ahead at the continuing war on terrorism, the amorphous nature of al Qaeda, the cost of rebuilding Iraq and the continued homeland security challenges confronting the United States, it would be foolhardy to count on this kind of peace dividend again. So the likelihood is of red ink spreading as far as the eye can see. And the knife twists even further. Conventional calculations of the budget deficit include the money being paid into Social Security today. Because there are currently more working-age contributors than claimants, the Social Security account is in "surplus." Strip that out and the true underlying deficit is more like $720 billion than the $521 billion quoted in this week's speeches. The policy options all are politically difficult: canceling the Bush tax cuts; cutting defense costs; exiting Iraq and Afghanistan quickly; increasing the eligibility age for Social Security and Medicare, and negotiating with the drug companies to require lower prices for Medicare drugs (as Europeans and Canadians have done for decades). But as in a 12-step program, the most important first step is simply to face the truth: Those deficits will not go away by themselves, the Reagan magic will not return, and we must take action to fix the problem. The writer, an assistant secretary of commerce in the Clinton administration, teaches budget and financial management at Harvard's Kennedy School of Government. She will discuss this article online today at noon on washingtonpost.com. </DIV><hr SIZE=1> Do you Yahoo!? Yahoo! Finance: <a href="http://us.rd.yahoo.com/evt=22055/*http://taxes.yahoo.com/filing.html">Get your refund fast by filing online</a>