The White House said Tuesday that the federal budget will take a deep plunge into the red in the next two years, projecting record back-to-back deficits totaling nearly $1 trillion combined and handing Democrats a possibly potent political issue.
The Office of Management and Budget projected the deficit will surge to $455 billion in fiscal year 2003, which ends Sept. 30, and jump further to $475 billion in fiscal 2004 before beginning to decline. The previous record was a $290 billion deficit in fiscal 1992, when President Bush’s father was in the White House.
The deteriorating budget picture reflects an economic slump that has persisted since 2000, the cost of fighting the war in Iraq and defending the nation against terrorist attacks, and the president’s large tax cuts. The White House’s deficit projection is 50 percent higher than it was in February.
Testifying before Congress on Tuesday, Federal Reserve Chairman Alan Greenspan emphasized that the government needs to control the deficit in the next few years to prevent long-term interest rates from rising and choking off economic growth. The deficit will “create major problems for us in the future unless we turn it around,” he said.
The Fed chief also said the central bank is prepared to keep short-term interest rates at their lowest level in 45 years for “as long as it takes” to restore the economy to health–and cut them further if needed. But he said the Fed would refrain for now from taking the unusual and dramatic step of buying U.S. bonds to cut long-term interest rates.
This statement, plus news of the larger-than-expected deficits, had an immediate impact on long-term interest rates, with 10-year bond rates jumping to 3.9 percent from 3.72 percent. This signaled that mortgage interest rates also could inch back up and possibly cool the refinancing boom, said economist David Wyss of Standard & Poor’s. A month ago, he said, 10-year bond rates were 3.1 percent.
Greenspan cited many obstacles to economic recovery, including corporate reluctance to invest and too much business capacity to produce goods around the world. But he said there are signs of economic improvement, adding, “We could well be embarking on a period of extended growth.”
The economy grew at an annual rate of less than 2 percent in the first half of the year, but many private analysts believe it will increase at a faster rate in the second half, with Bush’s tax cuts and the Fed’s lower interest rates providing the impetus. Government deficit spending also is being counted on to boost the economy.
In a slack economy, large federal budget deficits generally are not considered harmful, as the government can easily borrow to cover the budget shortfall from the private financial markets. But once economic conditions improve, private borrowers and the government compete for a finite amount of private capital–and interest rates go up.
The deficits over the next two years would amount to 4.2 percent of annual economic growth, administration officials said, below the 5 percent levels reached during the Reagan administration.
Still, at $455 billion, the red ink is more than the government’s combined spending for defense and education.
Retirements pose worry
Greenspan and private economists said there is another reason high deficits are a greater concern than they were two decades ago–the retirement of members of the Baby Boom generation within the next eight years will cause Social Security and Medicare expenditures to rise sharply. The government will have little reserve to deal with these huge costs if it is still deep in the red, they said.
“The demographics will overwhelm the budget,” said John Silvia, economist at Wachovia Securities in Charlotte, N.C.
The White House called the higher deficits “manageable” and said the red ink in the budget would be cut in half over the next few years. But Democrats pounced on the dramatic reversal in the nation’s fiscal fortunes, pointing out that the federal government was projecting a huge surplus over the decade when Bush took office in 2001.
Sen. Joseph Lieberman (D-Conn.), a presidential candidate, blamed the higher deficits on “the unfair, unaffordable and ineffective Bush tax cuts” and said Bush is “misleading the American people and ducking responsibility for his mistakes.”
Rep. John Spratt (D-S.C.), the ranking Democrat on the House Budget Committee, said the deficits are likely to get worse. In 2004, he said, the administration failed to include all the costs of U.S. military operations in Iraq and Afghanistan and legislation to fix the tax code.
The president’s new budget director, Joshua Bolten, said Bush’s tax cuts “are not the problem” but are the solution to the economy’s woes. However, Senate Majority Leader Bill Frist (R-Tenn.) cited the tax cuts as one reason for the higher deficit — though Frist added that tax reductions were needed for long-term economic growth.
Bolten said there is enough money in the budget in fiscal 2003 to cover the war costs in Iraq, with $20 billion left over to pay for U.S. troop deployments in Iraq in fiscal 2004. Last week, Defense Secretary Donald Rumsfeld said the U.S. military is spending nearly $4 billion a month in Iraq.
With Democrats accusing the administration of being fiscally irresponsible, Bolten told reporters, “A balanced budget is not a higher priority than winning the global war on terror, protecting the American homeland, or restoring economic growth and job creation.”
Bush’s predictions
The administration said the deficit would fall to $304 billion in fiscal 2005, $238 billion in fiscal 2006 and $213 billion in fiscal 2007 and then go up to $226 billion in fiscal 2008. Bush’s predicted string of deficits is immense by any measure, but if the administration succeeds in reducing the red ink, the deficit would fall to 1.7 percent of economic growth in 2008.
Greenspan spoke before the House Financial Services Committee in connection with the Fed’s twice-yearly economic report to Congress. He tempered his prediction for an economic rebound with reservations.
He said there is “little evidence” yet that his lower interest rates and Bush’s tax cuts have “materially improved the willingness of top executives to increase capital investment.” “Although forward-looking indicators are mostly positive, downside risks to the business outlook are also apparent, including the partial rebound in energy costs and some recent signs that aggregate demand may be flagging among some of our important trading partners,” he said.
