Bush's New Budget Is as Bad as It Gets

In preparing its fiscal 2005 budget, the Bush administration had to choose one of two possible positions on the outlook for the deficit. It could either acknowledge that the deficit is a problem and then propose ways to deal with it, or it could leave the deficit substantially unaddressed and argue that the outlook gives no cause for concern. Never lacking in nerve, the administration has decided to combine these apparently contradictory strategies: The budget proposal says that the fiscal outlook is worrying and that the deficit does need to be reduced, and then does nothing meaningful to reduce it. The president's main idea, in fact, is to simply keep cutting taxes, come what may—which in itself, of course, tends to make the deficit worse.

The administration's new fiscal plans would be easier to respect if they were expressly based on the belief that deficits do not matter. That would at least allow the White House to mount an internally consistent defense of its arithmetic. Some economists, although very much in the minority, would actually go along with that view. What is so striking about the new proposals, though, is that the administration chooses not to defend its plans this way.

Just the opposite, in fact. The White House first acknowledges that, long-term, the budget is indeed on an "unsustainable" path—implying that action is required. Next, it seeks credit for what it says are plans to cut the medium-term deficit in half. Thus, running in pre-election mode, the president is claiming to be an orthodox fiscal conservative: He concedes that the budget outlook is a concern, and promises to take action. The trouble is, this posture is brazenly dishonest.

According to the administration's numbers, the deficit does fall by half (as a proportion of gross domestic product) by 2009, but this forecast is about as unconvincing a piece of fiction as you could ask for. William Gale and Peter Orszag of the Brookings Institution and the Tax Policy Center have pointed out the principal flaws.

The president's numbers are based, to begin with, on completely implausible promises of lower spending on domestic discretionary programs other than national security (which receives increases). Excluding spending on defense, homeland security, and international affairs, outlays per head on domestic discretionary programs are projected to fall in real terms by no less than 15 percent in the next five years. It will never happen. As if to prove that, the president's budget actually includes several spending increases for 2005, while proposing to reverse them starting in 2006. If the president is so determined to curb non-essential spending, why not start now?

On top of this, the administration's plans inexcusably ignore some big looming pressures that are certain to add to the deficit. One is spending in Iraq and Afghanistan: The administration has said it will make a supplementary budget request after September for these (very large) outlays—on the order of $50 billion. Another unaddressed issue is the cost of dealing with the growing anomaly of the alternative minimum tax.

The structure of the AMT is fixed in nominal (as opposed to inflation-adjusted) terms, and it is not revised annually to take account of other changes in the tax code. Over time, more and more rich taxpayers will be caught in this net, chiefly of course, because the administration's tax changes have so dramatically lowered the taxes that the rich pay under the standard code. Gale and Orszag note that under the president's budget proposals, some 30 million taxpayers would be caught by the AMT by 2009, and some 44 million by 2014. This is politically intolerable, and if it is allowed to stand, it would make nonsense of the tax changes of which the president is so proud.

Also bear in mind two other things. First, the deficit starts rising strongly again beyond the middle of the next decade, even according to the administration's own false numbers. This happens as demographic and other pressures come into play. Second, Bush's projected decline in the deficit between now and 2014 would have happened, again using the administration's own bogus assumptions, even if the budget had included no new proposals. Essentially, the new budget first makes the deficit bigger, mainly by calling for the recent Bush tax cuts to be made permanent (up to now, the formal position has been that they will expire in due course), and then it reclaims that rise in the deficit by tightening the screws later on spending.

Compared with present policies, therefore, the budget hardly changes the overall deficit position, which remains as unsustainable as before. Even if you bought the administration's rosy predictions—which you would be crazy to do—you could not regard this budget as an effective new measure of deficit reduction. In short, the budget is a clumsy fraud from start to finish.

But does it really matter? Perhaps, as some economists would argue, dishonesty is the only accusation one can fairly make against the White House in this case (and it is, after all, an election year). If huge budget deficits did no economic harm, you might be inclined to forgive the president for only pretending to cut them. But this line of defense is of no use. Unfortunately for the country, and for the wider world economy, the balance of the evidence suggests that persistent large deficits do place a long-term burden on the economy, holding back savings and growth, and that such deficits also add to the risk of sudden financial crises. Worst of all, chronic deficits lessen the effectiveness of fiscal policy as a stimulus when economic circumstances require one.

Deficits have to be financed by tapping a pool of capital that is, in the end, limited. When lenders lose their appetite for extending credit to the government, they will begin to demand higher interest rates. This will reduce private saving and investment, which is the wellspring of future economic growth. In addition, now that so much of the government's credit is advanced by foreign lenders, the stability of the foreign-exchange market is called into question. A crisis of confidence and forced interruption of borrowing may therefore be accompanied one day not just by higher interest rates, but also by a sharp and sudden collapse in the dollar. That, in turn, brings the risk of inflation.

The past year has shown that a policy of expanding the budget deficit does indeed make sense under certain circumstances. When private demand is low, as it was during the post-boom collapse in business confidence, an increase in public borrowing can keep the economy on a higher growth track. But this does not mean that big deficits are not generally a problem, still less that they always spur growth. The crucial thing is to retain the option to increase the deficit quickly and sharply at times when private demand subsides. The Bush administration had this option in the first part of this decade and rightly exercised it. The president increased the deficit in a way that failed to realize the full potential for stimulus—relying too much on tax cuts, many of them delayed, and too little on fast and temporary increases in recession-related spending—but the decision to widen the deficit was nonetheless correct.

However, this option was available only because both President Clinton and the first President Bush had overseen a dramatic reduction in the deficit. Because of that, the current President Bush could relax fiscal policy massively without alarming the global financial markets. A responsible government would now regard it as urgent to put the budget deficit on a path that will renew this fiscal option for use next time— for nothing is more certain than that it will be required at some point. The president's failure to start doing this, while claiming so fraudulently that he is acting properly, is the most dangerous aspect of his current policy.

As you would expect, many of the administration's critics are attacking the wrong target. The preoccupation with the idea that the deficit taxes the nation's children, by shifting the cost of the government's operations onto future generations, is vastly overdone, in my view. That claim is true, of course, in an accounting sense, but this line of criticism suggests that bigger budget deficits are always somehow unethical. They are not. If the intelligent use of deficits bequeaths to future generations a stronger and more prosperous economy, the nation's children will have nothing to complain about. The administration's decision to expand the deficit could have been justified, at the outset, perfectly well in this way. But there is no such justification for a policy that denies the fiscal remedy to future administrations. The new budget is indefensible.