APRIL 14, 2003
STREET WISE
Watch Out, the Deficit Is Gaining | Tax cuts and military spending are coloring the future with dark and deepening shades of red ink. For investors, it's not a pretty picture
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Most investors aren't worried right now about the mounting federal budget deficit. More pressing problems are weighing on them, including weak corporate earnings, the moribund economy, and what could happen in Iraq now that Saddam Hussein's regime has fallen. The Bush Administration's proposals to boost government spending for defense and cut taxes to stimulate the economy still strike some investors as a welcome antidote to the market's ills.
That additional spending and the tax cut's cost, however, mean the deficit is headed skyward. Is that bad policy? "We've got two big-ticket items to take care of -- the war and getting the economy going," says Trip Jones, a senior vice-president at Fulcrum Global Partners. "I myself have no problem with deficit spending for the right reason."
Indeed, with leaders of the Senate and House of Representatives currently wrangling over the size of the tax cut, more investors seem to be pulling for larger tax breaks than worrying about the deficit's size.
ETERNAL DEBT? Still, the rapidly rising red ink alarms some experts. In March, the Congressional Budget Office estimated the deficit at $287 billion this fiscal year and as much as $338 billion in 2004. But Goldman Sachs economists, who, unlike the CBO, include this year's expected tax cuts and Iraq-related spending in their estimates, believe the deficit will be $425 billion in 2003 and $450 billion next year.
Those are pretty big numbers, especially compared to the surpluses the federal government ran for four consecutive years, from 1998 to 2001. And the real worry of deficit-watchers comes in later years. The CBO estimates a cumulative deficit of $1.2 trillion from 2004 to 2008, and then it believes the budget would return to a surplus. Economists warn, however, that those baseline estimates are the products of a strict formula and are likely to bear little resemblance to reality.
Using what they consider to be fairly conservative estimates, Goldman's economists believe the deficit will equal 3% to 4% of gross domestic product (GDP) over the next 10 years, growing to $4.2 trillion by 2013 and persisting indefinitely. Even the long-term analytical perspective provided in Bush Administration budget proposals projects that the budget may never come back to surplus, says William Gale, an economist and tax-policy expert at the Brookings Institution.
CAPITAL DRAIN. The federal budget outlook could deteriorate over the next 10 years for plenty of reasons, both on a macro level -- Bush seems to want to bring democracy to the Middle East at almost any cost -- and on a micro level. The alternative minimum tax is overdue for reform, which could result in a big hit to federal tax receipts. Most problematic of all, in 5 years to 10 years, those born in the bulge years of the baby boom will be at retirement age. That will mean a huge increase in the nation's Social Security and Medicare burdens.
Wall Street isn't too nervous now, since the deficit, even at 3% to 4% of GDP, isn't huge by historical standards (during World War II, it was 25% of GDP, says Gale). But the red ink is still running quite a bit higher than average -- and not that far from the 5% to 6% levels of GDP that sparked budget crises in the 1980s.
"The deficit isn't in uncharted territory, but in 28 years of continuous red ink from fiscal 1970 through 1997, the average deficit -- at 2.8% of GDP -- was below the 3% to 4% range that brackets most estimates of this year's shortfall," says Goldman Senior Economist Ed McKelvey. "If you're setting up a situation in which deficits are going to persist at the levels we think they are going to as far as you can see, that's a fairly significant drain on the capital markets."
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Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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